PROFIT TESTING FOR UNIT-LINKED POLICIES

LIFE CONTINGECIES (II) - SAC 407

WORKED EXAMPLE

1. A life office issues a large number of 3-year unit-linked endowment policies to men aged 65, under each of which level annual premiums of Kshs.
100,000 are paid. 80% of the first premium and 105% of each subsequent premium is invested in units at offer price. There is a bid/offer spread in
unit values, the bid price being 95% of the offer price. A fund management charge of 0.5% of the bid value of the policyholders fund is deducted
at the end of each policy year, before payment of any benefits then due.
The death benefit, which is payable at the end of the year of death, is Kshs. 300,000 or the bid value of the units if greater. The maturity value is
equal to the bid value of the units. The office incurs expenses of Kshs. 10,000 at the start of the first year and Kshs. 2,000 at the start of the 2nd and
3rd years.
Mortality is assumed to follow A1967-70 ultimate. It is assumed that at the end of each of the first two policy years, 2% of the surviving
policyholders withdraw. The withdrawal benefit is 98% of the bid value of the units after deducting the management charge.

a. Assuming that the growth in the unit value is 7% p.a and that the office holds unit reserves equal to the bid value of units and zero sterling
reserves at the end of each year, calculate the profit emerging at the end of each policy year per policy sold. Sterling reserves are assumed to
earn interest at 6% p.a
b. Calculate the revised profit emerging at the end of each year if the office takes a smaller profit in year 1 in order to ensure that the profit
emerging in the second and third years is zero.
Solution

i. First work out the value of the unit fund at time t (t=1,2,3); Ft
Ft Ft 1 (1 )a t p t (1 iu ) ct
(1)

(2)

(3)

(1 ) a t p t

76,000.00

99,750.00

99,750.00

(4)

(5)

Ft1 (1 )at pt (1 iu )

Ft 1
-

ct

(6) = (4-5)

Ft

81,320.00

406.60

80,913.40

80,913.40

193,309.84

966.55

192,343.29

192,343.29

312,539.82

1,562.70

310,977.12

LECTURER: MR. EVANS ONWONGA

ii. Calculate the profit vector and profit signature, allowing for withdrawals and given tV 0 for all t;
( PRO ) t' ( PRO ) t p x t 1 .wt ( Ft 0.98 Ft )
Where;

( PRO) t ( SCF ) t p t (1 )a t p t et (1 i s ) ct ( DG ) t
And;

t' t 1 p x (1 w1 )(1 w2 )....(1 wt 1 )( PRO ) t'

(1)

(2)

(3)

pt (1 )at pt

24,000.00

250.00

250.00

(9)

( PROF ) t ( SCF ) t

(4)

et

(5)

ct

(4) =(2-3)*(1+i)
10,000.00

(6)

(7)

q 65t 1

(8)= (4+5-7)

( SCF) t

( DG) t

14,840.00

406.60

0.02403 -

5,264.87

9,981.73

2,000.00 -

1,855.00

966.55

0.02654 -

2,856.72 -

3,745.18

2,000.00 -

1,855.00

1,562.70

(10)

(11)

p 65t 1

wt

(12)

0.97597

0.02
0.02 -

3,745.18

0.97346

292.30

0.70725

t 1

10,013.32

(13)

( PRO ) t' ( 9 ) (10 ) * (11 ) * 0 .02 Ft

9,981.73

0.29275

292.30

(14)
'
p 65

1.0000

t' (12 ) * (13 )

10,013.32

3,670.28

0.9564 -

3,510.44

292.30

0.9124 -

266.71

iii. Calculate the present value of negative profits in times t=2, 3, at time t=1, and deduct the amount thus computed from the profit at time t=1, to
find the reduced profit to be taken such that the profit emerging in the 2nd and 3rd years is zero.
The PV of the negative profits is:
3,510.44(1.06) 1 266.71(1.06) 2 3,549.11
The reduced profit taken at time 1 is:
10,013.32 3,549.11 = 6,464.21

LECTURER: MR. EVANS ONWONGA