Unit pricing

Question 1

What is the basic equity principle of unit pricing?

Answer 1

The interest of the unit-holders not involved in a transaction should be unaffected by that transaction.

For the basic equity principle to be achieved,
- The amount of money put into the fund ( taken out of the fund) for each unit created ( cancelled) should be such that the NAV per unit is the same after as before the appropriation (expropriation).

Question 2

Features of the unit-linked fund

Answer 2

• p/hs are sold units in this fund
• it consists of clearly identifiable assets
• fund is subdivided into a number of equal units consisting of identical subsets of the fund’s assets and liabilities
• May have a management box or excess of any fund ( reduces the need for creation or cancellation of units each day)

Question 3

significant risks in internal unit-linked funds?

Answer 3

• Investment risks
• Expense risk
• Operational risk

Question 4

Compare appropriation price to the expropriation price

Answer 4

• Appropriation price is the price at which the company will create a unit whilst the expropriation price is the price at which the company will cancel the units.

Question 5

what principles should policy wording for unit pricing follow?

Answer 5

policy wording should follow the following principles
- company needs to determine unit prices only when transactions are taking place.

• for the p/h, the relevant price are those at which the unit is allocated and redeemed.
• The movement i price between those two events should depend only on the performance of the assets backing the unit and charges deductible under the policy provisions.

Question 6

How to choose the pricing basis between the bid and offer basis.

Answer 6

• Consider the purpose for which the valuation is used for :

If marginal transaction involves creation of new units then offer basis.

If marginal transaction involves a cancellation pf units then bid basis.

Question 7

Potential basis,prices too use for unit pricing
( 4 )

Answer 7

offer basis, offer price
offer basis, bid price
bid basis, offer price
bid basis, bid price

Question 8

The difference between offer and bid basis

Answer 8

Offer basis
- money put into fund= net units created * appropriation price
- This basis expands the fund and used when the marginal transaction creates net units.

Bid basis
- money taken out of the fund= net units cancelled *expropriation price
- This basis contracts the fund and used when the marginal transaction results in net cancellation of units

Both under the basis there will be an offer price and bid price.

this then result in 4 potential prices

Question 9

How do you determine the prices when pricing under offer basis.

Answer 9

• use offer basis if there’s a net creation of units from the marginal transaction.
• Then determine the appropriation price
• The bid and offer price are derived from the appropriation price

How?

• They could use the unadjusted appropriation price.

But will adjust for practicality and commercial reasons.

Adjustments

(1) Initial charges (bid offer spread)
are added to the appropriation price
* These charges contribute to meeting management expenses+ commission payments+ profit

• Then offer price = appropriation price + initial charges
  bid price = appropriation price

(2) Rounding
- round offer price up, bid price down
- round offer price down, bid price down] favours customer

-

Question 10

Description of actuarial funding

( 4)

Answer 10

• Actuarial funding reduce’s the 1st years capital reserve/ business strain by holding lower reserves for unit-linked contracts.

Adjusted reserve= normal reserve - EPV ( Initial expenses)

• The money saved is used to cover initial expenses.
• The missing units are then bought later from the future management charges
• hence this charge needs to be greater than necessary to cover the actual fund management expenses.

Question 11

How do you determine the prices ( bid price and offer price) when pricing under bid basis.

( 4 steps)

Answer 11

• Use the bid basis when marginal transaction results in marginal cancellation of units.
• Then determine the expropriation price
• the bid and offer prices are derived from the expropriation price
  How?
• Could use the unadjusted expropriation price

or could adjust practicality reasons and commercial reasons

( 1) Add initial charges( bid/offer spread)
Offer price= expropriation price + initial charges
bid price= expropriation price

(2) Rounding

Question 12

Conditions of actuarial funding

Question 13

How do you choose the discount rate?

Answer 13

• It should be a proportion of the fund management charges.
• Consider the company’s ability to cover on-going renewal expenses using the management charge on all units.

Question 14

Effect of actuarial funding factors on the net CF from unit fund.

Question 15

Conditions for actuarial funding

Question 16

How to calculate the appropriation price

Answer 16

Appropriation price = NAV of fund on offer basis/ # units existing at valuation date before units are created

NAV of fund on offer basis=
Market offer price value of the value of the assets held
+ dealing Expenses
+ value of any current assets e.g. cash on deposit
+ Any accrued income
- Value of any current liabilities
- allowance for accrued tax( if applicable)

Question 17

expropriation price calculation

Answer 17

Appropriation price = NAV of fund on bid basis/ # units existing at valuation date before units are cancelled

NAV of fund on bid basis=
Proceeds from selling the assets in the fund
+ dealing Expenses
+ value of any current assets e.g. cash on deposit
+ Any accrued income
- Value of any current liabilities
- allowance for accrued tax( if applicable)

Question 18

How do you apply the basic equity principle?

Answer 18

Application of the basic equity principle:
*
The basic equity principle is only achievable if the amount of money put into the fund, or taken out of the fund, is such that the net asset value per unit is the same before or after appropriation.
*
Appropriation price is this amount of money when creating a unit.
➢
It preserves the interests of existing policyholders.
*
Expropriation price is this amount of money when cancelling a unit.
➢
It preserves the interests of continuing policyholders.

Question 19

what is the rationale of the basic equity principle

Answer 19

*
For unit holders the only prices relevant are those at which they buy units in the fund
➢
and those at which they redeem their units.
*
In theory, the movement in price between those two events should only reflect the performance of the assets backing the unit
➢
and charges deductible under the policy provisions.
*
Price should not be affected by creation or cancellation of other units,
➢
otherwise, cross-subsidies between unit holders will arise.