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PROJECT TOPIC: EXAMINATION OF THE IMPACT OF LARGE NUMBERS APPROACH IN THE VALUATION OF LIFE ASSURANCE BUSINESS

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CHAPTER ONE

INTRODUCTION

1.1     BACKGROUND OF THE STUDY

Traditionally life assurance companies have reported financial result to shareholders on the basis of the statutory requirements of the insurance companies’ legislation. So the most common measure of a life insurance company’s financial year was the statutory earnings from operation. This convenient measure since it also represents the amount of money which can be paid to policyholder or paid in the form of dividends.

The major disadvantage to relying upon statutory earnings as a measure of how well a company is doing is that statutory accounting tends to be designed to protect against insolvency and therefore, by its very nature, suffers from ovens conservatism.

Statutory earnings do not measure well a company is doing on a going concern basis. For example, capital invested in acquiring business (Acquisition of profitable new business results in an immediate “Loss” followed by a subsequent enhanced series of profits.

Although suitable for solvency testing, the statutory approach, by charging the “Capital” cost of new business to revenue and ignoring the future surplus stream attributable to new business, fails to display in any accounting period a meaningful account of trading activity of that period for most products, a slowdown in sales will result in an immediate increase in statutory earnings and generally, most would not regard slowdown in sales as being a sign of a healthy company. So, it is as that statutory earning is the wrong method to measure the health of the company.

Largely, as a result of the inadequacies of statutory accounting, US insurers were required by the securities exchange commission in the early 1970’s to begin to report earnings to shareholders on a generally accepted principles (GAAP) basis.

The major advantages of GAAP accounting is that it does attempt to produce earnings that reflect how well or how badly the insurance company had performed in a form, which is useful to management. With GAAP, generally an increase in sales will not depress GAAP earnings to the same degree, as it would statutory earnings.

Unfortunately, because 100% of acquisition costs are deferred, increased sales will still depress GAAP earnings to some extent. Additionally, margins for conservation are normally introduced into the assumption, and GAAP might suffer from the lock-in principle. Once assumptions are set for a particulars generation or branch of business, the assumptions cannot be changed unless future losses are life. Another major disadvantage to GAAP is that GAAP earnings may very significantly between two identical companies depending on the objectiveness of management in establishing assumption. Therefore, overall, GAAP is not a good prognostication for how well a company is doing.

During the period of fluctuation in interest rates, which occurred in the US during the mid-1970s and early 1080s some US corps began to look at cash flows as a measure of “how well” their companies were doing.

1.2     STATMENT OF THE PROBLEMS

The following are the problems which has been existing that initiated my zeal to research on the above topic.

1. Life assurance valuation has not impacted adequately on the economy.

2. Good valuation model improves the profitability of life assurance form.

3. The principle of large numbers significantly impact on the assurance valuation.

4. inadequate impact of life assurance valuation on the development of the economy.


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