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IAI Actuarial Core Principles · Actuarial Mathematics for Modelling · Projecting expected future cashflows and profit testing

In profit testing a unit-linked contract, what is the purpose of zeroisation when setting non-unit reserves?

Zeroisation sets non-unit reserves at the minimum amounts needed to cancel projected negative non-unit cashflows in later years. The reserve is financed from earlier positive cashflow, so reserve-adjusted profit in each year is not negative. It does not zero the unit fund or remove expenses.

  1. ATo set the unit fund equal to zero at the end of each policy year
  2. BTo remove all expenses from the projection so that only claims remain
  3. CTo hold the smallest non-unit reserve at each time that removes any negative future non-unit cashflow, so that the reserve-adjusted profit is not negative in any yearCorrect
  4. DTo set the risk discount rate equal to the valuation interest rate
  5. To ensure the expected profit signature equals the profit vector in every year

Explanation

Zeroisation looks at projected non-unit cashflows. Where a future cashflow would be negative, a reserve is held at the earlier time, funded from earlier profit, just large enough to bring that cashflow to zero. This avoids negative profit after reserves. The other options confuse it with unit fund, expenses or discount rate settings.

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