New Business Strain
Encyclopedia
For a life insurer, even if profitable business is written, the value of the company may appear to worsen (when viewed from a regulatory basis, for example) because of new business strain. This is a concept dealt with regularly by actuaries.
New business strain occurs because the initial outgoings (such as commission, expenses, reserves, etc.) will take place when the policy
is written, and thus have an immediate negative impact on the company's financial position. Over the life of the contract, future income (premiums, investment income, etc.) is expected to repay this initial outlay. However under some accounting regimes, the insurer may not take credit for such future surpluses.
The impact is thus an immediate hit to solvency
and profitability when a policy is written, followed by surpluses in later years that pay this back.
New Business Strain is artificial in that it is a function of how a regulatory body, for example, might look at a life insurer's financial position. This tends not to be realistic, but instead conservative - because that is the role a regulator plays. Assuming its pricing assumptions are robust, a company's solvency and profitability actually increases when a new policy is written.
Depending on what reporting basis is being used, new business strain can be eased by the use of Zillmerisation
or a Deferred acquisition cost asset. As a result, local GAAP
accounting and IFRS accounting tends to show much lower levels of new business strain than regulatory accounting.
New business strain occurs because the initial outgoings (such as commission, expenses, reserves, etc.) will take place when the policy
Policy
A policy is typically described as a principle or rule to guide decisions and achieve rational outcome. The term is not normally used to denote what is actually done, this is normally referred to as either procedure or protocol...
is written, and thus have an immediate negative impact on the company's financial position. Over the life of the contract, future income (premiums, investment income, etc.) is expected to repay this initial outlay. However under some accounting regimes, the insurer may not take credit for such future surpluses.
The impact is thus an immediate hit to solvency
Solvency
Solvency, in finance or business, is the degree to which the current assets of an individual or entity exceed the current liabilities of that individual or entity. Solvency can also be described as the ability of a corporation to meet its long-term fixed expenses and to accomplish long-term...
and profitability when a policy is written, followed by surpluses in later years that pay this back.
New Business Strain is artificial in that it is a function of how a regulatory body, for example, might look at a life insurer's financial position. This tends not to be realistic, but instead conservative - because that is the role a regulator plays. Assuming its pricing assumptions are robust, a company's solvency and profitability actually increases when a new policy is written.
Depending on what reporting basis is being used, new business strain can be eased by the use of Zillmerisation
Zillmerisation
Zillmerisation relates to the valuation of a Life insurer by an actuary.When new business is written, the value of the company may reduce even if the business is likely to be profitable. This is known as New Business Strain...
or a Deferred acquisition cost asset. As a result, local GAAP
Gaap
In demonology, Gaap is a mighty Prince and Great President of Hell, commanding sixty-six legions of demons. He is, according to The Lesser Key of Solomon, the king and prince of the southern region of Hell and Earth, and according to the Pseudomonarchia Daemonum the king of the western region and...
accounting and IFRS accounting tends to show much lower levels of new business strain than regulatory accounting.