Page 73 - Risk Management in current scenario

The point to note in the last column "Net CF" which is a sum total of
premium income adding interest income and subtracting all other
columns as they are out goes from insurance company point of view
giving rise to net cash flow position.

The incidence of cash flows in the Net CF column may be seen as positive
cash flows for first 12 years and the negative cash flows from 13th to
24th year. This is typical of insurance contracts because the incidences
of premium income are level whereas other cash flows occur at different
timings.

In this case, the insurance company will have positive cash flows followed
by negative cash flows; now what insurance company should do to make
the guaranteed payment from the year 13 to 24.

To deal with the this kind of situation, there is a method within the life
insurance company is to create reserves when there are excess of positive
cash flows and release those reserves when the reserves are needed in
later years. Such reserving is also recommended by the entire regulator
world over.
Because the reserves are the money held back within the insurance
company and not released to the shareholders as profit, there is a deferral
of profit for shareholder from higher surplus in the initial years to
relatively evenly spread share of profit for the entire term to the
shareholders. This can be seen in the table below when the reserves are
set up

Risk Management in Current Scenario | 71