 Hey guys, it's MJ the student-actry and this is CT5 chapter 12 and it's called profit testing and there's quite a lot to get through in this chapter and the exam questions actually count a lot of marks But in order to understand this whole thing you need to understand unit funds and that's what I'm going to talk to you guys about in this video Okay, so a unit fund it's it's a type of investment fund where instead of you saying, okay I've invested 10,000 into this fund. How much has this 10,000 grown? What you do is you purchase these units and these units are they take the investment fund and they divide it into these units So you'll say you'll buy a hundred units at whatever price and then the units their price changes daily And you can sell out your units So how does it work? Well, what I've done is I've drawn a little diagram So first of all you come to the investment company or the life insurance and you pay them a premium Okay of this premium some of it gets allocated to towards buying the units and some of it like a small percentage Gets taken off. This is going to be added to the company's profits to cover the expenses and whatever With your allocated Amount it then goes into Something else that cuts it up some more and that's what we call the bid offer spread so what you'll do is Units might when you want to buy a unit it might be cost you 105 percent and when you come to sell it it'll be 95 percent And this difference between the bid and the offer is known as the spread and again. It's another source of profit for the company So then once you've gone through that you can use that to purchase Units in the unit fund and this is separate to the non-unit fund which is managed by the company And on a regular basis, there will be an additional charge Sometimes it's called management charge and that's like every year 1 percent of the fund will be deducted towards Towards paying your company expenses and and so forth And then y'all so what these funds pay out eventually is the unit fund will pay out a benefit to the policy holder And the non-unit fund will Cover company expenses Like we've mentioned and it might also pay out a benefit to the policy holder And this dark blue benefit here is what we call it would be like a guarantee So let's say the unit fund does really badly The company might pay you back all your premiums or or some sort of of benefits What is interesting about this is this unit fund accumulates at interest And why they why this whole structure came out to be is they found that Life insurance companies were initially offering a product that dealt with risk So you buy life insurance and if you die you get paid out and amount But they thought since we're collecting money from people, why don't we offer them a savings element as well? And so the risk element covers the risk and the savings element is money that people put in additionally and that accumulates And that's where this whole unit fund came into be. So you'll normally see like endowment assurances They're normally the the product that incorporates this whole unit fund system So, yeah, let me just show you the diagram again So you pay your premium some of it gets siphoned off And then some of it gets siphoned off again and then it goes into this fund which starts earning interest But then some more gets siphoned off And in the the test, maybe let's just jump there because basically all these items and stuff I have talked about So we can actually jump very very quickly to I want to show you how these exam questions are Because your exam question comes about And here we go. Okay, that's quite small. So let me show you This one here. Okay, so this is when you have to do you have to calculate the profit margin On a question like this So the first thing you're going to do is you want to just create a quick summary of the question because it's going to be like a page Along they're going to bombard you with facts Okay The first thing you're going to do is construct construct a multi decrement table Because people can either die Or they can surrender their policies so they can say I want to get out Normally, they're then going to incur penalty and that would actually become a profit to the company So you want to construct your multi decrement table using these formulas to change your independent probabilities into your dependent probabilities And then what you want to do is you want to create two Cash flows and this is a bit like accounting Hold on. Let me just push this thing up here The first one is the unit fund. So These will be your rows and then These rows. Yeah, these are your rows and then your columns will be the various years. It's normally three or four years Value at the start Plus your allocated premium less the bit off the spread Add the interest subtract the measurement charge What's your value at the end then that comes back to the value of the start from the second year And you repeat the process Then you get a little profit vector over there Then you're also going to calculate the non-unit cash flow and Yeah, so here you get the unallocated premium plus the bit off the spread less your expenses plus interest This is a different type of interest. This is the non-unit interest It will normally be a little bit lower, but it doesn't have to be Plus management charges and then here you can see there's debt benefits surrender benefits and even maturity benefits And then you sum those things up And then the resulting of that will give you your net present value Well, what you first want to do is just discount it By your force of interest and by the force of mortality and this will be at another interest rate So there's going to be lots of interest rates in this question And then you're going to do the same with the premiums And then the profit margin is simply dividing your expected profit by your expected premiums And another type of question that they can ask with regarding this chapter Is the profit margin with a non-unit account? And you can basically do the same thing except there's one additional step in the beginning And there's you want to calculate the reserves for the various years using that formula Then you do your decrement table, then you do your cash flow, which is quite similar But you're not going to create a non-unit cash flow because it's all non-unit Instead you're going to have these additional ones Hold on. Let's see you Move this up here And that is your subtract the increasing in reserves Add the interest in reserves. That's going to give you your profit vector You're going to multiply by the cumulative probability of survival Multiply that by the discount factor. That's going to give you the present value of profit And then you're going to just like we did at last time Divide it and you can get your profit margin Or you can use this formula here to calculate the internal rate of return And if the reserve basis change, you must redo this whole cash flow area here And introducing reserves will normally decrease the net present value So yeah, that is I find this question quite challenging in the sense that it's very time consuming And if you don't know this process, if you don't learn this process, you're not going to know where to start and you're going to stuff it up So Go back watch this video again pause. Look at the formulas I've written They're very I try to make them as generic as possible But please remember that you need to understand the question and you might have to make little tweaks here and there to the formulas I've got you So do lots and lots of these as a practice how I did it even was I looked at the the answer With the question paper and I try to figure out the process that way. I did that with a few before attempting some by myself but job that is That is your profit testing chapter 12. It's quite a tricky one So spend a little bit of time trying to figure this one out. But job. Thanks guys for watching Please hit that like button hit the subscribe button and write a comment If you have a comment in the comment section below awesome. Cheers