32. Provisions Flashcards
What are provisions?
- Calculated amounts
- Need to be set aside
- Meet a provider’s future liabilities
- Value depends on the assumptions used to value future E[Cashflow]
Why does a provider calculates provision?
BAD MEDICS
- Benefit improvements for a benefit scheme
- Accounts and reports- published and internal
- Discontinuance/ surrender benefits
- Merger and acquisition
- Excess of A over L => whether any discretionary benefit can be awarded
- Disclosure information for beneficiaries
- Investment strategy
- Contribution/ premium setting
- Statutory solvency reports
What is the difference between individual and global provisions?
- Individual provisions=> Individual contract or scheme member
- Global provisions=> Provider’ss liability as a whole
What financial risk might a provider calculate a global provision for?
- Mismatching A and L
What non-financial risk might a provider calculate a global provision for?
- Operational risk
What is a basis
- Collection of assumptions
What is a best estimate basis?
- Collection of assumptions => = Prob of over stating and understating V(A) and V(L)
What is an optimistic (weak) basis?
- Assumption=> Overstate V(A) + understate V(L)
What is a cautious (prudent/strong) basis?
- Assumptions=> Understate V(A)+ overstate V(L)
What are the main factors which dictate the strength of the basis on which values should be determined?
3
- Purpose of the valuation
- Needs of the client
- Regulatory/ legislative requirements
Give three examples of how the nature of assets held can impact the liability valuation?
- L may be specifically defined in terms of the performance of A (Unit linked contract, Unit trust)
- Sponsor not make up any shortfall=> Benefit payments (L) reduced to reflect actual A available
- Market consistent valuation of life insurance financial guarantees => V(L) depend on the volatility of returns on the A held
What factors should be considered when valuing the liabilities to be shown in the providers published accounts?
- Accounting principles and legislation in the country concerned
- Consider- going concern basis?
- Consider whether must show true and fair value
- Basis required? => Prudent or best estimate?
What factors should be considered when valuing liabilities to demonstrate supervisory solvency?
6
- Legislation and regulation in the jurisdiction concerned
- Going concern basis or discontinuous basis?
- Basis prescribed or left to actuarial judgement
- Any relavant rules or any actuarial guidance
- Regulators may want a realistic picture of a providers financial position
- Alternatively, they may wish to purposely understate the financial strength of a provider
What basis should be used when valuing the liabilities to be shown in the providers internal accounts?
- BE=> realistic picture for decision making by management
What factors should be considered when valuing the liabilities for a transfer of liabilities between two providers?
- Transferring company will prefer optimistic basis
- Receiving company will prefer cautious basis
- A BE basis is fair
- Basis used=> Depends on bargaining power and the relative supply+ demand for liability transfer
- Possible two sides agree not to reflect a BE of future costs
- E.g. Hold a margin to protect the security of benefits
What basis should be used when determining whether discretionary benefits can be awarded or benefit improvements made?
- Provider wants assumptions that=> DO NOT overestimate surplus available
- Avoid pressure of distributing surplus as discretionary or additional benefits
- Similalry, DO NOT undervalue proposed benefit improvements
- Because such benefits may prove in practise to be more expensive than anticipated
- Most realistic indication=> BE basis but
- Cautious basis or range of assumptions may be used
What factors should be considered when valuing L to set contributions for a DB scheme, from the perspective of the trustees and beneficiaries?
- Cautious basis to ensure better security of benefits
- But not too cautious such that the sponsor believes cost of benefits to be too excessive and hence:
- => reduces future benefits
- Closes the scheme to future accrual
- Pay high contribution rate => insolvent
What factors should be considered when valuing liabilities to set contribution for DB scheme, from the perspective of the sponsor?
7
High liability values <=> higher contributions
*Optimistic = lower valuation of liabilities
- Optimistic if there is a high opportunity cost of capital
- Cautious=> Higher contributions now leads to more flexibility in the future
- Cautious=> High contributions now result in tax deferral
- Cautious=> Sponsor wants to be viewed as paternalistic (carrying for employees)
- Cautious=> Low opportunity cost of capital
- Cautious=> Better investment returns can be earned within the scheme- > leading to lower long term costs
- BE-stability of cost
What basis should be used when setting discontinuance terms, in order to be fair to all parties?
- BE=> Fairness for
- Discontinuing
- Remaining
- Provider
What factors should be considered when valuing the liabilities to set an investment strategy?
- A large # of different scenarios should be examined
- BE and Cautious
- A stochastic model=> assess risk and values under each possible investment strategy
Outline the factors to consider when setting a basis to illustrate the level of benefits to which an individual is entitled, the level of investment return they might expect to receive and contributions they might be required to make to target a specific level of benefits
- Circumstances of the individual e.g. AGE, GENDER, MARITAL STATUS
- BE=> Realistic decisions to be made
- Range of values communicate uncertainty involved
- If individual is averse to the risk of under provision => a cautious approach may be appropiate
