32. Provisions

Question 1

Reasons for setting up provisions

Answer 1

• Published accounts + reports
• Supervisory solvency
• Internal management accounts
• Valuations for mergers and acquisitions
• Determine excess of A over L &; if discretionary benefits can be awarded
• Set future contributions
• Value benefit improvements
• Calculate discontinuance/surrender benefits
• Influence investment strategy
• Provide disclosure info for beneficiaries
• Provide for expected credit losses for a bank

Question 2

Methods of calculating provisions

Answer 2

•	LI: formula/discounted cashflow
•	GI: statistical methods/case estimates
•	Benefit schemes:
-	DC: Acc contributions net of charges
-	DB: Discounted cashflow
•	Banks: Formulae with complicated assumptions e.g. default probabilities

Question 3

Bases

Answer 3

• Best estimate
• Cautious
• Optimistic

Question 4

Factors affecting choice of basis + method

Answer 4

• Purpose
• Client’s needs
• Nature of the assets held

Question 5

Considerations when setting assumptions for published accounts

Answer 5

• Legislation
• Accounting principles
• Going concern basis vs Break up basis

Question 6

Considerations for supervisory solvency

Answer 6

• Degree of prudence
• Prescription of methods/assumptions by supervisory authority
• Method of valuation of A/L
• Types of A held
• Level of global provisions to hold

Question 7

Examples of when nature of assets affects provisions

Answer 7

• L linked to A e.g. unit trusts/internal investment funds
• When covenant of sponsor has no value (e.g. sponsor doesn’t commit to make up shortfall)»> reduce benefits to reflect actual A
• Market consistent valuations of L on financial guarantees in LI, since value depends on volatility of asset returns.