33 Valuation of Liabilities

Question 1

Approaches to valuing L [8]

Answer 1

TRADITIONAL DISCOUNTED CASHFLOW METHOD
* same rate as long term A

FAIR VALUE = MARKET BASED 
* DEF: 
   ¹ settled between knowledge,
      willing parties at arms length 
     or
   ² amount to pay 3rd party to
     take over the L
* TYPES: 
   ¹ Replicating Portfolio, 
     market to market:
     - A taken at market value 
     - discount L at A yield that 
       match often bonds
     - gov or corporate bonds, corp
       allow for credit risk
     - or use yield curve, but
       more complex 
   ² Replicating Portfolio, 
     Bond yield + Risk Premium 
     - A taken at market value 
     - discount L at (bond yields +
       equity risk premium)
     - if constant risk premium 
       then same as market to market 
       but lower L
     - if variable risk premium use
       market info + actuarial
        judgement 
   ³ Asset-Based discount rate:
     Weighed average return from A
     - A taken at market value 
     - market discount rate for each
       asset class
     - L discount at proportion of
       A weighted ave return

Question 2

Methods to allow for Risk in Cashflows [3]

Answer 2

1) build a margin into each assumption
* q’ = q(1+¤)
* i’ = i(1-¤)
* expn’ = expn(1+¤)
2) overall loading by increasing L
* V’ = V(1+ prudent%)
3) adjust discount rate to
reflect risk
* v’ = 0.95v

Question 3

Different methods of calculating provision [1.5]

Answer 3

1) statistical analysis: have many claims, follow pattern
2) case by case estimate: few claims and varying

3) proportionate approach: based on amount net premiums still to receive
e.g. in short term insurance
claim = 0.75Premiums