APN 107-Embedded Value Reporting Flashcards
outline considerations regarding renewals, reinsurance and tax when determining the PVIF? (2)
• PVIF includes the expected value of renewals of inforce business (example group risk business) therefore the actuary needs to determine whether the contract boundaries used for determining liabilities are appropriate for EV
• PVIF should be net of reinsurance and net of tax
Outline the general APN 107 methodology for calculating EV?(3)
• The assets relating to existing covered business, policyholder liabilities and required capital should be projected until the expected covered business is no longer expected to be in-force
• The EV should reflect the aggregate risk in covered business when projecting cashflows therefore interactions between embedded investment guarantees, level and cost of required capital and the risk discount rate
• The guidance in these notes relate to a real world approach where investment returns and the risk-discount rate are set equal to the risk-free rate plus a risk margin
Outline the specific allowance for tax in APN 107 EV methodology? (3)
• The valuation must allow for taxes which would affect cashflows before distribution to shareholders
• The projections should allow for tax on a tax liability basis which may be different to the liability valuation chosen for EV purposes
• Where appropriate the actuary should discount deferred tax assets or liabilities on the balance sheet depending on materiality
outline the valuation of free surplus according to APN 107? (5)
• The value placed on assets should exclude intangibles to the extent there value is supported by profit recognised in PVIF (e.g. deferred acquisition costs and negative policyholder reserves)
• Or to the extent that that they represent the book value of acquisitions (such as transactions relating to goodwill)
• Any value placed on intangibles may only be included in assets backing required capital and liabilities
• The value of assets should include total assets attributable to covered business even if not included as part of prudential reporting
• Assets should be valued at fair value i.e. market value or valued according to generally recognised valuation techniques using market observable values e.g. private equity, over the counter options
outline the valuation of required capital according to APN 107? (5)
• Where EVM is aligned to SAM methodology and assumptions required capital can be aligned with SCR given that the EVM liabilities are aligned with SAMs liability metric
• The required capital should include capital required to meet internal objectives
• The amount of required should be presented from a shareholder perspective and so should net of sources of funding other than shareholder resources example subordinated debt
• The minimum is subject to SCR required by prudential regulation
outline the difference regarding new business and renewals in APN 107? (10)
• New business is defined as the sale of new contracts and once of premium increases in respect of inforce business during the reporting period (excluding cancelations at inception)
• Typical examples of once of premiums include:
o Continuations beyond the original term of an individual policy fixed maturity date (unless continuation assumption was made in PVIF)
o Non-contractual premium increases
o Renewable single premiums
o Premium increases from new benefits
• The projected cashflows used to calculated PVIF should anticipate renewals of in-force business and reasonable predictable increases in renewable premiums
• Reasonable predictable variations in premiums of in-force premiums should be included in PVIF
• Typical example of renewals and reasonably predictable variations in premiums are:
o Continuations beyond the minimum term of an open ended contract
o Renewable recurring premiums under group assurance such as PHI and group life assurance
o Automatic regular increases
o Increases in premiums due to increases in member’s salaries in group contracts
outline the allowance for debt and reinsurance in the calculation of EV? (3)
• Financing types of reinsurance and debt including subordinated debt and contingent loans can create a leveraging effect which should be included in the risk to shareholders
• Such debt should be calculated at fair value and deducted from EV
• Projections of all future cashflows should be net of outward reinsurance
outline the methodology regarding sensitivity checks in the reporting of EV? (9)
• Sensitivity of the results due to change in key assumptions should provide the users with a better understanding of valued placed on covered business
• Sensitivities should be provided for the PVIF, CoRC and VNB
• Accounting standards require the disclosure of sensitivity of profit and loss to changes in key assumptions (consistent with these test are encouraged)
• In general all other assumptions should remain the same unless where directly affected by revised economic conditions (e.g. bonus rates)
• Where companies dynamically vary reserving basis it would be acceptable to include a day one impact on reserving basis changes
• The impact of investment market
changes should be allowed in valuation of embedded investment derivatives as this affects the shareholder cashflows
• Sensitivities should be disclosed annually
• Usually a single direction change in assumptions are adequate unless the opposite direction would result in a asymmetrical change
• Where appropriate the actuary should take into account likely management actions which should be disclosed
outline checks that will be conducted on EV results? (4)
• The comparison of items such as opening reserves, premiums and claims in the first year of profit projection with number in the financial statements
• The reconciliation of expense assumed for EV purposes with expenses to actual expense incurred
• The level of profit projected to be earned in the first year of the projection period relative to actual profit earned in the previous year
• External disclosures of the above checks are not required
outline general considerations when setting EV assumptions? (8)
• The assessment of appropriate assumptions should have regard to both past, current and expected future experience and to any other relevant data
• Changes for expected future experience should be allowed when sufficient evidence exists indicating that changes are relatively certain
• If EV assumptions are set to be over-optimistic then these will emerge in future years as negative operating experience and/or investment variances
• The projection assumptions should be determined using best estimate assumptions of future cashflows for each policy group
• The best estimate assumptions should be consistent with other form of reporting e.g. SAM, IFRS
• The most important assumptions to be disclosed should be discussed and approved by the board and relevant committees
• The VNB assumptions can be based on assumptions (demographic and economic) at the point of sale or revised assumptions at the reporting date
• However where premiums are based on investment yields e.g. annuities the VNB must be based on investment yields at the point of sale
outline operating assumption considerations for EV calculations? (3)
• Premium increases should be modelled under EVM using a best estimate take up rate
• Business where reserves are set retrospectively e.g. group business management would have to make a view on future experience e.g. growth in business
• However growth assumptions based on current experience would need to be adjusted in later years
outline considerations in setting expense assumptions for Ev calculations? (8)
• Future renewal and claim expenses should reflect expected on-going expenses to support covered business including investment in systems to manage the inforce portfolio
• The future expenses should be set based on actual experience and split by acquisition expenses, renewal expenses and non-recurring/ development expenses consistent with the liability basis where relevant
• For group business expenses are typically not included in the valuation of liabilities but should be set based on current experience allowing for inflation and the growth/decline of the business
• Once of costs not included in unit expenses should be separately disclosed
• Overhead expenses should be allocated to new business, existing business and developmental projects in a way that is consistent with past allocations, current business plans and future expectations
• Favourable changes in unit costs such as productivity gains should not include more than what is achieved at the end of the reporting period
• All expected expense overruns should be appropriately allowed for
• Where an external service company is used in the management of covered business the actual and future expected fee or charges should be allowed in calculation PVIF, CoRC and VNB
outline the setting of economic assumptions? (2)
• Economic assumptions should be internally consist and consistent with observable, reliable market data (no smoothing is permitted)
• Economic assumptions should be regularly reviewed i.e. updated for each reported calculation of EV
outline the setting of investment assumptions? (6)
• Assumed investment return should reflect the expected return of assets attributed to covered business
• Returns should reflect expected default on the investment
• Regular review of risk-free rate and risk premiums for different asset classes are encouraged
• Current gross redemption yields implied by zero-coupon yield curve and swap yield curve should be considered with current portfolio when setting fixed interest assumptions
• Reinvestment of future positive cashflows would require consideration of the expected future investment strategy
• Assumptions may allow switching between investment classes which needs to be allowed for in capital requirements
outline the setting of inflation assumptions? (2)
• Assumptions should be consistent with observed inflation and investment markets e.g. inflation-linked securities
• The expense inflation needs to be consistent with the type of expenditure (e.g. office space, staff, IT systems) expected which could be different from price inflation
