APN401 - Establishing Technical Provisions for Short-Term Insurers

Question 1

Purpose of APN401

Answer 1

To assist ASSA members in discharging their professional responsibility in relation to the valuation of a short-term insurer’s technical provisions.

Question 2

3 Valuations of short-term insurers’ technical provisions that are regularly required

Answer 2

• published financial accounts
• statutory reporting
• calculation of the insurer’s tax liability

Question 3

Published financial reporting needs to comply with (2)

Answer 3

• the Companies Act, 2008 (Act 71 of 2008)

- the Short-Term Insurance Act, 1998 (Act 53 of 1998)

Question 4

Statutory Reporting needs to comply with

Answer 4

the Short-Term Insurance Act, 1998 (Act 53 of 1998) and associated Board Notices and Directives.

Question 5

To use an alternative method of calculating technical reserves / UPP / IBNR, the insurer needs to …

Answer 5

Apply to the FSB for approval before this method is applied for statutory reporting. The application must be accompanied by a report signed by an actuary who is in the possession of a valid and appropriate practicing certificate issued by ASSA.

Question 6

Claims provisions would incorporate (6)

Answer 6

• case estimates
• provision for future development on known claims (incurred but not enough reported)
• estimates for reopened claims
• provision for claims incurred but not reported
• profit commission and/or sliding scale contingent commission provisions; and
• claims handling expenses

Question 7

Premium provisions

Answer 7

Set up to provide for future claim payments arising from future events insured under existing policies for which premiums have already been received.

Question 8

5 Issues to consider when determining what the “cash-back” bonus provisions should include

Answer 8

• Benefits payable as per policy-wording
• Status of policy at valuation date, i.e. accumulated bonus or zero accumulated bonus due to recent claims experience
• Anticipated claims that will be made between valuation date and bonus-payment date
• Anticipated lapse rates
• Anticipated premium increases

Question 9

The member should have an understanding of (6), which may materially affect the estimation of the technical provisions.

Answer 9

• nature of coverage, including any unusual terms and conditions of contracts
• underwriting strategy and the nature and mix of risks underwritten
• benefits pyable under policy terms or by virtue of legislation, including deductibles and limits
• reinsurance arrangements, including any special or unusual features of the reinsurance arrangements that might affect reinsurance recoveries.
• claim management philosophies, rules and guidelines, and the insurer’s practices in setting case estimates.
• monitoring reports that the insurer prepares of its claim and underwriting guidelines, and
• changes in data quality or interpretation when staff turnover affects key positions, where personnel have a central role in the preparation of accounts or other relevant data.

Question 10

Claims experience analysis should include some or all of (8)

Answer 10

• CLAIM FREQUENCY relative to some measure of exposure
• RATE OF REPORTING claims
• RATE OF SETTLEMENT
• DEVELOPMENT of payments
• adequacy of CASE ESTIMATES
• incidence of LARGE CLAIMS
• overall pattern of CLAIM OCCURRENCE over the duration of the policy period

Question 11

The member should be familiar with (6) changes and trends that may affect the value of the technical provisions.

Answer 11

• economic
• technological
• medical
• environmental
• regulatory
• social
  changes and trends

Question 12

Analysis of experience should take into account special features, including (6)

Answer 12

Developments & trends in experience:

• changes in deductibles
• aggregate limits
• claims handling procedures
• the mix of business within the portfolio
• changes in legislation
• the impact of large claims paid and outstanding

Question 13

APN401:

treatment of VAT

Answer 13

VAT is normally excluded from claims provisions, consistent with the accounting treatment of premiums and claims.

Question 14

Should experience be gross/net of recoveries?

Answer 14

Experience should normally be analysed on a gross of recoveries basis.

In both claims and premium provisions, explicit allowance for reinsurance and other recoveries, such as third party recoveries, salvage and subrogation needs to be made.

Question 15

APN401:

Obtaining central estimates

Answer 15

The central estimate is intended to be the mean of the underlying probability distribution when using a stochastic method.

Quantifiable trends must be recognised in the central estimate.

The member is required to determine the central estimate of the liability and recommend technical provisions no less than the central estimate.

Question 16

Published financial reporting falls under …

Answer 16

the Registrar of Companies

Question 17

IFRS 4 (AC 141) Insurance Contracts

Answer 17

Deals with the recognition, measurement and disclosure of insurance contracts.

The measurement will continue to be based on the principles applied at adoption of IFRS 4.

Question 18

IASB

Answer 18

International Accounting Standards Board

Question 19

APN401: Data (3)

Answer 19

The member must ensure that the data used for a valuation of technical provisions is appropriate and sufficient
for the specified purpose of the valuation.

The degree to which the member relies upon data provided by the insurer, and the resulting limitations that this places on the reliability of the member’s conclusions, should be commented on in the report.

Where the member is in any doubt regarding the sufficiency of the data used in the valuation, other actuarial guidance on data should also be considered.

Question 20

When determining the margin, the member needs to consider (3)

Answer 20

• Diversification benefit and correlations between classes;
• Independent variation; and
• Systemic uncertainty

Question 21

Uncertainty can be broadly divided into (2)

Answer 21

• Independent variation, which operates at the individual claim level and is uncorrelated; and
• Systemic variation, which operates at the valuation unit level and affects all claims similarly.

Question 22

3 Typical sources of systemic variation

Answer 22

• economic
• social
• climatic
  factors

Question 23

The member should comment on external issues that may change the credibility of the data at the valuation date, such as (6)

Answer 23

• Changes in the mix of business of the insurer
• Changes in processing claims or premiums (e.g. administrative delays, changes to case estimation procedures)
• Identified systems issues (new systems or changes to systems)
• Changes in underwriting
• Changes in reinsurance arrangements; and
• Changes in the economic and legal environment

Question 24

Where case estimates are used as a component of the provisions, the member needs to determine how they relate to what is likely to be paid out.

11 Considerations when doing this

Answer 24

• Given sufficient historical data, standard actuarial techniques can be used to
  quantify this relationship.
• In the absence of such data, the member should form a view on the relationship by consulting with people responsible for estimates.
• The member should adjust the estimates to reflect central estimates, not best-case or worst-case scenarios.
• Making allowance for inflation and discounting where applicable and material.
• Salvage and subrogation should be included in a consistent manner in estimates.
• Whether estimation procedures (or even key personnel) have changed. In this case a subjective estimate of the change may be required until experience emerges.
• All available information, including information obtained after the valuation date.
• Effect of large claims on the relationship of ultimate payment to initial estimates.
• Effect of reinsurance programmes on estimates and relationship to claims paid.
• Possible nominal estimates entered on administration systems that will not lead to payments.
• Materiality.

Question 25

When considering case estimates for long-tailed business, the member needs to (2)

Answer 25

• Consider the additional data credibility requirements.

- Ensure that extra care is taken to understand the business and estimation processes.

Question 26

APN401: Inflation

Technical provisions should include allowance for the impact on future claim payments of (4)

Answer 26

• wage inflation
• price inflation
• court decisions
• other economic or environmental causes

Question 27

APN401: Inflation

Explicit allowance for inflation is required if…

Answer 27

past inflation has been unstable

or if future inflation rates are expected to differ from past inflation rates

Question 28

APN401: Inflation

If inflation is allowed for explicitly, then it is usual to…

Answer 28

… convert past historical payments into values as at the date of calculation.

Allowance must then be made for future claim inflation.

In doing this, it may be useful to separate 0claim escalation into:

• standard inflation
• superimposed inflation.

Question 29

Superimposed inflation

Answer 29

Specific to an insurer’s portfolio.

It follows that an assessment of superimposed inflation should derive ideally from analyses of the insurer’s own claim statistics.

Question 30

Discounting should only be applied if …

Answer 30

it will make a material impact to the central estimate result.

As a general guideline, when the discounted mean term of liabilities is expected to exceed 4 years, then estimates should be discounted.

Question 31

6 Factors to be considered in arriving at an appropriate discount rate

Answer 31

• Expected future investment returns on a portfolio of assets appropriate to the liabilities, bearing in mind the term, nature and currency of the liabilities.
• The rate of return on specific matching assets. It is normally presumed that, as far as possible, technical provisions are matched by fixed interest investments and cash, rather than securities and creditors.
• Yields on fixed interest securities.
• An allowance for tax.
• Allowance for default risk.
• Consistency with inflation assumptions.

Question 32

APN401: Expenses

Answer 32

Claims provisions should incorporate an allowance for future claims handling expenses.

This allowance may be separated into allocated and unallocated expenses.

Premium provisions should incorporate an allowance for future policy and claims administration expenses.

Question 33

In allowing for expenses, the following should be considered: (6)

Answer 33

• Whether expenses are included in the data being analysed, and the corresponding impact on development ratios
• Historic expense analyses, including claims expenses as a percentage of gross payments.
• Distortions in past expenses analyses due to large claims or unsuitable methodology.
• Stability of past and future claims and expenses within each portfolio, by type and age of claim.
• Materiality of the expense assumptions within the context of the overall estimate of the provisions.
• Allowance for increasing (or decreasing expenses per policy for a closed portfolio)

Question 34

APN401: Gross / net of reinsurance and other recoveries

Answer 34

• Outstanding claims and premium provisions should be estimated both gross and net of reinsurance and other recoveries, and separately for each line of business.
• The bases used to estimate gross and net provisions should be consistent with each other.
• In many circumstances, it may be appropriate to use the model for estimating the gross provisions as the starting point for development of the model estimating reinsurance recoveries.
• Where reinsurance arrangements embrace risks from more than one class of business, the member may need to allocate an adjustment between classes.
• Where a reinsurer is in default / at serious risk, such reinsurances should be reported on explicitly, rather than as a component of net technical provisions.
• The estimated uncertainty for each valuation unit should normally make the appropriate allowance for reinsurance, especially the increased uncertainty brought about by reinsurance terms and possible reinsurer failure.

Question 35

For premium provisions, the unearned premium approach may be applied to produce either a gross or a net value.

When adjusting from a net to a gross value (or vice-versa), the following need to be considered: (3)

Answer 35

• For proportional reinsurance and sharing agreements, consider the average proportion retained.
• For non-proportional reinsurance, the simplest approach is to adjust with a fraction of the unearned non-proportional reinsurance premium. This requires an assessment of the expense and profit margins contained in those premiums.
• Where reinsurance is written on an events occurring basis, allow for:
• – future reinsurance premiums for the unexpired period after the current reinsurances expire;
• – the expected cost of reinsurance under both current and future reinsurances;
• – other recoveries (sharing, salvage, subrogation, third-party recoveries)

Question 36

APN401: Run-off / wind-up basis

Answer 36

• In the case where the insurer is in run-off / wind-up, the member must consider the run-off expenses and should allow for this additional liability when estimating the technical provisions. The provision must be shown separately for allocated and unallocated loss adjustment expenses and other expenses incurred in the event of wind-up.
• The member has to consider whether or not an allowance is required for reinsurance recovery write-off in the event of wind-up.
• Appropriate allowance needs to be made for non-reinsurance recoveries as it may not be as successful as in normal going concern conditions to recoup all the recoveries.
• The member must consider the impact of costs arising from normal operations increasing as a percentage of income, or even claims provisions.

Question 37

When considering materiality, the following factors should be taken into account: (4)

Answer 37

• Statistical significance of the estimates
• Purpose for which the estimates are required, and other potential uses;
• The cumulative impact of items disregarded on the grounds of immateriality; and
• How the uncertainty of results is to be communicated.

Question 38

Reasonableness should be assessed in relation to (6)

Answer 38

• comparable results for that valuation unit in the previous year
• development in the valuation unit over the inter-valuation period
• the experience of the valuation unit since the previous valuation
• changes in economic assumptions, particularly investment and inflation assumptions
• changes to the actuarial model
• available industry results or benchmarks

Question 39

List the components that need to be considered for estimating the technical provisions

Answer 39

CLAIM PROVISIONS:

• case estimates
• claims handling expenses
• Estimates for reopened claims
• Profit commission and/or sliding scale contingenc commission provisions
• IBNR
• IBNER

PREMIUM PROVISIONS:
Set up to provide for future claim payments arising from future events insured under existing policies for which premiums have already been received.
- Include an amount in respect of internal expenses that the insurer expects to incur in administering the policies and settling the relevant claims

CASH-BACK BONUS ALLOWANCE:
Need to consider:
- Benefits payable as per policy-wording
- Status of the policy at valuation date
- Anticipated claims to be made between the valuation date and bonus-payment date
- Anticipated lapse rates
- Anticipated premium increases

ADDITIONAL UNEXPIRED RISK RESERVE
Required if it is expected that future premiums will not cover future claims and expenses including commission.

Question 40

If asked to value technical provisions as at a date prior to the reporting date, 2 acceptable approaches can be considered:

Answer 40

• Undertaking the valuation at an earlier date with the resulting estimates subsequently updated to the reporting date.
• Deriving the valuation models from data at an earlier date and subsequently applied to data at the reporting date.

Question 41

Subdivision of data

Answer 41

The estimation of provisions may require the subdivision of the data into groups of claims exhibiting similar characteristics.

In the determination of appropriate subdivisions, a balance must be found between homogeneity and statistical reliability.

Question 42

Selection of the most appropriate valuation model to estimate the provisions is the responsibility of the member.

The model should take account of: (3)

Answer 42

• available data
• nature of the portfolio
• results of analysis of experience

Question 43

Claims experience assumptions should allow for:(4)

Answer 43

• trends in claim experience
• changes in underwriting
• alterations of policy terms
• assumptions about reinsurance and other recoveries

Question 44

Standard inflation

Answer 44

Inflation not specific to an insurer’s portfolio.

It is an external factor operating in the economy at large. As such, it is appropriate to refer to publicly available information.

Historic inflation is contained in the indices produced by Statistics South Africa while economists’ forecasts can be consulted for the future inflation outlook.

The inflation index used in the claims escalation analyses should be relevant to the particular class of business considered.