CH:33 Valuation of liabilities

Question 1

What are the approaches that can be taken to value assets and liabilities?

Answer 1

• “traditional” discounted cashflow approaches based on long-term assumptions
• market based approaches that reflect assets held
• “fair value” approaches

Question 2

What are the 2 methods for fair value of liability valuation

Answer 2

• amount for which an asset could be exchanged or a liability settled between willing parties
• amount that the enterprise would pay a third party to take over the liability

Question 3

Why would an option not be exercised “in the money”?

Answer 3

• cash lump sum available instead
• tax-free benefit of lump sum

Question 4

What is the best method to value gaurantees

Answer 4

Stochastic approach, allowing for the likelihood of the guarantee biting and its expected cost

Question 5

How do you allow for risk in a discounted cashflow valuation

Answer 5

• build a margin into each assumption
• apply overall contingency loading by increasing the liability value by a percentage
• adjust the discount rate to reflect the project or liability

Question 6

How do you allow for risk in a fair valuation

Answer 6

• no need to adjust for financial risk (already implicitly allowed for)
• for non-financial risk
  
  • adjust the cashflows (or discount rate)
  • hold an extra provision

Question 7

what are the different methods for calculating provisions for a general insurer

Answer 7

• statistical analysis - if there are many claims, following a known pattern
• case by case estimate - individual assessment of claim records
• proportionate approach- based on amount of net premium yet to expire