Ch32: Provisions

Question 1

Reasons for calculating provisions needed by a provider (11)

Answer 1

• To influence investment strategy
• Determine the liabilities to be shown in the provider’s published accounts and reports
• Supervison of solvency accounts and reports
• Determine the liabilities toe be shown in internal management accounts and reports of the provider
• To provide disclosure information for beneficiaries
• To set future contributions of a benefit scheme
• Determine excess of assets over liabilities and whether any discretionary benefits can be awarded
• To value benefit improvements for a benefit scheme
• To calculate discontinuance/surrender benefits
• To provide for expected credit losses for a bank
• To value the provider for merger or acquisition

Question 2

Different bases

Answer 2

• Best estimate basis
  * Defined as set of assumptions that has equal probability of overstating or understating the values
• Optimistic (weak) basis - high value of assets; low value of liabilities
• Cautious (strong) basis - low val of assets; high val of liabilities

Question 3

Factors affecting the choice of basis and method (10)

Answer 3

• Any legislation, regulation or accounting principles that may apply
• Risk characteristics of business and the risk management strategy of the provider
• Size of solvency capital (if valued for supervisory solvency purposes)
• Nature of the assets
• Negotiating power of the parties (if for transfer of liabilities)
• Whether valuation assumes break-up or going concern basis
• Purpose of the valuation
• Type of business being considered and expected future experience
• Risk appetite of client to whom valuation is performed
• Quality and quantity of data used (affects extent of margins)

Question 4

Need for global provisions

Answer 4

• In addition to provisions established for individual contracts undertaken by the provider
• Frequently necessary to make global provisions lookng at the provider’s liabilities in aggregate, if solvency is to be demonstrated unambiguously
• Provider will be exposed to range of financial and non-financial risks - which may merit additional provision in excess of the sum of provisions for each contract or member
• E.g. additional provision may be necessary to cover risks from mismatching of assts and liabilies, credit risk and operational risk
• Provider’s risk management strategy influences level of provision required - detailed, effective and regular risk management sysetm will reduce exposure to some financial and non-financial risks. Supervisory authority may impose less stringent solvency reqs