Chapter 22: Setting assumptions (2)

Question 1

Define liabilities

Answer 1

Liabilities can be determined as the present value of future claims plus expenses plus taxes, less premiums.

Question 2

Assumptions used for liabilities to be shown in public accounts:

Answer 2

The assumptions used to determine the liabilities to be shown in an insurer’s published accounts should be consistent with the:
- legislation and
- accounting principles
governing the preparation of those accounts in the country concerned.

Question 3

Any published accounts may be subject to legislative constraints, in particular regarding:

Answer 3

1. whether the accounts are to be prepared on a going concern basis or a break-up basis
2. whether the accounts are required to show a true and fair view
3. whether assumptions should be best estimate or include margins

Question 4

Outline the principles to be followed for internal management accounts preparation: (2)

Answer 4

The principles to be followed in preparing internal management accounts are matters to be discussed and agreed with insurer.

The aim is likely to be to produce expected values of the future experience, based on realistic assumptions.

Question 5

Define Embedded value

Answer 5

Embedded value is the present value of future shareholder profits in respect of the existing business of a company, including the release of shareholder-owned net assets.

Question 6

How the calculation of shareholder profits may differ for different types of business: (3)

Answer 6

1. Conventional without-profits: the present value of future premiums plus investment income less claims and expenses, plus the release of supervisory reserves.
2. Unit-linked business: the present value of future charges (including surrender penalties) less expenses and benefits in excess of the unit fund, plus investment income earned on and the release of any non-unit reserves.
3. With-profits business: the present value of future shareholder transfers, for example as generated by bonus declarations.

Question 7

Appraisal value

Answer 7

The appraisal value is the sum of the embedded value and the goodwill (i.e. the estimated profits from future business)

Question 8

The basis for a valuation should reflect: (4)

Answer 8

1. expected future experience
2. margins to ensure adequacy of reserves
3. legislation/ regulation (for published reserves)
4. the need for consistency

Question 9

Embedded value can be calculated as the sum of: (2)

Answer 9

1. Shareholder-owned share of net assets, where net assets are defined as the excess assets held over those required to meet liabilities.
2. The present value of future shareholder profits resulting from existing business.

Question 10

Setting an embedded value basis: (2)

Answer 10

1. The expected future experience is usually taken as best estimate, unless more prudence is needed for the particular purpose for which the accounts are required.
2. Risk can be allowed for by using a risk discount rate that is higher than the risk-free rate, or by deducting a risk margin.