Chapter 32 - Provisions

Question 1

Reasons for calculating provisions

Answer 1

BAD MEDICS

• value BENEFIT improvements for a benefit scheme
• to determine liabilities to be shown in ACCOUNTS - internal management accounts and published accounts
• to calculate level of DISCONTINUANCE / surrender benefits
• to value the provider for MERGERS and acquisitions
• EXCESS of assets over liabilities and so whether any discretionary benefits can be awarded
• provide DISCLOSURE of information for beneficiaries
• influence INVESTMENT strategy
• to set future CONTRIBUTION / premium setting
• to demonstrate Statutory SOLVENCY reports

Question 2

Purpose of global provisions

Answer 2

CAR

• COVER risks, both financial & non-financial, that is not linked to individual contracts
• ACT as additional protection against insolvency
• REFLECT the degree of mismatching of assets and liabilities

Question 3

Best estimate basis

Answer 3

Set of assumptions that have an equal probability of overstating and understating the value of the assets and the liabilities.

Question 4

Optimistic (or weak) basis

Answer 4

Assumptions are chosen which collectively result in a high value of assets and/or a low value of liabilities.

Question 5

Cautious (or prudent/strong) basis

Answer 5

Assumptions are chosen which collectively result in a low value of assets and/pr a high value of liabilities

Question 6

State the 3 main factors that usually dictate the strength of the basis on which values should be determined

Answer 6

1. Purpose of the valuation
2. Needs of the client
3. Regulatory / legislative requirements

Question 7

Outline the factors to consider when valuing the liabilities to be shown in the provider’s published accounts

Answer 7

1. Consider accounting principles and legislation in the country concerned.
2. Consider whether the accounts are to be prepared on a going concern basis.
3. Consider whether they are required to show a true and fair view.
4. Consider whether the basis required is best estimate or some other basis and how this is to be interpreted. (One of the accounting principles is prudence and this often results in the basis used being on the slightly prudent side of best estimate)

Question 8

Outline the factors to consider when valuing the liabilities to demonstrate supervisory solvency

Answer 8

1. Consider the regulation and legislation in the territory concerned
2. Consider whether the accounts are to be prepared on a going concern basis or a discontinuance basis.
3. Consider whether the basis is prescribed or left to actuarial judgement
4. Consider whether there are any relevant rules and actuarial guidance.
5. Regulators may wish to consider values that present a realistic picture of the provider’s finances. Alternatively, they may wish to consider values that intentionally understate (or perhaps overstate) the financial strength of the provider.

Question 9

What basis should be used when valuing the liabilities to be shown in the provider’s internal accounts?

Answer 9

Best estimate, to provide a realistic picture for decision-making by management

Question 10

Outline the factors to consider when valuing the liabilities for a transfer of liabilities between two providers.

Answer 10

1. The transferring company will prefer optimistic assumptions.
2. The receiving company will prefer cautious assumptions.
3. A best estimate basis is fair, and the need to to agree may result in a best estimate basis being used.
4. However, the basis will depend on the relative bargaining powers of both sides and relative supply and demand for liability transfers.
5. It is possible that the two sides agree that the transfer should not reflect a best estimate of future costs, for example if they recognize a need to hold a margin to protect the security of the benefits

Question 11

Outline the factors to consider when setting a basis to illustrate the level of benefits to which an individual is entitled, the level of investment return they might expect to receive and the contributions they might be required to make to target a specific level of benefits.

Answer 11

1. The assumptions should take into account the circumstances of the individual, e.g. age, gender, marital status.
2. Best estimate allows realistic decisions to be made.
3. A range of values communicates the uncertainty involved.
4. If the individual is averse to the risk of under-provision, a cautious approach may be appropriate.