Chapter 33: Valuation of liabilities

Question 1

Mark to market valuation APDR LADAOS

Answer 1

Identify the assets that best replicates the future liability outgo, usually bonds in this case
The price of these assets are the market price
we then use the underlying market discount rate of these assets to value the liabilities
A single discount rate can be chosen
or it can vary with term like the yield curve does
Risk premium elements in each asset should be included or not based on the use of assets
———————————————–
Liabilities assessed
- CANT
- ALM (Stochastic modelling etc.)
Asset management strategy
- DAMM
Disount rate
- Required return
- Variation with term
Allowance for uncertainty
- MCR
Options and guarantee consideration \
- DECS CICAT & MESSG
Sensitivity analysis

Question 2

Factors to consider when valuing options DECS CICAT

Answer 2

Demographics
Expensive options not always exercised
Cultural bias
State of the economy

Consumer sophistication and needs 
Immediate benefit vs. Higher deferred benefit 
Cost increases in the valuation 
Anti-selection
Tax benefits

Question 3

Different techniques to value Liabilities:

DAMM

Answer 3

Discounted cashflow approach
Asset based discount rate
Mark to market approach: Replicating portfolio
Mark to market: Bond yield + risk premium

Question 4

Goal of sensitivity analysis

Answer 4

Determines the:

• Extent of margins needed in assumptions to allow for adverse experience
• Extent of any global provisions required

Question 5

Methods for calculating reserves:

SPEC

Answer 5

Statistical analysis: Large population exposed to risk and consequence of risk has a known distribution (Reserves = Expected loss, Forward/ backward looking reserves)
Proportionate: prop of outstanding premiums allocated to the expected future claims is the provision held
Equalisation reserve: stable/smooth annual results, catastrophe, deferring of tax and profit
Case by case: Rare events

Question 6

Different methods of allowing for prudence:

MaCoR

Answer 6

Margin built into each assumption
Contingency loading: increase liability by some value
Risk premium built into the discount rate

Question 7

Merits of traditional discounted cash flow approach compared to market related approach for liability valuation.

DCA VA

(Discounted Cashflow Approach VAluation)

Answer 7

Discounted cashflow approach difficult to explain to clients

Consistent valuation of assets and liabilities and stability of results over time

Allows for actuarial judgement to be added and market related approaches does not (can be viewed as negative)

Valuation of assets easier using market related approach
Accounting standards moving towards Market related approaches