Chapter 35: Valuing liabilities Flashcards
Provisions
Provisions are amounts set aside to meet future liabilities.
The value placed on the provisions is highly dependent on the assumptions used, which, in turn, will be highly dependent on the reasons for calculating the provisions.
3 Bases
- optimistic
- best estimate
- cautious
Best estimate basis
a basis with an equal probability of overstating or understating values.
The strength of the basis used depends upon (3):
- the reason for the valuation
- the needs of the client
- regulation
3 other factors that might affect the valuation basis
- Decisions by individuals
- Decisions by shareholders
- Decisions relating to investments
10 Reasons for calculating individual provisions
- demonstrating supervisory SOLVENCY
- determining the value of liabilities for:
- —- published ACCOUNTS
- —- INTERNAL management ACCOUNTS
- valuing the provider for merger or ACQUISITION
- determining whether DISCRETIONARY benefits can be paid
- setting future CONTRIBUTION LEVELS for a benefit scheme
- valuing BENEFITS IMPROVEMENTS for a pension scheme
- calculating DISCONTINUANCE BENEFITS
- to provide disclosure information beneficiaries
- influencing INVESTMENT STRATEGY
The purpose of global provision (3)
- act as additional protection against insolvency
- cover risks, both financial and non-financial, that cannot necessarily be attributed to individual contracts
- reflect degree of mismatching of assets and liabilities.
The assumptions for calculating will depend critically both on… (2)
- the purpose for which the provisions are calculated
- the client for whom the calculation is for
Purposes for which the provisions are calculated (8)
- The published accounts
- Demonstrating supervisory solvency
- The internal accounts
- Calculating discontinuance benefits
- Determining whether discretionary benefits can be paid
- Setting contribution levels
- Setting investment strategy
- Disclosure information for beneficiaries
Assumptions used for published accounts (3)
The assumptions will reflect legislation and accounting principles. Matters to be considered include: (3)
- whether the accounts use a going concern or break-up basis
- whether the accounts require a true and fair view
- the degree of prudence in the basis
Purposes for which the provisions are calculated:
- Demonstrating supervisory solvency
There will be a need for:
- prudence
- any prescribed methods / assumptions to be followed
Purposes for which the provisions are calculated:
- The internal accounts
A realistic (best estimate set of assumptions is typically used)
Purposes for which the provisions are calculated:
- Calculating discontinuance benefits
A best estimate basis may be considered to be fair. Other bases may be appropriate, eg a more cautious basis fi the aim is to encourage surrenders.
Purposes for which the provisions are calculated:
- Determining whether discretionary benefits can be paid
Likely to err on the side of caution so surplus is not over-stated
Purposes for which the provisions are calculated:
- Setting contribution levels
The assumptions used will depend on the objectives of the parties concerned. Eg trustees are concerned with the security of the benefits so will want prudcent assumptions, whereas the sponsor may not want to unduly tie up capital in the pension scheme, and so may prefer optimistic assumptions.