Chapter 9: Supervisory and published reporting valuations

Question 1

1 PUBLISHED FINANCIAL REPORTING METHODOLOGY

Question 2

For the purpose of determining which insurance obligations arise in relation to an insurance contract, the contract boundary is defined as the date at which the insurer has the unilateral right to: (3)

Answer 2

1. Terminate the contract
2. Reject the premiums payable under the contract; or
3. Amend the premiums or benefits payable under the contract at a future date in such a way that the premiums fully reflect the risks.

Question 3

General principles for setting best-estimate assumptions: (4)

Answer 3

1. Best-estimate assumptions should be considered separately for relatively independent groups of homogeneous policies.
2. The best-estimate assumptions should be:
   - realistic, generally guided by immediate past experience
   - and modified by any knowledge of or expectations regarding the future.
3. Best-estimate assumptions should depend on the nature of the business.
4. The actuary, in setting the assumptions, must take cognizance of the sensitivity of valuation results to changes in the various parameters, and may need to undertake the valuations on more than one basis.

Question 4

The FSV reserve for group life contracts can be split into four parts: (4)

Answer 4

1. Unexpired (unearned) premium reserve
2. Incurred but not reported claims reserve (IBNR)
3. Deficiency reserve
4. Experience refund (or profit share) reserve.

Question 5

The FSV is intended to be ____:

Answer 5

The FSV is intended to be prudently realistic, allowing explicitly for actual premiums that are expected to be received in terms of the contract that have not been recognized for accounting purposes and for future experience that may be expected in respect of interest rates, expenses, mortality, morbidity and other experience.

Question 6

Under FSV, how are future options that can be taken up by policyholders dealt with?:

Answer 6

Where there are future options that can be taken by policyholders (for example, voluntary premium increases), these should only be taken into account where they lead to a higher liability.

Question 7

Best-estimate assumptions should depend on the nature and term of the business, and allowance must be made for (Assumptions): (3)

Answer 7

1. Expenses at a realistic level, including the split between renewal and initial expenses, making allowances for escalation of future expenses at an inflation rate that is consistent with the rates(s) of interest used.
2. The effect of lapses and surrenders at a level that is consistent with past experience, modified by expected future trends.
3. Mortality and morbidity, at a level consistent with past experience and modified by expected future trends. This must include the best-estimate of the effect of AIDS.

Question 8

When setting the interest rate(s) at which to discount the liabilities, the actuary should: (3)

Answer 8

1. Ensure that the rates used are mutually consistent and consistent with market yields to maturity of fixed-interest securities.
2. Consider the expected future investment returns on a portfolio of assets appropriate to the liabilities, bearing in mind characteristics such as term, nature and duration.
3. Make allowance for tax, using the actuary’s expectation of the effect of the tax basis on the expected future investment returns and of any expected future changes in the long-term insurer’s tax position.

Question 9

Compulsory margins : (9)

Answer 9

1. Mortality - 7.5% (increase for assurance, decrease for annuities)
2. Morbidity - 10%
3. Health - 15%
4. Lapse - 25% (increase or decrease depending on which alternative increases liabilities)
5. Termination for disability income - Increase of 10%
6. Surrenders - 10% (increase or decrease depending on which alternative increases liabilities)
7. Expenses - 10%
8. Expense inflation - 10% (of estimate escalation rate)
9. Charge against investment return - 25 bps in the management fee or an equivalent asset-based or investment performance-based margin

Question 10

2. PRUDENTIAL SUPERVISION REPORTING

Question 11

(Prudential Supervision Reporting) Actuarial liabilities:

Answer 11

• Actuarial liabilities, known as technical provisions for prudential supervision reporting, are calculated using market-consistent principles.
• They consist of best-estimate liabilities and a risk margin on non-hedgeable risks.

Question 12

(Prudential Supervision Reporting) Best-estimate liabilities:

Answer 12

The best-estimate liability is equal to the probability-weighted average of future cash flows, taking account of the time value of money by discounting using a risk-free yield curve.

Question 13

(Prudential Supervision Reporting) Risk margin:

Answer 13

The risk margin represents the premium over and above the best-estimate liabilities that one insurer would require to take on the obligations of another insurer.

Question 14

(Prudential Supervision Reporting): How is the BEL determined

Answer 14

• The best-estimate liability (BEL) is determined as the discounted value of projected cash flows under each policy up to the “contract boundart”, calculated on a policy-by-policy basis.
• It is possible for the best-estimate liability to be negative.
• The assumptions underlying the best-estimate liability should be best-estimate with no additional margins for prudence.
• The projections should allow for all expected decrements and policyholder actions, including lapses.

Question 15

(Prudential Supervision Reporting) How is the risk margin calculated?

Answer 15

The risk margin is calculated as 6% of the projected non-headeable SCR at each future year-end, discounted using risk-free rates of return.

Question 16

3.4 GROUP LIFE CONTRACTS

Question 17

3 TREATMENT OF SPECIFIC PRODUCTS UNDER FSV AND PRUDENTIAL SUPERVISION REPORTING

Question 18

Participating and smoothed bonus business (FSV) - things to consider: (

Answer 18

1. Allocations of profit to shareholders
2. The bonus stabilisation reserve (BSR)

Question 19

Participating and smoothed bonus business (Prudential) - things to consider:

Answer 19

1. Future discretionary benefits
2. Realistic management actions and policyholder behaviour
3. Value of shareholder transfers
4. Separate BEL for guaranteed and future discretionary benefits

Question 20

5. INTRODUCTION TO IFRS 17

Answer 20

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Question 21

What is IFRS17:

Answer 21

IFRS 17 is an International Financial Reporting Standard developed by the International Accounting Standards Board (IASB) which provides a new standard for reporting profit emergence from insurance contracts, replacing the current standard, IFRS4.

Question 22

Key elements of IFRS 17: (3)

Answer 22

1. Contract Classification
2. Level of Aggregation (Groups of contracts)
3. Measurement model and Revenue Recognition

Question 23

Contract classification:

The definition of an insurance contract to fall within scope of IFRS 17:

Answer 23

• The definition of an insurance contract (to fall within scope of IFRS 17) requires that one party accepts significant insurance risk from another party.
• Insurance risk is significant if, and only if, an insured event could cause the entity to pay additional amounts that are significant in any single scenario.

Question 24

IFRS 17 Level of aggregation:

Contracts are grouped by: (3)

Answer 24

1. Portfolio
2. Cohort period
3. Profitability criteria

Question 25

Level of aggregation: (Profitability criteria)

An entity shall divide each portfolio of insurance contracts issued into a minimum of the following groups: (3)

Answer 25

a. a group of contracts that are onerous at initial recognition (i.e. result in a loss being recognised at inception), if any;
b. a group of contracts that at initial recognition have no significant possibility of becoming onerous subsequently, if any; and
c. a group of the remaining contracts in the portfolio if any.

Question 26

IFRS 17 Liability measurement:

Under IFRS 17 an entity shall measure the liabilities for a group of insurance contracts as the total of: (2)

Answer 26

1. the fulfillment cash flows, which comprise:
   i. best-estimates of future cash flows and an adjustment to reflect the time value of money (BEL)
   ii. a risk adjustment for non-financial risk (RA)
2. the contractual service margin (CSM)

Question 27

IFRS 17 Liability measurement:

Discounted Best estimate cash flows: (3)

Answer 27

1. Cash flows are projected up until the contract boundary of the contract using probability weighted best estimate assumptions to get a best-estimate assessment of the future cash flows, such as premiums, claims, commission and expenses.
2. The discount rate applied to give the best-estimate liability (BEL) shall reflect the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contracts.
3. Allowance should be made for the cost of any guarantees.

Question 28

IFRS 17 Liability measurement:

The BEL may differ from the liabilities calculated for prudential supervision reporting purposes due to differences in (amongst others): (5)

Answer 28

1. The acquisition and maintenance expenses allowed to be included in the expense assumptions;
2. The discount rate used
3. The contract boundary;
4. The tax-related flows included in fulfilment cashflows; and
5. The requirement to unbundle certain contracts under IFRS17.

Question 29

IFRS 17 Liability measurement:

Risk adjustment: (3)

Answer 29

1. This is an adjustment to reflect the compensation that the entity requires for bearing the uncertainty about the amount and timing of the cash flows that arises from non-financial risks.
2. IFRS 17 does not specify the method required to calculate the RA (e.g. cost of capital, value-at-risk or additions of margins) but it does require an entity to disclose the confidence level used to determine the RA.
3. The RA is released to insurance profits over time as the risk underlying the group of contracts reduces.

Question 30

IFRS 17 Liability measurement - General Measurement Model (GMM)

The GMM has four building blocks: (4)

Answer 30

1. the best estimate of future cashflows;
2. the time value of money
3. the risk adjustment (RA); and
4. the contractual service margin (CSM)

Question 31

IFRS 17 Liability measurement:

Contractual Service Margin (CSM):

Answer 31

• The CSM is set up at inception for a group of contracts.
• It represents the unearned profit on the group of contracts which emerges in line with general accounting principles.
• it relates to future service to be provided under the contracts in the group.

Question 32

IFRS 17 Liability measurement

Treatment of loss or profit at inception of a group of contracts:

Answer 32

• When contracts make a loss at inception, that loss is incurred immediately,
• and when contracts make a profit, the profit will be earned over the term of those contracts.

Question 33

IFRS 17 Liability measurement:

At each reporting date after inception of the group of policies, the CSM is built up in a retrospective manner allowing for: (3)

Answer 33

1. Growth from interest on the CSM based on the discount rate at inception (interest accretion);
2. A reassessment of fulfilment cash flows relating to future service i.e. the CSM is adjusted by the change in value of BEL and RA due to non-financial variances or assumption changes; and;
3. An amount released from the CSM into profit in recognition of services provided to policyholders in the period.

Question 34

IFRS 17 Liability measurement

Retrospective build-up of CSM over time: (6)

Answer 34

1. CSM at the start of the reporting period
2. • Interest on the CSM
3. +(-) Non-financial variances and assumption change relating to future service.
4. • CSM release for services provided during the period.
5. • Losses unable to be absorbed by CSM
6. CSM at the end of the reporting period.

Question 35

IFRS 17 Liability measurement

The Loss component:

Answer 35

• The loss component is a tracking mechanism that does not affect the net profit recognised.
• Like the CSM, the loss component is also buit up retrospectively and is also reduced systematically over time.

Question 36

IFRS 17 Liability measurement

A loss component can come about in one of the following ways: (2)

Answer 36

1. It is set up for groups of contract that are classified as onerous at initial recognition; or
2. After inception, where the CSM is not large enough to absorb an increase in the BEL and RA due to non-financial variances and assumption changes, a loss component equal to the amount of the shortfall will be set up.

Question 37

IFRS 17 Liability measurement

The Variable Fee Approach (VFA)

Answer 37

The Variable Fee Approach (VFA) is typically used for certain unit-linked, with-profits or other contracts in which some of the fulfillment cash flows vary in line with a pool of assets.

Question 38

IFRS 17 Liability measurement

Key difference between the GMM and the VFA (discount rate):

Answer 38

• For the VFA, the discount rate is calculated with reference to the pool of assets, and the CSM is unlocked at each future period to absorb the change in the value of BEL and RA as a result of the change in the discount rate.
• Under the GMM, the discount rate is based on market observable data, and the CSM is not unlocked when the discount rate changes.

Question 39

IFRS 17 Liability measurement:

An entity may simplify the measurement of a group of insurance contracts by using the Premium Allocation Approach (PAA), if and only if, at the inception of the contract: (2)

Answer 39

1. The entity reasonably expects that the simplification will produce a measurement of the liability that would not differ materially from the GMM approach (BEL, RA and CSM); or
2. The contract boundary of the underlying contracts is one year or less.