Chapter 9- Supervisory and Published Reporting Valuations Flashcards
Describe the 3 main purposes for the valuation of liabilities as well as the associated bodies and regulation in which they are governed (3)?
(1) Published Reporting in financial statements which is governed by the registrar of companies and the companies Act. Usually valued using an IFRS methodology.
(2) Prudential reporting which is governed by the prudential authority and the Insurance Act 2017 and associated prudential standards
(3)Tax liability calculations are governed by SARS as well as the Income Tax Act
Describe the IFRS standards apllicable to the financial soundness methodology (FSV) ? (5)
• The financial soundness valuation method (described in SAP 104) play an important role in the valuation of liabilities for IFRS purposes for insurance contracts
• This methodology is current recognised practice and should be used unless a more reliable and relevant standard such is IFRS 17 is adopted
• Investment contracts with discretionary participation features can be valued using the financial soundness valuation until the implementation of IFRS 17 (look into this further when reading SAP 104)
• Other investment contracts are required to be treated in accordance with IFRS 9 (financial instruments) with disclosures governed by IFRS 7
• IFRS 15 revenue from contracts with customers deals with revenue recognition with investment contracts
Describe the valuation of liabilities in the financial soundness methodology (FSV) ? (10)
FSV is intended to be prudently realistic and explicitly allow for
o future actual premiums received over the term of the contract
o as well as future experience including interest rates, expense, mortality and morbidity and other factors
• Minimum resilience is added to best estimate values of parameters through a compulsory margin
• Further resilience and prudent release of profits may be achieved through additional discretionary margins
• Negative reserves can be remove in order to remove the risk of surrender strain form earnings
• Both decision regarding the use of discretionary margins as well as treatment of negative liabilities lies with the board of directors
• Future options such a voluntary premium increases should only be included if they lead to higher liabilities
• The premium and benefits that should be included in the valuation must be those payable I terms of the contract and incorporate policyholder reasonable expectations
• The liabilities must be calculated excluding reinsurance with values of reinsurance separately quantified and reported
• Additional guidance for allowing for AIDS in mortality assumptions are included in APN 105
• Additional guidance for valuing guarantees and options are included in APN 110
List the 4 components that influecne the valuation assumptions in FSV (4)?
• Best-estimate assumptions
• Compulsory margins
• Discretionary margins
• PRE
Describe how best estimate liabilities are calculated in FSV (5)?
• Should be realistic,
o generally guided by past experience,
o and modified by any expectations regarding the future
o depend on nature & term of business
• Consider separately for homogeneous policy groups – eg split by:
o product type,
o demographic characteristics (cohort),
o distribution channel and
o location
• Allow for
o Realistic expenses
Split between initial and renewal
Expense inflation – consistent with i-rate used
o Lapses & surrender
Consistent with past experience – modify for future trends
o Mortality & morbidity
Consistent with past – modify for trends
Include BE effect of AIDS
• Interest rate(s) to discount L’s
o Mutually consistent & consistent with yields of fixed-I securities
o Consider future inv returns of appropriate portfolio of A’s
Term, nature & duration
o Allow for tax
Effect of tax on inv returns
Future changes in tax position
Consider separately for each tax fund
• Sensitivity testing
o Assess sensitivity of valuation results to changes in parameters
o may need to undertake valuations on more than one basis (but only report on ONE)
Describe purpose and application requirements (not values) of complusory margins for liabilities calculated in FSV (5)?
• To introduce a degree of prudence
o and to defer profits
(reduce risk that profits are recognised prematurely)
• If business not expected to be profitable on [BE assumptions] + [compulsory margins]
o a [new business loss] will have to be reported
• Retrospectively calculated reserves should be at least equal to the
o corresponding prospective reserve, which must make allowance for the compulsory margins
• Must be added throughout the lifetime of policies,
o except for regular renewable policies
until at a min: max(12m; next renewal date)
• Future management actions may not be assumed to reduce compulsory margins
Describe the calculations of the complusoty margin for various assumptions? (9)
Mortality 7.5% (increase for assurance, decrease for annuities)
Morbidity 10%
Health/medical 15%
Lapse 25% (eg if BE is 10% margin is 2.5%)
Terminations for disability benefits in pmt 10%
Surrenders 10% (increase or decrease, depending on which alternative increases liabilities)
Expenses 10% level
Expense inflation 10% (of estimated escalation rate)
Charge against investment return
• Linked business (rand reserve):
o assume an investment fee (mngmt fee) that is 25 bps lower
o Eg inv fee is 1.5% assume 1.25%
• Non-profit business:
o value liabilities at 0.25% less than the rate for valuing assets,
o adjusted for ax, asset mngmt charge and credit risk
• Reversionary bonus business:
o value liabilities at 0.25% less than the valuation rate for assets,
o adjust for tax, asset mngmt charge and credit risk
o WITHOUT adjusting the expected future bonus rate accordingly
Describe how the direction of the complusory margin needs to be taken into account in the application (3)?
• Apply margins at a [policy grouping level]
o consistent with the level at which best-estimate assumptions have been set
o e.g. mortality assumption increase for assurance vs decrease for annuity
• Direction may depend on duration of policy
o e.g. lapses increase in early duration vs decrease at later durations
whichever is more prudent (otherwise reserve is understated)
if possible, increase lapse assumption in early durations and decrease it at later durations
• Charge against the investment return:
o negative liabilities at certain durations for some policies rather ADD investment return margin to the BE rate
Describe the puprose of discretionary margins including various examples of discretionary margins (5)?
• Include where the actuary believes that:
o Compulsory margins are insufficient for prudent reserving in a particular case
o To defer release of profits consistent with policy design or company practice
• Examples:
o Additional margin over & above compulsory margin
Compulsory margin not prudent enough or
Allow profits to be released in line with key profit drivers (eg mort)
o Add margin to assumption without compulsory margin
Eg 20% margin to retrenchment claim rates
Introduce appropriate prudence or
Allow profits to be released in line with retrenchment risk
o Reserving on retrospective basis
Discretionary margin = [retrospective L] - [prospective L including compulsory margins]
Align release of profits with occurrence of policy CF’s
o Zeroising negative L’s
Policy-per-policy basis / product level
Increase prudence around withdrawal risk
Reduce excessive profits at point of sale
• Zeroised Ls profits recognised as and when you earn them
• Negative Ls profits recognised at inception
Descrbe how policyholder reasonable expectations need to be taken into account in the valuation of liabilities under FSV? (4)
• Depends on: type of product, past practice, market practice, marketing material, announcements / actions (e.g. PPFM published by 2007 year-end), market returns
• In calc of L’s take account of PRE that will influence decisions on future distributions of surplus
• The bonus declarations will be set such that it is consistent with future economic conditions however PRE may result in declarations being different due to smoothing or repuational considerations
• The insurer may have made clear actions to change expectations of policyholders
o The actuary would need to considered what expectations have been created and how does the action change these expectations
o Expectation are usually created through the following:
History of maintenance of bonus rates or strong smoothing of bonus over sustained period
Illustration of future values assuming maintenance of bonus rates
Describe the prudential valuation methodology (SAM) arcording to the Insurance Act 2017? (8)
• Actuarial liabilities calculated for prudential supervisory reporting are based on market consistent principles
• They consist of a best estimate liability as well as a risk margin for non-hedgeable risk
• The best estimate liability is a probability weighted average of projected cashflow discounted using a risk-free term structure
• The risk margin is an additional value to compensates the “receiver insurer” for the cost of capital to maintain financial soundness regarding the liabilities transferred
• When the cashflows of liabilities can be replicated in all scenarios by a portfolio of assets which are traded in an active market with reliable market values then the technical provisions can be set to the market value of portfolio of assets
• In this case it is not necessary to calculate the best estimate value and the risk margin as the technical provisions can be calculated as a whole
• Furthermore best estimates should be calculated gross of reinsurance with reinsurance recoverables (net of credit default risk) explicitly reflected as an asset on the balance sheet
• Simplifications can be done in the calculation of technical provisions and reinsurance recoverables that are proportionate to the nature, scale and complexity of the risk
Describe the calculation of the best estimate liabilities in SAM valuation? (9)
• This is the discounted value of projected cashflows under each policy up until the “contract boundary” on a policy per policy basis
• It is possible for the best estimate liability to be negative
• The assumptions underlying the calculations of best estimate liabilities should be best estimate without a margin for prudence
• Projection should allow for expected decrements and policyholder actions including lapses
• The assumptions must be set by considering both internal and external data such that they reflect the risk profile/characteristics of the underling book
• The best estimate assumptions can allow for future management actions (such as reviewing premiums that the insurer could reasonably expect to implement)
• The management actions should take into account implementation time and be realistic and consistent with current business practice and strategy (unless evidence that this may change)
• Management actions should also be consistent with PPFM (principles and practice of financial management)
• Financial guarantees and options would need to be valued using stochastic analysis
Describe the risk-discount rates used in the valuation of liabilities under SAM? (3)
• The risk-free term structure to discount cashflows shall be a government bond curve
• Where an insurer matches the liability with swap based assets the insurer can apply a swap curve (adjusted from credit and liquidity) as a basis for risk-free curve
• For annuities an illiquidity premium may be added subject to certain requirements to allow for the fact that a higher rate can be earned if assets are held to maturity
Describe the calculation of the risk premium in the valuation of liabilities under SAM? (6)
• The risk premium is the additional amount that the receiver insurer would require to take over liabilities above the best estimate value
• It representations theoretical compensation of experience being worse than assumed in best estimates as well as for the cost of regulatory capital held against the risk
• The risk margin is calculated as the cost of holding an amount of eligible capital equal to SCR to support insurance obligations over lifetime (only for non-hedgeable risks)
• The prescribed cost of capital to be used in the calculation is 6% i.e. frictional cost of locking in SCR rather than using it freely
• When projection future non-hedgeable SCR simplifications can be used subject to the principle of proportionality
• The calculation of SCR allows for diversification across different lines of business therefore it is calculated for the business as a whole and then proportioned
Contrast the valuation of participating and smooth bonus contracts under FSV and SAM? (11)
• Valuation of participating business under FSV should include expected allocation of profit to shareholders (if there is a relationship between profit attributable to shareholders and bonus declared for policyholders)
• However if expected allocations to shareholders acts as a buffer to adverse experience, the higher of expected allocations or compulsory margins should be used
• Where there is smoothing of distribution (i.e. conventional or accumulating with-profit) polices should also include the bonus stabilisation reserve that exists (i.e. undistributed surplus for future distribution)
• If the bonus fluctuation reserves is negative because of downward fluctuations in the market and the amount will likely be recovered through under distribution in ensuing three years which that this has been agreed with the board it can be used to reduce liabilities
• Under prudential supervisory reserves future discretionary bonuses needs to be included in technical provisions
• This is based on what the insurer expects to declare given the with profit asset pool
• The future bonuses increase/decrease in line with how bonuses are expected to be declared in the future
• The calculation needs to reflect realistic management actions e.g. dynamic reversionary bonus rates, equity backing ratios, charges that vary with economic conditions
• Furthermore policyholder behaviour would need to be taken into account example withdrawals relative to attractiveness of guarantees
• Unlike FSV it does not include the value of shareholder transfers in respect of future bonus declarations (recognition of surplus upfront for shareholder allocations)
• The best estimate valuation for business with discretionary elements should be calculated based on two separate components
o i.e. the guaranteed component i.e. basic benefit and vested bonuses attaching
o Unvested bonuses declared and future bonus declarartions possibly using stochastic methods
