Chapter 9 - Supervisory and published reporting valuations Flashcards
What are the 3 main valuation bases?
- The prudential supervision basis (known colloquially as SAM)
- The published reporting or IFRS basis
- The embedded value or EV basis
Who are the key stakeholders for the prudential supervision basis in insurance, and what is their primary concern?
Key Stakeholders:
* Regulator (Prudential Authority) and
* Policyholders
Primary Concern:
* Ensuring the insurer can meet its obligations to existing policyholders under expected and significantly adverse future outcomes.
* Obligations to policyholders take precedence over obligations to capital providers
What is the main focus of prudential supervision reporting, and what metrics are central to it?
Main Focus:
* Ensuring sufficient assets and liabilities to meet future policyholder obligations at all times.
Central Metrics:
Balance sheet metrics, specifically:
* Liabilities (best estimate technical provisions and risk margins)
* Assets
* Required Capital (Solvency Capital Requirements)
* Surplus Capital
Earnings on this basis are a consequence of balance sheet changes, not the primary reason for calculating these metrics.
Who are the key stakeholders for published reporting of insurers, and what is their primary focus?
Key Stakeholders:
* Current and potential future shareholders and bondholders.
Primary Focus:
* The income statement, particularly how revenue and expenditure are recognized within a reporting period.
* Shareholders: Concerned with earnings over time (driving dividends and return on capital).
* Bondholders: Rely on interest coverage ratios derived from financial statements.
What is the crucial aspect of published reporting for insurers, and how does IFRS 17 influence it?
Crucial Aspect:
* Establishing how revenue and expenditure related to insurance contracts are recognized over the contract term to determine shareholder earnings.
IFRS 17 Impact:
* The pattern of recognizing future revenue and expenditure (income statement) is driven by the calculation of policyholder liabilities (balance sheet).
* Changes in estimated future premiums and expenditure impact policyholder liabilities and are reflected in the income statement.
Embedded Value (EV) bases: Purpose and Key Characteristics?
- Provide a current and future investors with estimated market value of the insurer, i.e balance sheet view
- This is not a universal or regulatory prescribed basis
what are the 4 key principles under IFRS17
- accrual accounting
- fair value accounting
- “spread profits, accept losses”
- portforlio approach
Explain the principle of fair value accounting under IFRS17
IFRS 17 addresses the challenge of applying fair value by requiring a “current risk-adjusted present value” that incorporates:
* All reasonable and supportable information about future cash flows (without undue cost or effort).
* A way that is consistent with observable market information.
Results in the first three building blocks underlying the GMM and VA under IFRS17
What are the first three building blocks underlying GMM and VA
- the best estimate of future cashflows;
- the time value of money; and
- the risk adjustment (RA)
Explain accrual accounting principle (2)
- Accrual accounting is essential for insurance contracts due to the mismatch between premium inflows and the timing of insurance service fulfillment
- IFRS 17, mandates the recognition of insurance revenue as the insurer provides coverage, often resulting in the initial premium being recognized over the contract term, as illustrated by the concept of the unearned premium reserve (UPR) under the Premium Allocation Approach (PAA).
Explain the principle of the portfolio approach (3)
- Portfolio Unit: Insurance contracts are accounted for in portfolios of similar risks.
- Group by Profitability: Portfolios are split by expected profit (loss recognized upfront).
- Accurate Loss/Profit: This ensures timely loss recognition and appropriate profit spreading.
What happens to CSM if actual expenses is different to expected?
Release of CSM stays the same as your future expected revenue and expenses have not changed
What are 2 sources of revenue
- insurance service activities - promise to pay an amount following occurence of future event
- insurance finance activities - result from revenue from investing premiums
Under the GMM an entity shall measure the liabilities (or carrying value) for a group of insurance contracts as the total of:
- the fulfilment cash flows, which comprise:
i. best-estimates of future cash flows and an adjustment to reflect the time value of
money (the Best Estimate Liabilities or BEL)
ii. a risk adjustment for non-financial risk (RA) - the contractual service margin (CSM).
What is the methodology for calculating BEL
- 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 cashflows, such as premiums, claims, commission and expenses.
- 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. This should be derived from observable market data.
- Allowance should be made for the cost of any guarantees.
