CIA - Discounting

Question 1

Fundamental elements of discounting policy liabilities.

Answer 1

The selection of the Discount Rate, Payment Pattern, and the Mfad.

Question 2

Formula relating the Net, Gross, and Ceded values.

Answer 2

Net = Gross - Ceded

Doesn’t matter if losses are on an undiscounted, PV or APV basis

Question 3

Considerations for which two quantities to calculate directly when calculating policy liabilities. (4)

Answer 3

• Data (availability/credibility)
• Cash flow (volatility)
• Reinsurance
• Discount rate

Question 4

Considerations for Data.

Answer 4

• Credibility

Eg: ceded data may be thin so calculate net & gross directly

Question 5

Considerations for CF (Cash Flow).

Answer 5

• volatility
• duration of cash flows
  note: may take a different choice for different LOBs

Question 6

Considerations for Reinsurance.

Answer 6

• type of program
• consistency
  Eg: if net retention level has changed, then do NOT calculate net losses directly (CALCULATE net = gross - ceded)

Question 7

Considerations for Discount Rate.

Answer 7

If the rate used for NPV & CPV are different, then calculate GPV = NPV + CPV

Question 8

Definition of Claims Liability.

Answer 8

The portion of insurance contract liabilities in respect of claims incurred on or before the balance sheet date.

Question 9

Definition of Premium Liability.

Answer 9

The portion of insurance contract liabilities that are not claim liabilities.

Question 10

What are the considerations when selecting a discount rate (or expected investment return rate)? (hint: MARY-(IE)-CapG)

Answer 10

• METHODS for asset valuation & reporting investment income
• ALLOCATIONS of assets & investment income by LOB
• RETURN on assets @ balance sheet date
• YIELD on assets acquired after B/S date
• INVESTMENT EXPENSES & losses from default
• CAPITAL Gains/losses on assets sold after the balance sheet date

Question 11

Considerations for Payment Patterns of Claim Liabilities. (3)

Answer 11

CREATE HOMOGENEOUS GROUPS:

1) use payment patterns of groups used for valuation of undiscounted liabilities
2) length of payout pattern
3) any predetermined schedule of payments

Question 12

Types of cash flows related to Premium Liabilities. (3)

Answer 12

• Future claims & LAE
• Future reinsurance costs
• Maintenance expenses

Question 13

Considerations for Payment Patterns or Premium Liabilities (future claims & LAE).

Answer 13

Same as for Claims Liabilities + (AAD & APD for future claims costs)

Question 14

Considerations for Payment Patterns for Premium Liabilities (reinsurance, maintenance).

Answer 14

Discounting is insignificant for reinsurance and maintenance costs associated with premium liabilities.

Question 15

Criteria for assets used for calculating the discount rate. (2)

Answer 15

• Asset must SUPPORT net policy liabilities

- Asset cash flow should be CONSISTENT with liability cash flow

Question 16

Define Portfolio Yield Return (PYR).

Answer 16

PYR = IRR (Internal Rate of Return) at which the PV of all future cash flows are equal to the current book value of the portfolio.

Question 17

For NPV, can you use the PYR? (assuming no cash flow mismatch between assets & liabilities)

Answer 17

Yes and the same rate used for both the claims liabilities and premium liabilities.

Question 18

Risks associated with timing of asset cash flows vs liability cash flows. (2)

Answer 18

• Reinvestment Risk: if the assets come due BEFORE the liabilities ie: positive cash flow
• Liquidation Risk: if the assets come due after the liabilities ie: negative cash flow

Question 19

Selection considerations when reinvesting positive cash flows. (2)

Answer 19

• expected return on reinvestment dollars

- insurer’s investment strategy (growth vs buy & hold)

Question 20

Selection considerations when reinvesting negative cash flows. (2)

Answer 20

• maturity dates & liquidity of assets AGAINST liabilities
• Expected cash flow from future business to cover shortfalls

Question 21

Considerations for NPV, given reinvestment/liquidation due to cash flow mismatch between assets and liabilities. (3)

Answer 21

Blended rate based on:

• current PYR
• future reinvestment rates
• capital gain/loss from premature liquidation

Question 22

For CPV - identify possible choices for ceded discount rate (3)

Answer 22

• discount rate used by assuming company
• risk-free rate
• PYR (ie: same rate as for NPV), if insurer’s assets are sufficient to cover gross PV of liabilities

Question 23

For GPV - identify possible choices for gross discount rate (2)

Answer 23

• if NPV & CPV use the same discount rate THEN use that for GPV also
• IF NPV & CPV do not use the same discount rate THEN calculate GPV as NPV + CPV

Question 24

Formula for GAPV (gross APV).

Answer 24

GAPV = GPV + PfAD(gross claims) + PfAD(gross discount rate)

Question 25

Formula for CAPC (ceded APV).

Answer 25

CAPV = CPV + PfAD(ceded claims) + PfAD(ceded discount rate) - PfAD(reinsurance)
Note: reinsurance is not described as net or ceded and it’s component is subtracted