CIA.IFRS-2

Question 1

Briefly describe the concept of “risk adjustment” under IFRS 17

Answer 1

RA adjusts the PV(future cash flows) to reflect the compensation the entity requires for bearing uncertainty related to the amount and timing of cash flows

(the compensation the entity requires is a subjective assessment of an entity’s own risk appetite)

Question 2

Identify methods for calculating the RA (Risk Adjustment) under IFRS 17 (4)

Answer 2

• Quantile Methods
• Cost-of-capital method
• Margin Method
• A combination of methods

Question 3

Identify 4 qualitative principles to consider for calculating the non-financial risk adjustment in IFRS 17

Answer 3

1. Risks with low freq and high sev will result in higher RA for non-financial risk
2. For similar risks, contracts with a longer duration will result in higher RAs for non-financial risks vs shorter-duration contracts
3. Risks with a wider probability distribution will result in higher RAs for non-financial risks than risks with narrower distribution
4. The less that is known about the current estimate and its trend, the higher will be the RA for non-financial risk

Question 4

List some important considerations that will be relevant to how an entity determines its approach to estimating the RA (will include but are not limited to)

Answer 4

• Consistency with how the insurer assesses risk from a fulfilment perspective
• Practicality of implementation and ongoing re-measurement
• Translation of risk adjustment for disclosure of an equivalent confidence level measure

Question 5

Briefly explain two differences between the RA under IFRS 17 and the PfADs under current CIA practice

Answer 5

RAs under IFRS 17 only includes provisions for non-financial risk

PfADs cover uncertainty in both economic and non-economic assumptions

RAs reflect the compensation the entity requires for taking on risk vs PfADs that cover adverse deviations

Question 6

Identify 3 questions an Actuary would ask itself when going from IFRS4 MfADs to IFRS17 RAs

Answer 6

• Is the current level of PfAD consistent with the compensation the entity requires for bearing uncertainty?
• Are the diversification benefits included in current PfADs consistent with those that would be reflected in IFRS 17?
• How would the confidence level inherent to current PfADs be determined?

Question 7

Possible conditions for a zero RA

Answer 7

If the entity holds capital to support uncertainty in the future cash flows; or

if group of contracts has a short contract boundary (entity is able to recover deficits through future premiums)

Question 8

Must the RA at each reporting date satisfy the overall requirements of IFRS 17 for measurement, presentation and disclosure?

Answer 8

Yes

Question 9

Are the following requirements based on “unit of account” or “aggregate” level:
- Measurement
- Presentation
- Disclosure

Answer 9

Measurement: Unit of Account

Presentation & Disclosure: Aggregate

Question 10

Briefly discuss diversification benefits related to risk adjustments for non-financial risk

Answer 10

If the units of accounts are diversified, then your aggregate RA should be lower, and if you calculate the RA at the aggregate level, this diversification benefit will presumably be factored in.

If however your RA is done at the unit of account level, and the aggregate RA is expressed as the sum of individual RAs, then the diversification benefit might not be accurately reflected.

Question 11

How can an overall RA (calculated aggregately) be disaggregated?

Answer 11

• Based on the indicated RAs solely based on each amalgamated group
• Based on the margin impact of removing each amalgamated group on the indicated overall RA
• An average of the first two approaches; or
• An alternative approach

Question 12

Definition of RA for non financial risk for reinsurance contracts held

Answer 12

The RA for non-financial risk represents the amount of risk being transferred by the holder of the group of reinsurance contracts to the issuer of those contracts.

Conceptually: is the different in the risk position of the entity with and without the reinsurance held. So the RA could be determined based on the difference between these amounts.

Question 13

The key concepts underlying the RA are:

Answer 13

The gross RA represents the compensation for non-financial risk that the entity requires for issuing those contracts

The ceded RA represents the non-financial risk transferred from the entity to the reinsurer(s)

Question 14

Is discounting obligatory for the calculation of RAs for non-financial risk?

Answer 14

No, this is at the discretion of the entity

Question 15

What is the appropriate time horizon for calculation IFRS 17 RA?

Answer 15

It is the lifetime of the uncertainty in the insurance contract cash flows

Question 16

What are the disclosure requirements for the confidence level for the RA for non-financial risk

Answer 16

An entity shall disclose the confidence level used to determine the RA for non-financial risk. If the entity uses a technique other than the confidence level technique for determining the RA for non-financial risk, it shall disclose the technique used and the confidence level corresponding to the results of that technique.

Question 17

Identify the best RA method for incorporating a confidence interval

Answer 17

Quantile method (since is already part of the method)

Question 18

Briefly describe the quantile method for calculating the RA under IFRS 17, along with an advantage and a disadvantage

Answer 18

Quantile method:
- Quantile methods assess the probability of the adequacy of the Fulfilment Cash flow
- These probabilities are used to quantify the RA
- Specific methods include VaR (Value at Risk) and CTE (Conditional Tail Expectation)

Advantage: Satisfies the disclosure requirements regarding confidence level corresponding to the RA

Disadvantage: If misrepresented, it may introduce spurious accuracy

Question 19

Important differences between an entity’s existing VaR approach (for ex: for ORSA) vs the VaR approach for RAs

Answer 19

Risk profile: economic capital typically includes all risks, whereas RA only reflects non-financial risk

Time horizon: Economic capital tends to be calculated over 1-yr horizon whereas time horizon for the calculation of the confidence level of the RA would reflect all cash flows within the contract boundaries

Comparability: Economic capital is often calculated at higher percentiles & over 1-yr horizon. Confidence level of RA would generally reflect lower percentile over longer time horizon

Question 20

Briefly describe the cost-of-capital method for calculating the RA under IFRS 17, along with an advantage and a disadvantage

Answer 20

CoC method:
- RA is based on the compensation an entity requires to meet a target return on capital and has 3 components:
1. Projected capital amounts (for the level of non-financial risk during the duration of the contract)
2. Cost of capital rate(s) (for the relative compensation required by the entity for holding this capital)
3. Discount rates (for the PV calculation)

Advantage: Conceptually close to definition of RA and allows allocation of the RA at a more granular level

Disadvantage: Method is more complex (projection of capital requirements is an input to the RA calculation)

Question 21

Possible adjustments to capital requirement in the Cost of Capital Method

Answer 21

Remove capital component(s) related to risks other than non-financial risks in scope of the RA

Diversification if not specifically addressed in the capital model used

Consideration of risk-sharing mechanisms reflected in estimates of future cash flows

Question 22

Briefly describe the margin method for calculating the RA under IFRS 17

Answer 22

Margin Method:
- Select margins that reflect the compensation the entity requires for uncertainty related to non-financial risk

Question 23

Identify methods for calculating the risk adjustment for reinsurance held

Answer 23

• Quantile Method
• Catastrophe Models (specific to reins. held)
• Proportional Scaling (specific to reins. held)
• Cost of capital

Question 24

Briefly describe 2 IFRS 17 risk adjustment methods that are specific to reinsurance held

Answer 24

Catastrophe models:
- Use output from a CAT model tailored to an entity’s book of business
- Select a percentile directly from the given distribution

Proportional Scaling (works well for proportional or quota-share reinsurance)
- Use the same percentage of FCFs for the ceded RA as for the direct RA
- But percentage could be modified for considerations such as: ceding commissions, expense allowances, reinstatement premiums
- Method may also work for non-proportional reinsurance if the ceded RA can consistently be expressed as a portion of the gross RA

Question 25

Why might ceded losses for CAT reinsurance need a separate RA analysis from an entity’s direct losses?

Answer 25

Catastrophe reinsurance covers low-frequency, high-severity events

• A standard quantile method may produce an RA that is too small or even 0

Question 26

Describe a method for calculating an RA for ceded losses related to CAT reinsurance and high percentile events

Answer 26

Use a cost-of-capital method with an assumption for required capital set at a higher percentile

• This captures the compensation required at higher levels of the treaty

Question 27

Describe a way of combining RA methods for a “unit of account” approach

Answer 27

For groups with less skewed distributions - use VaR

For groups with highly skewed distributions - use of cost of capital methods or margins

Question 28

Identify the primary methods for calculating the RA under an “aggregate approach”

Answer 28

Quantile methods

Cost of capital methods