CIA.IFRS-2 Flashcards
Briefly describe the concept of “risk adjustment” under IFRS 17
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)
Identify methods for calculating the RA (Risk Adjustment) under IFRS 17 (4)
- Quantile Methods
- Cost-of-capital method
- Margin Method
- A combination of methods
Identify 4 qualitative principles to consider for calculating the non-financial risk adjustment in IFRS 17
- Risks with low freq and high sev will result in higher RA for non-financial risk
- For similar risks, contracts with a longer duration will result in higher RAs for non-financial risks vs shorter-duration contracts
- Risks with a wider probability distribution will result in higher RAs for non-financial risks than risks with narrower distribution
- The less that is known about the current estimate and its trend, the higher will be the RA for non-financial risk
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)
- 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
Briefly explain two differences between the RA under IFRS 17 and the PfADs under current CIA practice
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
Identify 3 questions an Actuary would ask itself when going from IFRS4 MfADs to IFRS17 RAs
- 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?
Possible conditions for a zero RA
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)
Must the RA at each reporting date satisfy the overall requirements of IFRS 17 for measurement, presentation and disclosure?
Yes
Are the following requirements based on “unit of account” or “aggregate” level:
- Measurement
- Presentation
- Disclosure
Measurement: Unit of Account
Presentation & Disclosure: Aggregate
Briefly discuss diversification benefits related to risk adjustments for non-financial risk
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.
How can an overall RA (calculated aggregately) be disaggregated?
- 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
Definition of RA for non financial risk for reinsurance contracts held
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.
The key concepts underlying the RA are:
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)
Is discounting obligatory for the calculation of RAs for non-financial risk?
No, this is at the discretion of the entity
What is the appropriate time horizon for calculation IFRS 17 RA?
It is the lifetime of the uncertainty in the insurance contract cash flows
What are the disclosure requirements for the confidence level for the RA for non-financial risk
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.
Identify the best RA method for incorporating a confidence interval
Quantile method (since is already part of the method)
Briefly describe the quantile method for calculating the RA under IFRS 17, along with an advantage and a disadvantage
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
Important differences between an entity’s existing VaR approach (for ex: for ORSA) vs the VaR approach for RAs
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
Briefly describe the cost-of-capital method for calculating the RA under IFRS 17, along with an advantage and a disadvantage
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)
Possible adjustments to capital requirement in the Cost of Capital Method
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
Briefly describe the margin method for calculating the RA under IFRS 17
Margin Method:
- Select margins that reflect the compensation the entity requires for uncertainty related to non-financial risk
Identify methods for calculating the risk adjustment for reinsurance held
- Quantile Method
- Catastrophe Models (specific to reins. held)
- Proportional Scaling (specific to reins. held)
- Cost of capital
Briefly describe 2 IFRS 17 risk adjustment methods that are specific to reinsurance held
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
Why might ceded losses for CAT reinsurance need a separate RA analysis from an entity’s direct losses?
Catastrophe reinsurance covers low-frequency, high-severity events
- A standard quantile method may produce an RA that is too small or even 0
Describe a method for calculating an RA for ceded losses related to CAT reinsurance and high percentile events
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
Describe a way of combining RA methods for a “unit of account” approach
For groups with less skewed distributions - use VaR
For groups with highly skewed distributions - use of cost of capital methods or margins
Identify the primary methods for calculating the RA under an “aggregate approach”
Quantile methods
Cost of capital methods
