CIA.IFRS17-DiscountingRate

Question 1

define Discount Rate

Answer 1

rate used to discount the estimates of future cash flows which is consistent with the timing, liquidity and currency of the insurance contract cash flows

Question 2

define Fulfillment Cash Flow

Answer 2

= PV(future cash flows) + (risk adj for non-financial risk)

Question 3

define Liquidity Premium

Answer 3

• adj made to a liquid risk-free yield curve
• reflects differences between
  -> liquidity characteristics of the financial instruments that underlie the risk-free rates
  and
  -> liquidity characteristics of the insurance contracts
• note that HIGHLY liquid investment have low liquidity premium (and vice versa)

Question 4

define Reference Portfolio

Answer 4

• a portfolio of assets used to derive discount rates based on current market rates of return
• the portfolio rate of return is then adjusted to remove returns related to risk characteristics that are not in insurance contracts

Question 5

considerations in deciding whether to use net or gross & ceded data for analysis

Answer 5

Data availability
-> if data is sparse, it may not be possible to directly estimate the present value of ceded cash flows

Cash flow volatility
-> different approaches may be warranted for different segments of business depending on the volatility of cash flows by segment

Reinsurance held:
-> consider type and consistency of reinsurance held

Question 6

considerations in segmenting data for selecting payment pattern

Answer 6

• business segments used for analyzing undiscounted data
• payout period
• existence of a predetermined schedule of payments

Question 7

characteristics an IFRS 17 discount rate should possess

Answer 7

a) the discount rate should reflect the:
- time value of money
- characteristics of cash flows
- liquidity characteristics of insurance contracts
b) the discount rate should be consistent with:
- market prices for financial instruments with similar cash flow characteristics as insurance contracts
c) the discount rate should exclude:
- factors that affect market prices but do not affect cash flows for insurance contracts

Question 8

identify risk factors that may differ between a reference portfolio and insurance contracts

Answer 8

• liquidity
• investment risk (i.e. credit risk, market risk)
• timing
• currency risk

Question 9

identify examples of credit risk adjustments

Answer 9

• default risk

- downgrade risk

Question 10

identify 1 or more insurance contract features that increase liquidity

Answer 10

• low inherent value of contract

- high exit value of contract (large portion of inherent value is paid out)

Question 11

identify 1 or more insurance contract features that decrease liquidity

Answer 11

high exit costs for contracts (i.e. surrender penalties)

Question 12

identify the steps in a “combined approach” for estimating the liability liquidity premium LLP

Answer 12

1. create a reference portfolio and calculate the risk of return
2. subtract the risk-free rate to get the indicated asset liquidity premium ALP
3. then LLP = r * ALP + (constant liquidity premium difference)

Question 13

under IFRS 17, what is a reference curve

Answer 13

a “standardized” yield curve use to facilitate comparison among entities in the unobservable period

Question 14

under IFRS 17, when would a “locked-in” yield curve be used for discounting

Answer 14

• when an entity uses the GMA to determine the LRC for some or all groups of insurance contracts
  and
• when an entity elects the OCI option for some or all portfolios of insurance contracts

Question 15

identify 2 lines on the Income Statement where insurance expenses are reported

Answer 15

• insurance service expense

- insurance finance expenese

Question 16

what do “insurance expensee” refer to

Answer 16

they refer to the change in the carrying amount of the group of insurance contracts arising from:

• the effect of the time value of money and changes in the time value of money
• the effect of financial risk and changes in financial risk

Question 17

what is meant by the ‘unwinding of discounts’

Answer 17

the difference between discounting the cash flows to the beginning of the period and discounting to the end of the period

Question 18

identify methods for calculating the unwinding of discounts

Answer 18

constant yield curve:
- uses the same discount curve at the beginning and end of the period
unwinding using spot rates
- uses an end of period discount curve that is equal to the beginning discount curve shifted by one period
expectation hypothesis
- proposes that the term structure of interest rates is solely determined by market expectations of future interest rate changes

Question 19

what level of aggregation should be used for calculating FCFs

Answer 19

any level of aggregation provided estimates of LIC can be allocated back to portfolios and groups