CIA.IFRS17-DR Flashcards
Briefly describe discount rate
- rate used to discount the estimates of future CFs
- consistent with the timing, liquidity and currency of the insurance contract CFs
Briefly describe liquidity premium
adjustment made to a liquid risk-free yield curve to reflect the differences between:
- liquidity characteristics of the financial instruments that underlie the risk-free rates
and
- the liquidity characteristics of the insurance contracts
HIGHLY liquid investments have low liquidity premium
Identify considerations in deciding wether to use net or gross & ceded data for analysis (3)
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 (may not be appropriate to use the net basis if the entity’s retention has changed significantly over the experience period)
Identify considerations when selecting a payment pattern (3)
- business segments used for analyzing undiscounted liabilities
- payout period
- existence of a predetermined schedule of payments
Identify characteristics discount rate should possess (3)
(a) reflect the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contracts
(b) be consistent with observable current market prices for financial instruments with similar cash flow characteristic as insurance contracts
(c) should exclude factors that affect market prices but do not affect cash flows for insurance contracts
Identify and briefly describe methods for selecting the discount rates to be used for the valuation of insurance contract liabilities (2)
bottom-up approach
* a liquid, risk-free yield curve is adjusted to reflect:
→ differences between the liquidity characteristics of market financial instruments and the liquidity characteristics of the insurance contracts
top-down approach
* the yield to maturity of a reference portfolio of assets is adjusted to eliminate:
→ any factors that are not relevant to insurance contracts
Formula discount rate bottom-up approach
discount rate = (risk-free rate) + (liquidity premium)
Other notes:
advantage: availability of risk-free yield curves
disadvantage: the need to derive a liquidity premium
Formula discount rate top-down approach
discount rate = (reference portfolio yield) - (credit risk) - (market & other risks)
Other notes:
advantage: does not require the explicit derivation of a liquidity premium
disadvantage: potential complexity of the derivation of a reference portfolio rate
Identify factors that may differ from a reference portfolio and insurance contracts (4)
LITU
- liquidity
- investment risk (e.g. credit risk, market risk)
- timing
- currency risk
*The credit risk adjustment may include default risk and downgrade risk. Note also that a market risk adjustment would not be necessary if the reference portfolio consists solely of bonds.
Formula discount rate combined approach
discount rate = (risk-free rate) + (reference portfolio liquidity premium)
Formula reference portfolio liquidity premium
reference portfolio liquidity premium = (top-down discount rate) - (risk-free rate)
Identify 1 contract feature that decrease the liquidity of an insurance contract
- exit costs (surrender charges/penalties)
Identify 2 contract features that increase the liquidity of an insurance contract
- negligible/no inherent value other than any exit costs
- high exit value of contract (large portion of inherent value is paid out)
Is LIC considered liquid or illiquid?
Illiquid, no potential avenue for the policyholder to obtain the exit value yet there is tangible inherent value (else a claim would not have been made)
Is LRC considered liquid or illiquid?
liquid, no claims have yet occurred, the policyholder can cancel the policy before expiry date and receive value without significant exit costs
What is a reference curve
a standardized yield curve used to facilitate comparison among entities in the unobservable period
What is a locked-in yield curve
yield curves determined at the initial recognition of the group of contracts
When would a locked-in yield-curve be used for discounting (2)
In the context of financial reporting for P&C insurance contracts, locked-in yield curves are typically not used unless:
* the entity uses the GMA to determine the LRC for some or all groups of insurance
contracts; or
* the entity elects the OCI option for some or all portfolios of insurance contracts.
Identify the two seperate lines of the income statement where the insurance expenses are accounted for
- insurance service expense (claims)
- insurance finance expense
What does insurance finance expenses comprises (2)
comprises 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
Define the unwinding of discount
difference between discounting the cash flows to the beginning of the period and discounting to the end of the period
(release of the effect of discounting)
Briefly describe 3 different methods for calculating unwinding
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
