Concepts Flashcards
Main purpose of each of the pillars in the SAM structure
Pillar 1 stipulates the quantitative requirements that insurers must satisfy to demonstrate that they have adequate financial resources.
The main purpose of Pillar 1 is to provide comfort to the Prudential Authority (PA) that insurers are able to meet their obligations to policyholders and beneficiaries under a number of scenarios.
Pillar 2 assesses the effectiveness of corporate governance and risk management of the insurer.
The main purposes of Pillar 2 are
* to require insurers to demonstrate that a risk management system is embedded in key business decisions.
* to enable the PA to assess the insurer’s system of governance
* to require insurers to consider the entirety of the processes and procedures employed to identify, assess, monitor, manage, and report long and short term risks they face.
* to require insurers to determine the suitability of own funds under Pillar 1 by developing stress tests, scenarios, reverse stress tests and risk appetite metrics to ensure that overall solvency needs are met at all times;
* and in doing so, to help insurers determine the overall level of economic capital they need.
Pillar 3 seeks to create transparency with the aim of harnessing market discipline in support of regulatory objectives.
The main purpose of Pillar 3 is to require insurers to disclose how risks are managed.
Outline the responsibilities of the Risk Management Function
- To identify the risks the insurer faces.
- To assess the identified risks effectively in order to gain and maintain an aggregated view of the risk profile of the insurer at an enterprise-wide and individual business unit level.
- To evaluate the internal and external risk environment on an on-going basis in order to identify and assess potential risks as early as possible.
- To conduct regular stress testing and scenario analyses, including in respect of outliers or matters with low probability but high potential impact.
- To regularly report to the management and the board of directors on the insurer’s risk profile, and the actions taken to mitigate the risks.
- To help ensure that the risk management framework is maintained and improved, which includes conducting regular assessments of the risk management function and the risk management system to identify improvements that are needed.
- To document and report material changes to the insurer’s risk management system
Outline the responsibilities of the Actuarial Function
- The main responsibility of the Actuarial function is to provide assurance to the board of directors regarding the accuracy of the calculations and the appropriateness of the assumptions underlying the insurance liabilities and the capital needed by the insurer.
- Ensuring the appropriateness of the methodologies and underlying models used and assumptions made.
- Assessing the sufficiency and quality of the data used in the calculations.
- Comparing best estimates against experience when evaluating liabilities.
- Informing the board of directors of the reliability and adequacy of the calculations.
- Overseeing the calculations in the cases where, due to insufficient data of appropriate quality to apply reliable actuarial method, approximations were used in the calculation of liabilities and capital.
- Expressing an opinion on the asset-liability management policy and the underwriting risk management policy.
- Expressing an opinion on the reinsurance and other forms of risk transfer policy and the adequacy of reinsurance arrangements.
- Expressing an opinion on the actuarial soundness of premiums, benefits, and any other values thereof, including the awarding of bonuses to policyholders.
Define the appraisal value of an insurance company
An appraisal value is a method used to put a value on an insurance company.
Where the EV is only concerned with the value of existing business, an appraisal value also looks at the value of future new business of a company.
Hence the appraisal value of a company is made up as follows:
* Embedded value (EV)
* Present value of future new business (PVFNB)
Describe embedded value
EV is a measure of the consolidated value of shareholders’ interests in the covered business.
Embedded value is calculated according to APN 107.
Embedded value, as well as the analysis of change in embedded value, is published in the annual financial statements of the company.
The embedded value (EV) of a listed life insurance company consists of
* the free surplus, in respect of the shareholders’ fund,
* the required capital to support the business,
* the present value of the future after tax profits from the p/h fund (VIF)
* an adjustment in respect of the cost of the required capital (CoRC)
The free surplus plus the required capital equals the adjusted net worth (ANW) of the company.
The cost of holding the required capital represents the difference between the return required by shareholders and the return, net of tax, that can be earned on the required capital.
The value of future new business is excluded from EV.
Describe present value of future new business (PVFNB)
PVFNB often referred to as the ‘goodwill’ value of the company.
The PVFNB is a very subjective value as assumptions on future business volumes needs to be made.
It is therefore common to produce a range of appraisal values based on different levels of future new business.
One method of calculating the PVFNB is to look at the VNB written over the last 12 months.
The PVFNB can then be estimated using a multiple of VNB.
The VNB should be calculated as per APN 107.
The multiple used in calculating the PVFNB will depend on:
* the company’s tax position,
* expected future new business growth
* as well as the RDR.
* It is also common practice to use a higher RDR in calculating the PVFNB than for the VIF.
* For products where insufficient business volumes were sold or new products that have not been launched yet, alternative methods can be used.
One possible approach is to project
* number of expected new policies during the next five years and discount the shareholders’ cash flows to current date.
* All acquisition costs and costs of capital requirements should be taken into account.
Goodwill could also include an allowance for the value of non-covered business.
Discuss the main components of the analysis of change of the embedded value
Change in embedded value
A suggested template for the analysis of the change in EV is set out in APN 107.
The three components (ANW, VIF and CoRC) of the embedded value should be analysed separately.
The expected profit transfer should have offsetting values in the ANW and VIF column – a positive value in the ANW column and a negative value in the VIF column.
The VIF would increase with unwinding of the risk discount rate.
The main components into which the change in ANW and VIF would be analysed are:
* The value of new business written during the year.
* The difference between the actual and the expected transfer to/from the VIF to the ANW.
* This difference includes operating experience (from mortality, persistency, alterations, expenses) variances and investment return variances
* Any change in operating assumptions (e.g. Decrements and expenses)
* Any model changes
* Any economic assumption changes.
* Any data changes (e.g. model point changes)
In addition to above the ANW will also change due to:
- Investment return (income and capital appreciation/depreciation ) on ANW
- Capital movements : Capital injections into the company and dividends paid out
Requirements of the underwriting risk management policy
Identify the nature of the insurer’s insurance business, including:
* Classes of insurance to be underwritten
* Types of risks that may be underwritten and those that are to be excluded
Describe the formal risk assessment process in underwriting, including:
* Criteria used for risk assessment
* Methods for monitoring emerging experience
* Methods by which the emerging experience is taken into consideration in the underwriting process.
- Provide for decision-making processes and controls where non-mandated intermediaries or underwriting managers perform binder functions on behalf of the insurer.
- Set out actions to be taken by the insurer to assess and manage the risk of loss, or of adverse changes in the values of insurance and reinsurance liabilities, resulting from inadequate pricing and provisioning assumptions.
- Set out the relevant data to be considered in the underwriting and reserving processes.
- Establish the insurer’s approach to assumption setting, including the level of conservatism needed to align with the insurer’s risk appetite.
- Provide for the regular review of the adequacy of claims management procedures including the extent to which they cover the overall cycle of claims.
In the context of EV, define Free Surplus.
The free surplus is the market value of any assets allocated to, but not required to support, the in-force business at the valuation date.
Assets should be valued at their fair value (which in the case of listed instruments is market value).
Where a market price is not readily available, assets should be valued at an estimate of their fair value calculated using generally accepted asset valuation techniques on a basis consistent with observable market data.
In the context of EV, define Required Capital.
Required capital should include any assets attribute to the covered business over and above the amount required to back liabilities and whose distribution to shareholders is in practice restricted.
The level of required capital should be based on the level of assets required to meet internal objectives, such as those based on an internal risk assessment, a specified multiple of solvency capital or those required to obtain a targeted credit rating.
The combined EVM internal capital target and EVM policy liabilities must always exceed the combined value of actuarial liabilities and solvency capital on the regulatory solvency basis.
Define PVIF
The present value of future shareholder cashflows from in-force covered business is the present value of future shareholder cash flows projected to emerge from the assets backing the liabilities of the in-force covered business. The actuary must adequately disclose the basis being used as well as the justification for that basis.
PVIF should include reinsurance accepted, be net of reinsurance ceded and net of tax.
Where the EVM has been aligned to the SAM methodology and assumptions, the PVIF may be implicitly included in other components of the EV.
In the context of EV, define VNB
Value of new business is defined as the present value of the expected after tax shareholder cash flows less cost of required capital arising at the point of sale in respect of new covered business contracts sold in the reporting period. The allowance for tax on VNB should be consistent with that of in-force business.
The calculation of VNB should allow for actual acquisition costs incurred and cash flow strains under the statutory valuation basis. Appropriate allowance should be made in the VNB for the expected cost of embedded investment guarantees.
In the context of EV, define New Business
New Business is defined as covered business arising from the sale of new contracts and one off premium increases in respect of in-force business during the reporting period. This definition includes business written during the reporting period that has subsequently gone off the books, but excludes policies cancelled at inception. The EV should only reflect in-force business, which excludes future new business.
Typical examples of one off premium increases defined as new business include:
* The continuation beyond the original term of individual policy contracts with a fixed maturity date (unless continuation of a proportion of maturities has previously been assumed when calculating the PVIF);
* Non-contractual premium increases at the request of the contract owner;
* Renewable single premiums; and
* Premium increases arising from new benefits that are added to existing contracts.
The basic principle that should be applied at all times is that the cash flows associated with each premium, and any variation against previous assumptions of these premiums, should be counted once and only once. Premium increases that have already been allowed for in the value of in-force business may not be counted again as new business when they actually occur (i.e. when premiums deviate from what was previously assumed).
Explain how assets are valued under the prudential supervisory balance sheet
The valuation of total assets mainly follows International Financial Reporting Standards (IFRS) and the main requirement is that of market consistency and an economic (or fair value) valuation approach.
There are some minor deviations form IFRS with the intention of bringing the treatment of assets and liabilities, excluding technical provisions, closer to an economic valuation approach, including:
* Goodwill should be valued as zero
* Disallowing deferred acquisition costs (DAC)
* Other intangible assets should only be included to the extent that a fair value can be placed on them.
* Financial assets (such as derivatives, loans payable and receivable, and debt and equity securities) must be valued as fair value.
* Participations (i.e. subsidiaries) must be valued at:
* Market value, if listed
* Adjusted net asset value, if unlisted and possible
* IFRS value, otherwise.
Adjusted net asset value is equal to the excess of assets over liabilities less goodwill and intangibles.
Reinsurance recoverables (net of counterparty default risk) should be reflected explicitly as an asset in the balance sheet.
Outline how liabilities are valued in the supervisory balance sheet
Liabilities consist of technical provisions plus other liabilities.
Technical Provisions
Technical provisions are the value of an insurer’s insurance obligations due to policyholders and beneficiaries, over the lifetime of those obligations, if such obligations were to be transferred immediately to another insurer. They are calculated on a market consistent basis.
They consist of the best estimate liability (BEL) and a risk margin. When the cash flow for a liability can be replicated exactly in all possible scenarios by an asset or portfolio of assets which are traded in an active market, the technical provisions can be set equal to the market value of the asset(s). There is no need to add a risk margin.
Other liabilities
Other liabilities are non-insurance liabilities and other creditors and can include subordinated debt. These are generally valued using IFRS fair value principles. Contingent liabilities should be defined and valued according to IFRS, but recognised as a liability.
Under SAM, explain how the BELs should be determined
The BEL must be determined as the value of the probability-weighted average projected cash flows up to the contract boundary discounted using a risk-free yield.
The BEL must be calculated on a gross basis, without deducting amounts recoverable from reinsurance contracts and other risk mitigation instruments.
The BEL must be calculated on a policy-by-policy basis on best estimate assumptions with no additional margins for prudence.
The BEL can be negative.
Projections should allow for all expected decrements and policyholder actions, including lapses.
Companies must take into account all relevant available data, both internal and external, when arriving at assumptions that best reflect the characteristics of the underlying insurance portfolio.
Best estimate assumptions can allow for future management actions (such as reviewing premiums or charges) that the insurer could reasonably expect to implement and which allow appropriately for expected policyholder behaviour. Need to allow for the time to implement management actions and the actions assumed must be consistent with the insurer’s current business practice.
Financial options and guarantees may be valued using: stochastic approach; series of deterministic projections, deterministic valuation based on expected cashflows.
The approach used to value the best estimate of contractual options and guarantees should be market-consistent and proportionate to the nature, scale and complexity of the insurer’s business.
