Final Revision Flashcards
AOS projection approach
- Most popular
- Project A, L over valuation year
- Set A=L at t=0
- Project A, L, A-L to t=1 on expected assumptions
- Change 1 assumption to actual at a time to get effect on surplus on this until all done
- Note effect on each assumptions depends on order
- No unique way
- Should be consistent year on year
- May be A->E, E->A etc.
- Reasonableness check appropriate given mechanical nature
AOS formula approach
- USe for non-linked without profits
- Too complex for ul, simplifying assumptions used
- Liabs at t=1 recalc on start year basis and contribution to surplus calc
- Other items require formulae e.g. mort/lapse/inv ret/NB
- Non-unique, A->E or E->A, consistency important
What change in reserves is profitable, use V0 and V1
Profitable change is V0-V1>0 (reserves reduce/release)
Items in the analysis of EEV?
What other items may be included in an internal AOEV
- Opening EEV
- Operating return:
a. Expected return on FS
b. Expected return on PVIF
c. Experience variance (non-econ)
d. Assumption changes (non-econ)
e. NB
f. Development costs
Total=Ops return before exceptionals and tax - Excpetionals
a. Investment return variance
b. Assumption changes (econ)
c. Currency movement
d. Exceptionals
Total=Ops return after exceptionals before tax - Tax
Total=Ops return after exceptionals and tax - Contribution to capital
- Distribution of capital
- Closing EEV
Extra items are:
- Model changes/corrections
- Unexplained (aim to minimise)
- Methodology changes
Actual experience = 100
Expected assumption = 80
What is the effect of experience variance?
A-E=100-80=+20
What is expected return on free surplus/PVIF?
i x FS0 or PVIF0
What is the effect on EV of an assumption change?
PVIF after change - PVIF before change
If actual lapse = 30% and expected lapse = 10%, what is the effect on reserves/PVIF that are 100 if expected lapse = 10%?
- Calculate the reserve without any lapses at time 1
=Reserve(t=1)/(1-actual lapse)
=100/0.7
=143 - Calculate the reserve with the expected lapse starting from the reserve without a lapse
=Reserve(no lapse)(1+expected lapse)
=1431.1
=157 - Release of reserves = Expected reserve - Actual reserve = 100-157 = -57
If expected reserve>actual then a release (as made a profit) - For PVIF use PVIF(t=1) instead of reserve(t=1) and final calculation is PVIF(t=1) - PVIF expected (so it’s opposite way round to reserve one)
What are the 3 payment times that should be considered in tax? How are they taxed on life/pensions
- Premiums L tax, P not
- Investment income/gains L tax, P not (except div)
- Benefits L not if Qualifying, P tax (except tax-free cash)
When is Life insurance qualifying?
Depends on:
Term
Premium paying term/frequency
Death benefit vs. total premiums payable
Explain tax for life insurance
Premiums: 1. from post tax earnings 2. no recovery of tax or additional tax 3. Max of 3600 pa Investment return: 1. Taxed for Q and Non-Q Benefits Non-qualifying: Taxed on maturity/death/surrender/part surrender/sale Qualifying: If <10yrs or 3/4 term if earlier taxed on s/ps/sale Else no tax
How is a life insurance Q or non-Q taxed on benefits, if it is taxed?
- Chargeable gains tax
- Total benefits - total premiums paid
- Taxed at marginal rate - lower tax rate (20%)
How are general annuities (PLA) taxed?
Premiums:
1. No tax relief.
Benefits:
1. Taxed annuity payments
2. Taxed on death/surrender @ full marginal rate
3. The tax liability is on amounts exceeding the capital content (ie. On the amount exceeding repayment of premium)
How is pensions business taxed? (includes pension annuities)
Premiums/Contributions
1. Paid from gross earnings
2. Tax relief on max(3600pa, salary) @ 20% at source, reclaim other amounts through HMRC
3. £40k max annual contribution, unused limits for past 3 years allowed
4, Employers only get tax relief if wholly for trade
Investment income
- Residential property/wine/antiques not allowed
- Tax-free roll up
Benefits:
- Taxed as earned income at marginal rate
- Up to 25% TFC
- Total lifetime allowance 1.25m
- Triviality on pensions<2000
- Release of pension funds at death is 55% tax
- OLTB formula
2. BLAGAB derivation
1. OLTB=trading profit P+I+G-C-E+(V0-V1)+(D1-D0)-L P=premiums I=investment income G=change in asset values C=claims outgo E=expenses V0-V1 = release of reserves D1-D0 = change in DAC L=losses carried forward
- BLAGAB = I-E basis = SH Profit + PH profit
a. PH Profit = Claims - Premiums
Where Claims = Claim outgo - (V0-V1)
b. SHP=P+I+G-E-(Claim outgo-(V0-V1))
But P-(Claim outgo-(V0-V1))= - PHP
c. SHP=I+G-E-PHP
d. So SHP+PHP=I-E (where I includes income and gain)
What are the contents of the I in the I-E basis?
- Investment income on property/bonds/gilts/cash deposits
- Not equity as that’s taxed on dividends
- Realised gains on property and equity allowing for indexation
- Capital value gains in gilts/bonds/derivatives
- Misc. income e.g. reinsurance income
What are the contents of E in the I-E basis
- BLAGAB share of expense s.t. DAC spreading over 7 years
- Income component of feneral annuities
- Full admin/commission
What might change the amount of tax paid?
- REgs
- OLTB trading profit
ie prem/inv income/asset values/expenses/claims/reserve changes/DAC changes/losses carried forward - I-E basis
ie. I = - inv income from gilts/prop/cash/bonds
- capital changes in proper/eq/gilts/bonds/derviatives
- misc income
E= - Expenses like commission and admin costs
- Income component of GAB
- DAC changes so NB
- Staff salary etc.
What is the tax amount if.. I=900 E=700 LATP=50 OLTB profit = 100 Corp tax = 24% Income tax = 20%
OLTB*24% Min profits test: I-E (+share of div income)=200>LATP So LATP@25% I-E (+div income) - LATP = 150*20%
If I-E+div income = 50 and LATP=80 what happens in tax?
LATP*corp tax
Increase E s.t. I-E+div income=80 (so by 30)
And carry over 30 excess E
AFH responsibilities
- Calc liabs - Advise management on risks affecting ph liabs
- Calc cap req - Advise management on capital required to support business
- Monitor risks and inform management of concerns over possible failure to meet liabs
- Inform management of concerns writing NB
- Advice governing body on methods/assumptions for actuarial investigations
- Perform these investigations included solvency ones
- Report results of investigations to governing body
WPA responsibilities
- Advise management of discretion used in WP
- Produce report on this advice at least annually
- Advise management on whether assumptions to calc WPICC are consistent with PPFM
- Produce publicly available annual report to ph
- Confimr in this report whether, in the WPA opinion, firm has accounted for PRE and TCF in using its discretion
What must a firm do for WPA/AFH?
- Keep them informed of plans and seek advice for implications to ph
- Pay due regard to their advice
- Provide them with adequate resources/data/systems as required
Explain Part VII transfers
- Must obtain sanction from high court
- Must be within EEA states
- REport given in form approved by PRA from independent expert approved/nominated by them
- Adequately publish scheme
- Send all ph notice approved by PRA
- Send statement to ph and sh which
a. Sets out terms of scheme
b. Contains summary of (3)’s opinion - Confirm new company authorised to do this business
- Confirm new company able to cover regulatory capital requirements
- Anyone including employess/PRA/FCA has right to be heard in court
- Set out in Part VII of FSMA
What is EV and ‘Change in EV plus profit transfer’
EV = shareholder value of insurer
‘change in EV plus profit transfer’ = Profit over a year
What guidance did APM give?
- Estimate each experience assumption e.g. investment return/lapses/expenses/mortality and may include MADs
- Estimate future SHT if (1) happens
- Discount to t=0, may include margin for risk
- Profit=’change in EV + profit transfer from supervisory returns
What did APM not give guidance in?
- Calc of g’s and o’s
2. no clear risk exposure guidance
What were the reasons for EEV?
- consistency in approach
- clearness on need to value g’s and o’s including time value
- minimum disclosure levels to address comparability concerns
What were the EEV minimum disclosures?
- The EV
- Sensitivities
- Analysis of movement in EEV
- Methodology/assumptions/results basis
What were the EEV failures?
- No consistency in approach
- No method on setting risk disc. rate
- No method on g’s and o’s
- No method on cost of holding capital req
- Numerous approaches so not comparable
What concerns in MCEV address?
- Address concerns over EEV
- Liquidity premium included in risk free rate (for expected return/discounting)
- Risk free rate on swap yields + liquidity premium
What were the goals of MCEV?
- MC calibration - CF’s at MV
- Consistency in application by being credible and robust
- Clear guidance on investment return/discount rate
- Guidance on movement analysis/NB value/non-hedgeable risks
- Disclosure guidance
What are the MCEV and EEV disclosures?
- EV value
- Sensitivities
- Standard report formats for consistency (new for MCEV)
- Analysis of movement
- MEthodology/assumptions/results basis disclosure
What are the 12 EEV principles?
- Measure…of consolidated value of shareholder interests in the covered business
- Covered business - clearly identified and disclosed
- EV formula - EV=FS+(Req cap - cost of holding req cap) + PVIF
- FS@MV
a. Amount of capital+surplus above required for business liabilities @ t=0 - Req Cap = assets not backing liabs directly but not able to be distributed to shareholders
- PVIF = PVF SH cashflows from assets backing liabs accounting for G’s and O’s
- G’s and O’s = All accounted for including stoch valn of time value
- Excludes NB (sales/renewals/alterations)
- Assumps -
a. account for past/current/future expectations and other relevant data.
b. Dynamic assumptions if sufficient evidence
c. actively reviewed - Economic assumps
a. At MV - consistent with observable/reliable market data
b. No smoothing of MV allowed or unrealised gains - WP assumps
a. Annual bonuses allowed for
b. SHT’s allowed for and assumptions made on PH vs. SH split
c. Assumptions consistent with projection/local market practice/company practice - Disclosure - results @ group level
Explain Peak 1?
Introduction
1. Prescriptive rules
2. Statutory valn satisfying minimum EU standards
3. Different rules if reg/real firm
Assets
1. Allowed to account for certain admissible assets
2. e.g. govt. bonds/equities/property/approved derivatives
3. Not PVFP NP in WP fund
4. Not assets that are high risk/hard to value
5. Assets are mostly valued at MV though straight line runs off or qualified valuer may be needed
Exposure limits
1. There are max market/counterparty exposurers
2. Apart from government/local authority assets
Liabs
1. These are mathematical reserves
2. Prudent basis with MADs
3. Future prospective valuation
4. Future valaution strain avoided
5. Future RB allowed for if reg. firm
6. Allowance for future lapse rates
7. VIR (rate at which assets grow) <=97.5% risk adj (lowered for default) yields on backing assets
Capital Req
1. Cap req = LTICR+RCR+WPICC
2. LTICR is a % of math res
3. RCR covers prop/eq/FI (market risk) shocks
3. RCR=0 if realistic firm
4. CRR=max(MCR,ECR) where MCR=…ECR=…
5. WPICC is max(0, reg. excess cap-realistic excess cap)
6. Peak 1 bites if WPICC=0 ie. Peak 1 has less FS
What is WC?
MV Assets in WP fund - realistic liabs (before any RCM)
What are the sources of WC movements? (Peak 2 surplus)
1, A not matching L
- PH g/o takeup
- Discretion used
- Assets not backing L investment return
- Opening adjustments - corrections/methodology/model changes/data changes
- Economic variance - investment return on WC, mismatch profits/losses e.g. from yield changes/volatility
- Insurance variance - mort/persistency/expenses (change in assumptions or actual vs. expected)
- NB
- Capital injections
- Other misc. variances
- Unexplained - aim to minimise or get within % of total liabs
How do you do an analysis of WC movement?
- Rerun model at start year RBS
- Model changes/corrections/methodology changes
- Change non-economic LT assumps (ideally only change from new valuation date)
- Roll forward model to new valuation date using actual investment return and economic scenarios calculated to new val date (gives total economic variance)
- Add NB
- Add actual insurance experience to get experience variance
- Unexplained = Time 1 BS - RF TIme 0 BS
How do you do an analysis of movement in RCM?
- Do the steps for an analysis of WC movement for most adverse stress
- Additional steps if change in test strength or most adverse stress changes
How are AOC and AOWC used?
- AOS doesn’t give true picture of performance as prudent base
- AOWC does as BE
- Used to provide possible limits on NB by looking at impact on WC
- IF reg. surplus movements are negative a lot then indicates basis not prudent enough
- Decision on how to derisk the BS and protect solvency
Why do an AOEV?
- DIsclosure requirement
- Recon opening/closing
- Help revising basis by comparing actual/expected experience
- NB value for management purposes
- ID profit/loss sources so actions can be taken to increase/decrease them
- ID unprofitable contracts for redesign/closure
- Validate data/calcs process
- Remuneration package (compare areas performance)
How might you split an EV analysis even more than the normal headings like Operating Return etc.
Impact on..
- FS
- Required capital
- PVIF
- Total
List the Math Res requirements
- Prospective valuation, prudent assumptions, sufficient MADs
- No future valuation strain
- Individual reserves>gteed SV if exists
- Sometimes reserve=NPV
Realistic firm can hold either NPV/GPV
Explain peak 1 assets
- Admissible assets
- Includes WP and NP in WP fund assets
- Derivatives are inadmissible
- Max exposure limits to single issuer, % of math res
- No max exposure on govt/local authority assets
- Max exposure limits on asset classes too
- No allowance for PVFP NP in WP fund
Explain Peak 2 assets
- Includes admissible assets backing WP but not NP in WP fund
- Inadmissible derivatives @ MV included
- Included excess admissibles (no exposure limits to single issuer)
- Included PVFP NP in WP fund; including LTICR release
- Includes support assets
How do you tell which peak bites?
- If WPICC=0 then peak 1 bites
2. WPICC>0, peak 2 bites
Formula for WPICC?
WPICC
=max(0, reg. XS capital - realistic XS capital)
=max(0, [Admissible Assets-(math.res+LTICR+RCR)]-[Realistic Assets-Realistic Liabs])
Explain credit risk, what is it and how to control it?
What is it? 1. Risk of loss if counterparty fails to perform contractual obligations including paying on time 2. May impact insurers ability to pay claims 3. Examples include: a. Default of coupons/principles on corporate bonds b. Bank defaults on cash c. Reinsurer default How to control it? 1. Systems needed to monitor exposure 2. Use derivatives to reduce exposure 3. Systems ensure exposure is: a. Adequately diversified b. Within regulations c. Within own risk appetite d. Within capital resources 4. Might not invest in corporate bonds at all
Explain market risk, what is it and how to control it?
What is it?
1. Risk market movements cause fluctuations in income/market value of assets or liabs
2. e.g. int rate/equity/currency/property
3. Note the source of risk in (2) are not independent
How to control it?
1. Systems of internal controls to monitor exposure to market risks
2. Must consider correlations of each source of risk
3. Could use derivatives to reduce exposure
4. May change asset mix to less volatile to reduce risk
5. Take into account regulations
6. Take into account governence, sensitivity of liabilities, management actions
7. Might not invest at all
Why do an AOS?
- Fin effect (reg/real basis) of diff between actual and expected experience
- Fin effect of writing NB
- Recon open/closing supervisory surplus
- If independent of valuation data, check on data/valn process
- Reg requirement in analysis of movement in WC for Peak 2 WP funds
What are the sources of surplus?
- Change in valuation assumption
- Actual vs. expected -
a. Inv ret
b. expenses
c. mort
d. exits e.g. lapses/retirements
e. changes in UL and accumulating WP
f tax
g. NB - Change in regs/models/methodology/correction
If VIR=3% what does it mean?
Expected return on assets is 3%
Design factors?
Admins systems Marketability Profitability Legal/Reg restrictions X subsidies
Distribution channel/commission Inadmissibility of assets Reinsurance terms/capacity Expenses Competition Tax
Financing/capital requirements A Company reputation TCF/PRE/PPFM O's and G's Risk Level Service standards/outsourcing
Matching NTC Liabs Customer needs of target market Profit sensitivity Underwriting standards Monitor/Review frequently
Unit linked product, changing charges - factors to consider?
- Matching charges and expenses timing/size
- Profit level target NPV/IRR/DPP etc
- Effect on Ev
- Current/future regs (SII)
- Level and shape of competition charges
- Higher charge means less business
- Lower charge may mean too much business and admin/capital requirements can’t cope
- Market sensitivity to price changes
- Service levels as IFA accounts for this
- Could do better services with increased charges
- Commission
- Is it Niche
- Information given to policyholder
- TCF/PRE
- Meets target market needs
- No unreasonable barriers to exit
- Regulatory constraings - current/future
- Extent of X-subs - business mix may change
- Complexity and misselling
- Tax rules when profit testing
- Allow for current tax regime
- Sense testing
- Other charges possible e.g. for guarantees
- Offer more features for more charges
- Iterative to find right mix of profit/marketability/risk/capital requirement
- There will always be compromise
Why is a CF method preferred when profit testing?
- Discounted CF method preferred to equating PV
- Enables measuring expected return to SH
- Sensitivity of profit can be investigated to find margins
- Allows explicitly for reserves and solvency requirements
- Allows analysis of financing requirements, for 1 product or whole group
- Allows easily for lapses and PUPs
- Copes easily with complex charging/benefit structures
- G’s and O’s modelled more appropriately
- Complex reinsurance can be modelled
- Dynamic assumptions varying over time allowed
- Stochastic assumptions allowed
- Risk discount rate allows for term structure
- Tax allowed for more appropriately
- If UL, it’s the only one that’ll work
What assumptions allowed for in pricing?
- Mortality including longevity
- Investment return (including correlation and economic scenarios if stochastic valuation)
3 Inflation (consistent with (2)) - Expenses including commission (from latest investigation/reinsurer/consultants)
- Persistency perhaps varying by premium level/dur_if (from latest investigation/reinsurer/consultants)
- Tax (OLTB/BLAGAB)
- Risk discount rate or risk free rate if MC with adjustments for risk elsewhere e.g. experience assumption/cost of capital method in SII
- Profitability measure - NPV/DPP/IRR
