IFRS17 DR

Question 1

define the IFRS 17 term: 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 the IFRS 17 term: Fulfillment Cash Flow (FCF)

Answer 2

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

Question 3

define the IFRS 17 term: liquidity premium

Answer 3

• adjustment 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 investments have low liquidity premium (and vice versa)

Question 4

define the IFRS 17 term: 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

is the liquidity of a government bond HIGH or low?

Answer 5

HIGH, because there is low risk and can be easily converted to cash

Question 6

is the liquidity of an investment in a messenger RNA research facility HIGH or low?

Answer 6

low, because it’s high-risk and could be difficult to convert back to cash

Question 7

identify contract features that affect the liquidity premium

Answer 7

exit costs
→ high exit costs like surrender penalties decrease liquidity (and therefore increase the liquidity premium)
inherent value
→ low inherent value increases liquidity (and therefore decreases the liquidity premium)
exit value
→ a large portion of inherent value being paid out increases liquidity (and therefore decreases the liquidity premium)

Question 8

(IFRS17 -1) Theoretical approach determine illiquidity premium

Answer 8

Replicating portfolio:
Level of illiquidity based on contract provisions affecting policy holders of reinsurance
1) cancel policy before expiry date
2) w.o significant exit cost
3) receive exit value in advance of payment schedule

Question 9

identify 1 or more insurance contract features that increase liquidity

Answer 9

• low inherent value of contract
• high exit value of contract (large portion of inherent value is paid out)
  (an increase in liquidity means lower liquidity premium)

Question 10

identify 1 or more insurance contract features that decrease liquidity

Answer 10

• high exit costs for contract (Ex: surrender penalties)
  (a decrease in liquidity means HIGHER liquidity premium)

Question 11

which set of insurance contract liabilities is more liquid: LIC or LRC

Answer 11

LRC is more liquid (Liability for Remaining Claims)
→ since no claims have yet occurred, it’s easier to cancel or otherwise get rid of the contract
→ recal that LIC stands for Liability for Incurred Claims

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 rate 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

identify considerations in deciding whether to use net or gross & ceded data for analysis (3)

Answer 13

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 14

identify considerations in segmenting data for selecting payment patterns (3)

Answer 14

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

Question 15

identify characteristics an IFRS 17 discount rate should possess (3)

Answer 15

(a) the discount rate should reflect:
* 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 characteristic as insurance contracts
(c) the discount rate should exclude:
* factors that affect market prices but do not affect cash flows for insurance contracts

Question 16

identify methods for selecting a discount rate for valuation of insurance contract liabilities under IFRS 17 (2)

Answer 16

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

Question 17

identify risk factors that may differ between a reference portfolio and insurance contracts (4)

Answer 17

• liquidity
• investment risk (Ex: credit risk, market risk)
• timing
• currency risk

Question 18

identify examples of credit risk adjustments

Answer 18

default risk, downgrade risk

Question 19

calculate the market risk adjustment if the reference portfolio consists solely of bonds

Answer 19

no adjustment is necessary

Question 20

which set of insurance contract liabilities is more liquid: LIC or LRC

Answer 20

LRC is more liquid (Liability for Remaining Claims)
→ since no claims have yet occurred, it’s easier to cancel or otherwise get rid of the contract
→ recal that LIC stands for Liability for Incurred Claims

Question 21

under IFRS 17, what is a reference curve

Answer 21

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

Question 22

under IFRS 17, should discount rates vary with the timing of cash flows

Answer 22

yes, this is the purpose of yield curve (versus a spot rate)

Question 23

under IFRS 17, what is a ‘locked-in’ yield curve

Answer 23

a yield curve determined at the initial recognition of the group of contracts

Question 24

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

Answer 24

• 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 25

under IFRS 17, identify 2 lines on the Income Statement where insurance expenses are reported

Answer 25

• insurance service expense
• insurance finance expense

Question 26

under IFRS 17, what does ‘insurance finance expense’ (or income) refer to

Answer 26

it refers 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 27

under IFRS 17, what is meant by the ‘unwinding of discounts’

Answer 27

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

Question 28

under IFRS 17, identify methods for calculating the unwinding of discounts

Answer 28

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 29

under IFRS 17, what level of aggregation should be used for calculating FCFs

Answer 29

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