IFRS17 DR Flashcards
define the IFRS 17 term: discount rate
- 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.
define the IFRS 17 term: Fulfillment Cash Flow (FCF)
FCF = PV(future cash flows) + (risk adjustment for non-financial risk)
define the IFRS 17 term: liquidity premium
- 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)
define the IFRS 17 term: reference portfolio
- 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
is the liquidity of a government bond HIGH or low?
HIGH, because there is low risk and can be easily converted to cash
is the liquidity of an investment in a messenger RNA research facility HIGH or low?
low, because it’s high-risk and could be difficult to convert back to cash
identify contract features that affect the liquidity premium
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)
(IFRS17 -1) Theoretical approach determine illiquidity premium
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
identify 1 or more insurance contract features that increase liquidity
- 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)
identify 1 or more insurance contract features that decrease liquidity
- high exit costs for contract (Ex: surrender penalties)
(a decrease in liquidity means HIGHER liquidity premium)
which set of insurance contract liabilities is more liquid: LIC or LRC
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
identify the steps in a “combined approach” for estimating the Liability Liquidity Premium LLP
[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)
identify considerations in deciding whether 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.
identify considerations in segmenting data for selecting payment patterns (3)
- business segments used for analyzing undiscounted data
- payout period
- existence of a predetermined schedule of payments
identify characteristics an IFRS 17 discount rate should possess (3)
(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
identify methods for selecting a discount rate for valuation of insurance contract liabilities under IFRS 17 (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
identify risk factors that may differ between a reference portfolio and insurance contracts (4)
- liquidity
- investment risk (Ex: credit risk, market risk)
- timing
- currency risk
identify examples of credit risk adjustments
default risk, downgrade risk
calculate the market risk adjustment if the reference portfolio consists solely of bonds
no adjustment is necessary
which set of insurance contract liabilities is more liquid: LIC or LRC
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
under IFRS 17, what is a reference curve
a “standardized” yield curve used to facilitate comparison among entities in the unobservable period
under IFRS 17, should discount rates vary with the timing of cash flows
yes, this is the purpose of yield curve (versus a spot rate)
under IFRS 17, what is a ‘locked-in’ yield curve
a yield curve determined at the initial recognition of the group of contracts
under IFRS 17, when would a ‘locked-in’ yield curve be used for discounting
- 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
under IFRS 17, identify 2 lines on the Income Statement where insurance expenses are reported
- insurance service expense
- insurance finance expense
under IFRS 17, what does ‘insurance finance expense’ (or income) refer to
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
under IFRS 17, what is meant by the ‘unwinding of discounts’
the difference between discounting the cash flows to the beginning of the period and discounting to the end of the period
under IFRS 17, identify methods for calculating the unwinding of discounts
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
under IFRS 17, what level of aggregation should be used for calculating FCFs
any level of aggregation provided estimates of LIC and/or LRC can be allocated back to portfolios and groups
