Part 9: Chapter 32, 33. 34 and 35 Provisions, Valuation of liabilities, reporting results, Insolvency and closure Flashcards
Reasons for calculating provisions (Individual and Global)
Individual:
Determine liabilities to be shown in accounts for
-Published accounts
-Supervision
-Internal Management
Value provider for merger/aquisition
Determine excess of A over L for discretionary benefit payouts
Set future contributions
Value benefit improvements
Calculate discontinuance/surrender benefits
Influence investment strategy
Provide disclosure info to benificiaries
Provide for expected credit losses (bank)
Global
Cover financial and non-financial risks - provisions in excess of what is already held
Additional protection against insolvency
Reflect degree of A-L-mismatch
Demonstrate unambiguous solvency
Ways to counter anti-selection:
Modify assumptions used
Eligibility criteria
Set terms that favour one option over another
Stricter underwriting
Group cover eliminates anti selection
Factors affecting the strength(Prudence) of basis used
Purpose of the valuation
Regulation and legislation
Management discretion
Factors influencing the choice of valuation method and assumptions when determining the value of insurers liabilities
Purpose of the valuation
- Reason e.g. accounting
- Needs of client (Beneficiaries, trustees…)
- Legislation/regulation or accounting principles
Nature of assets
- Linked to underlying assets
- Covenant of sponsor has no value
Purposes and the basis used
DiD PISC / DARIS DIP
Discontinuance basis - Best estimate
Discretionary benefits - Cautious
Published accounts- Depends, usually best estimate as it will need to reflect the most realistic view of the company
Internal accounts - Best estimate
Setting investment strategy - Best estimate basis
Contribution level- depends on the objectives and the structure
Factors to consider when valuing options and guarantees
Demographics
Expensive options not always exercised
Cultural bias
State of the economy
Consumer sophistication and needs
Immediate benefit vs. Higher deferred benefit
Cost increases in the valuation
Anti-selection
Tax benefits
Different techniques to value Liabilities
Discounted cashflow approach
Asset based discount rate
Replicating portfolio
Bond yield + risk premium
Goal of sensitivity analysis
Determines the:
- Extent of margins needed in assumptions to allow for adverse experience
- Extent of any global provisions required
Methods for calculating reserves
SPEC
Statistical analysis: Large population exposed to risk and consequence of risk has a known distribution (Reserves = Expected loss, Forward/ backward looking reserves)
Proportionate: prop of outstanding premiums allocated to the expected future claims is the provision held
Equalisation reserve: stable/smooth annual results, catastrophe, deferring of tax and profit
Case by case: Rare events
Different methods of allowing for prudence
Margin built into each assumption
Contingency loading: increase liability by some value
Risk premium built into the discount rate
Accounting concepts
Money measurement: Record only transactions that can be expressed in money terms
Cost: Assets should be recorded as the cash amount at the time that the asset is acquired
Matching: Expenses should be recorded in the same period where related revenue is earned
Materiality: Only material transactions should be recorded
Consistency: Same accounting principles be used from one period to the next
Business entity: The affairs of the owners should be kept seperate to the affairs of the company
Realisation: Revenue can only be realised when it is earned
Accruals: Income and expenses are realised in the period in which they occur rather than when payment is received
Dual Aspect: Every transaction will have two entries: Receive invoice, increase sales, decrease amounts receivable
Prudence: Do not overstate revenue and understate expenses ( A vs L)
Going concern: It is assumed that the company will continue trading indefinitely
Additional reports
● Chairperson’s and CEO’s statements- success, progress against key objectives, senior management changes.
● Investment report - The investment strategy and the performance of the fund(s)
● Strategic report - Progress against long term and short term strategic goals
● Risk report - attitude towards risk, key risk faced, risk management approaches taken
● Remuneration report - Directors’ pay, board attendance, turnover of directors
● Corporate governance report - organisation of board and committee, independence of directors
Interpreting accounts
Nature of the business:
*investment mix
*claim settlement pattern - Claims paid / Outstanding claims
*reinsurance
Financial condition:
*asset to liability ratio to assess financials strength
*assess the key ratios
*profitability and performance
- Claims ratio (gross and net) (c/p)
- Expense and commission ratio (e+com/np)
- Operating ratio (nc+e/np)
- Investment performance ratio (inv income/ A)
- return on capital ratio (post tax profit/ free reserves)
- profit margin (gprof/np)
- Reinsurance ratio
Similar aims for different accounting standards
CARS
Consistency in account treatments from year to year
Appropriate information disclosed
Recognize realistic cost of benefit accrual
Smooth benefit provision
Information to be disclosed includes
DISCLOSURE SRC
Director’s pension costs
Investment strategy and performance
Surplus/deficit (last year, accumulated to date)
Calculation method and assumptions
Liabilities (accrued over year, accrued to date)
Options and guarantees
Sponsor’s contributions and members’ contributions
Uncertainties (risks)
Rights on wind-up
Expenses
Strategic report - Key performance indicators shown
Risk report - attitude, management approach, risk based capital requirement calculation
Corporate governance - the management structure of board set out
Individual disclosures are often made on
PRICE
Payment commencement
Request
Intervals
Combination
Entry
Causes of inappropriate advice
CRIMES
Complicated products
Rubbish/incompetent advisors
Integrity of advisor lacking
Model/parameter error
Errors in data
State encouraged, but inappropriate, actions
Disclosure is important in a benefit scheme because SIMMERS
Sponsor aware of financial significance of benefits
Informed decisions can be made
Miss-selling is avoided
Manages expectations of members
Encourages take up
Regulatory requirement
Security of scheme improved as sponsor/trustees more
Why insurance companies rarely become insolvent
RIP T
Regulation requires the company to hold a minimum level of solvency capital
Intervention by regulator when capital falls below a certain threshold of capital (MCR)
Projection of solvency by insurance companies to ensure they make appropriate provisions
Take overs of insurance companies that are in trouble
When taking over discontinuance business or for a merger/acquisition, consider
RIEL SyCRETS
Relocation of staff
Integration of system platforms
Effect on unit costs
Location of Business
Synergy of the products
Cost vs Reward of the takeover/merge
Regulatory differences if in different sectors
Employee benefit scheme new members
The effect on the company’s long term goals
Shareholders on both sides
Options for benefit provision of discontinued benefit scheme
Two types of closures:
No new members, benefits still accrue
No new members, further accrual
Options for provision of outstanding benefits:
- Transfer liabilities to another scheme with the same sponsor
- Transfer of the funds to the beneficiary to extinguish the liability
- Transfer of the funds to an insurance company to invest and provide a group policy or and individual policy in the beneficiary’s name
- Transfer of the liabilities to an insurance company to guarantee the benefits
- Transfer of the liabilities to a central discontinuance fund, operated on a national or perhaps industry wide basis
Factors affecting the level of benefit paid out in the case of insolvency
Asset level - surplus or deficit
Rights of beneficiaries – terms of scheme or overriding legislation
Expectations – benefits if did not cease, future, accrued, discretionary.
Factors considered when modeling future solvency RECSOF
Redemption of debt - Amount and timing
Estimated future loss/profit net of tax to be paid to shareholders
Current value of surplus assets
Staff - Relationships & employee benefits
Outstanding financial obligations
Future actions - Changes in benefits, business expansions etc.
A bank is insolvent when
It is unable to meet its obligations to its depositors and creditors
A bank’s value of its assets falls below the value of its liabilities
