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
