Processes, Methods and Approaches Flashcards
Outline the steps to an asset-liability modelling process
- Clarify the key objectives of the process or desired output from the asset-liability matching exercise.
- Determine suitable assumptions for parameters and distribution functions (if relevant)
- Collect and validate proper data to use in the modelling process and use it to create model points.
- Run the model and store outputs generated by the model.
- Consider the overall nature of the liabilities.
- Analyse how the results may be influenced if different investment strategies are used by varying deterministic asset allocation assumptions.
- Assess the interaction between risks (increased mismatching) and reward (higher investment returns) by finding the point where risk is minimised, and return is maximised.
- Do sensitivity and scenario testing.
- Summarise and present results to help make decisions relating to, for example, investment strategies.
Explain how management actions can be used to reduce a life insurer’s SCR, and the practical limitations thereof.
A large portion of life assurance policies in South Africa allow the long-term insurer to adjust: charges for risk benefits, expense charges, policy value bases (i.e. surrender or maturity values), bonus rate, and non-vested values.
These adjustments are referred to as management actions or the “loss absorbency of technical provisions”.
In calculating the liabilities under the SCR for the various stress scenarios, it is appropriate to consider the management actions that are likely to be taken in the ‘adverse circumstances’ of the stress scenario.
The use of management actions therefore reduces the total liabilities under each SCR scenario, and therefore reduces the SCR.
Management actions can only be allowed for in the SCR calculation if they are allowed for in the policy contract.
Management actions must be consistent with the product PPFM (where applicable).
Management actions must take into account policyholder reasonable expectations that will have been formed by the PPFM and past actions by the company in similar circumstances.
The Management actions used in the SCR calculations must be approved by a management structure of the company (e.g. the Board).
The Board or other management structure must be satisfied that the management actions would be taken should the envisaged circumstances arise.
In practice this means considering the management actions that the company realistically feels it will take, and not just the maximum permitted by the policy conditions.
Management actions should be objective, realistic and verifiable – i.e. there should be evidence that the company has acted in the manner envisaged in the management actions when similar circumstances have arisen in the past.
However, not all of the stress scenarios envisaged in the SCR calculation would have occurred in the past so the discretion in management actions would not have been tested under severe scenarios in the past.
In calculating the effect of management actions allowance should be made for any changes to assumed policyholder behaviour as a result of the management action.
In calculating the effects of management actions, companies need to consider whether the shock is an industry-wide or company-specific event.
For a company-specific event, competitors will not be making similar changes, and hence competitive pressures may constrain the changes the insurer can make.
Furthermore an explicit adjustment is required within the Market Risk module to ensure that loss-absorbency is not double-counted by being taken into account in several sub-modules that give a larger effect than would be allowed under a combined scenario.
Briefly describe the operation of the various tax funds and how the tax payable by life offices is determined.
In terms of Section 29A of the Income Tax Act, every insurer is required to maintain five separate funds, which are treated as separate taxpayers.
The effect of these five funds is that a long-term insurer is not only required to pay tax on its profits, but also on the taxable income and capital gains generated on behalf of its policyholders.
The five funds are:
* The Risk Policy Fund (RPF) for policies where the benefits are solely payable due to death, disablement, illness or unemployment (excluding) annuity contracts.
* The Untaxed Policyholder Fund (UPF) for annuity contracts in payment, and for policies owned by pension, provident, retirement annuity, benefit funds, and owners who are exempt from tax.
* The Individual Policyholder Fund (IPF) for policies not in the RPF or UPF whose owner is any person other than a company.
* The Company Policyholder Fund (CPF) for policies not in the RPF or UPF whose owner is a company.
* The Corporate Fund (CF) or shareholder fund, which is represented by the assets held by the insurer that are not in the other four funds.
At the end of each financial year, insurers need to determine the value of liabilities in respect of the UPF, IPF, CPF and RPF.
Any excess or shortfall of the market value of the assets over the value of the liabilities shall be transferred to or from the corporate fund.
The taxable income for each fund consists of:
- RPF: profits earned in the fund (Premiums less claims, movement in policy liabilities and deduction for transfers to the CF).
- IFP and CPF: Investment income and other income such as administration fees within each tax fund, less a deduction for expenses.
- UPF: does not have any taxable income.
- CF: Investment income less expenses plus transfers from the other funds.
Any amount transferred from the corporate fund shall not be deducted from the taxable income of the corporate fund. However, it creates a special transfer balance for the Corporate Fund. Any future transfers to the CF from the same policyholder fund can be offset against this special transfer balance.
Different tax rates are applied to the taxable income of each fund.
Outline the main purpose of the SAM valuation
The main purpose of the statutory/regulatory/SAM valuation is to demonstrate to the regulatory authority that the life insurer is in a sound financial condition.
The quantitative requirement for solvency is that the excess of assets (after adjustments) over liabilities (including technical provisions) exceeds the solvency capital requirement (SCR).
In more extreme circumstances, the SAM valuation will demonstrate whether the company has the minimum capital to allow it to operate – the minimum capital requirement.
The statutory valuation also demonstrates the financial strength of the company to other stakeholders such as policyholders and shareholders.
SCR cover gives a simplistic measure to compare the relative strength of life insurers.
The statutory valuation is designed to ensure that the probability of failure over a 1-year period corresponds to a 1 in 200-year event.
Outline the main purpose of the ORAS
The main purpose of the ORSA (Own Risk and Solvency Assessment) is to determine the amount of capital needed to ensure future solvency and to meet the needs of the business plans.
Conducting an ORSA is a regulatory requirement which has the objectives of assessing:
* the resilience of an insurer’s solvency across a range of possible scenarios.
* the overall solvency needs of the insurer considering the specific risk profile, approved risk appetite and business strategy of the insurer.
* compliance, on a continuous basis, with financial soundness requirements.
* the significance with which the risk profile of the insurer deviates from the implied risk profile underlying the financial soundness requirements.
In addition to fulfilling the statutory role, an insurer may use the ORSA to determine the amount of required capital (or economic capital) that it needs to hold to meet it objectives.
The ORSA will help determine the capital required to:
* to maintain a certain SCR cover (or that the probability of the SCR cover falling below that level is acceptably low).
* be able to meet policyholders’ reasonable benefit expectations.
* to fund the ongoing business strategy.
* support the investment strategy (particularly if a riskier investment strategy is envisaged).
* fund development costs (e.g. implementation of IFRS17).
* or, particularly in the case of the small insurer that is planning to expand rapidly, the cost of building new branch offices, etc.
* acquire other companies or blocks of business.
* support with-profits business and the level of smoothing that is desired.
The ORSA can show the level of capital required to fund its new business plans, or alternatively the level of new business that can be supported by the existing capital.
Overall, the ORSA allows the impacts of strategic business decisions to be assessed.
The company may use the ORSA exercise to determine the probability of meeting metrics ratings agencies focus on, such as the level of SCR cover.
