Prudential Standard FSI 2.2 (Valuation of Technical Provisions) Flashcards
Key principles of the standard
- technical provisions correspond to the current value of insurance obligations
- insurance obligations should be segmented into homogeneous risk groups
- valuation should incorporate a best estimate and a risk margin (with exceptions)
- actuarial and statistical techniques used should be proportionate to the nature, scale and complexity of the risks
- recoverables must be calculated separately
- technical provisions should take into account the time value of money using the relevant risk-free interest rate term structure
- Insurers are permitted to apply simplified methods subject to proportionality
Broad calculation of best estimates
Best estimates should be calculated on a GROSS BASIS
without deducting reinsurance / risk mitigation recoverables.
Broach calculation of the risk margin
The risk margin should be calculated by reference to
… the COST of providing
… an amount of Eligible Own Funds
… necessary to support insurance obligations over their lifetime.
The purpose of segmentation
To prevent potential distortions in the valuation process that may arise from combining dissimilar lines of business.
Segmentation should be based on…
the nature of the risks underlying the insurance obligation,
rather than the legal form of the insurance contract.
(i.e. the principle of “substance over form”)
The best estimate
The probability weighted-average of an insurer’s future cash-flows stemming from its insurance business,
taking into account the time value of money,
and all possible scenarios of future potential outcomes.
8 Cash-flow characteristics that should be taken into account in the projection (for purposes of best-estimate valuation)
Uncertainty in the:
- timing, frequency and severity of claim events.
Uncertainty in:
- claim amounts and the period needed to settle claims;
- the value of an index used to determine claim amounts.
Uncertainty in entity and portfolio-specific factors, such as:
- legal,
- social, or
- economic environmental factors.
Uncertainty in policyholder behaviour
Path Dependency
Inter-dependency between 2 or more causes of uncertainty.
Path-Dependency of cash-flows
Where the cash-flows depend not only on circumstances such as economic conditions on the cash-flow date, but also on those circumstances at previous dates.
Best-estimate valuation of obligations in different currencies
The best-estimate must be valued SEPARATELY for obligations in different currencies.
The time value of money of future cash-flows in different currencies must be valued using the risk-free interest rate term structure of the relevant currency.
Best-estimate valuation methodology:
Treatment of reinsurance and risk-mitigation
The best estimate must be valued on a GROSS BASIS, without deducting amount recoverable from reinsurance contracts and other risk mitigation instruments.
Recoverables from reinsurance and other risk-mitigation instruments must be calculated separately.
Best-estimate valuation methodology:
Cash-flow projections
Cash-flow projections must reflect realistic future - demographic, - legal, - medical, - technological, - social, or - economic developments.
They should incorporate appropriate assumptions for future INFLATION.
Best-estimate valuation methodology:
Cash-flow projection horizon
Must cover the full lifetime of the cash in-flows and out-flows required to settle insurance obligations of existing policies.
For non-life insurers, a separate valuation of the best estimate must be carried out for provisions for
- claims outstanding
- premium provisions, and
- “other technical provisions”
Premium provisions relate to…
claim events occurring after the valuation date and during the remaining coverage period of existing policies.
The cash-flow projection w.r.t. the best estimate for premium provisions should comprise:
all future
- claim payments
- claims administration expenses
- ongoing administration expenses of existing policies
- expected premiums stemming from existing policies
Provisions for claims outstanding relate to…
claim events that have occurred before the valuation date - regardless of whether the claims arising from these events have been reported or not.
3 Components that should be valued separately in relation to the best estimate for “other technical provisions”
- Cash-back and other loyalty provisions
- Contingent commission provisions
- Other contingent payment provisions
Assumptions consistent with information about / provided by financial markets include: (3)
- Relevant risk-free interest rate term structure;
- Currency exchange rates; and
- Market inflation rates (CPI or sector inflation)
4 “Market-consistent asset model” criteria
when used to produce projections of market parameters
The model must:
- Generate asset prices consistent with deep, liquid and transparent financial markets
- Assume no arbitrage opportunities
- Allow for a properly calibrated volatility measure
- Be calibrated to reflect the nature and term of the liabilities, and the current risk-free interest rate term structure used to discount cash-flows.
The extent to which internal data is taken into account should be based on (2)
- the Availability, quality and relevance of external data
- the Amount and quality of internal data.
Where insurers use data from an external source, they must derive assumptions on underwriting risks that are based on that data according to 2 requirements:
- The insurer can demonstrate that the sole use of data which is available from an internal source is not more suitable than external data.
- The origin of the data, and assumptions or methodologies used to process them, is known to the insurer and the insurer is able to demonstrate that these assumptions and methodologies appropriately reflect the characteristics of the portfolio.
“Future management action”
Refers to all mechanisms or actions approved by a governance structure within the insurer that will be implemented in response to the occurrence of a specified adverse event, whereby the actions aim to reduce the impact of the specified adverse event on the insurer’s net asset value.
7 actions that may be considered as future management actions
- Changes in asset allocation to manage fund returns, liquidity rates, asset/liability mismatch risk, target asset mixes and changes in market conditions;
- Changes in bonus rates or product changes, such as changes to policies with profit participation to mitigate market risks.
- Changes in fees charged to policyholders, e.g. administration or investment management charges on linked business;
- Changes in assumed future market value adjustment factors;
- Renewal of outwards reinsurance arrangements;
- Renewal of hedging strategies; and
- Revision of premium rates.
Inclusion of management action in the valuation of technical provisions
The valuation of technical provisions should take account of potential future actions by the management of an insurer, and other risk mitigation instruments employed to manage an insurer’s risk.
