VALUATIONS Flashcards
What is the definition of an insurance contract? (IFRS 17 edition)
- Requires that one party accepts significant insurance risk from another party.
- Significant if, and only if, an insured event could cause the entity to pay additional amounts that are significant in any single scenario.
- Investment contracts with discretionary participation features (e.g. some with-profits or
products with smoothed-bonus type funds), are also included in the scope of IFRS 17 if the entity also issues insurance contracts.
What are the three different ways portfolios can be grouped
- Loss making at inception
- No significant probability of being loss-making
- Neither 1 or 2
When will insurance contracts being recognised initially?
The earliest of:
1. The beginning of the coverage period of the group of contracts
2. Date when first payment from PH in the group becomes due
3. For group of onerous contracts, when group becomes onerous.
Why would BEL be different IFRS 17 vs. prudential regulatory reporting purposes?
- the acquisition and maintenance expenses allowed to be included in expense assumptions
- discount rate used
- contract boundary
- tax-related flows included in fulfilment cashflows
- requirement to unbundle certain contracts under IFRS 17
To qualify for direct participation the following criteria need to be met (i.e. can use VFA method under IFRS 17)
(a) the contract says the PH participates in a share of a clearly identified pool of underlying items;
(b) the insurer expects the benefit = a big share of the FV returns on the underlying items
(c) the insurer expects a big share of any change in the benefit value to vary with the change in FV of the underlying items.
Note: significant guarantees limit market participation.
What are examples of non-hedgeable risks used to calculate the risk margin?
- mortality/morbidity/lapses
- operational risk (IT failure etc.)
- credit risk (reinsurer default)
- non-hedgeable market risk (illiquidity risk [cannot realise illiquidity premium] , long dated interest rate risk [up to certain point don’t get bonds anymore so all cashflows outside of that term is unhedged] )
What data checks are important?
Internal consistency (e.g., new business data matches accounts)
Policy movement reconciliation (beginning + new - exits = ending)
Consistency with financial accounts (premiums, claims, assets in the balance sheet)
What is the difference between EV and VNB?
Value of New Business (VNB)
The PV of expected future profits from new business written during a specific reporting period (typically one year)
Time scope: Forward-looking measure for only new policies sold
Formula: PVFP - CoC - FC (for new business only)
Measures sales productivity and new business profitability
Embedded Value (EV)
The PV of future profits from the entire existing book of business plus adjusted net asset value
Time scope: Comprehensive measure of all in-force business
Formula: ANAV + PVIF (Adjusted Net Asset Value + Value of In-Force business - Cost of Required Capital)
Measures overall company value and serves as basis for M&A valuations
What important assumptions are included in EV calculation?
- premium growth and attrition rates in the future
- expense assumptions
- economic assumptions (investment returns, risk discount rate, inflation, tax)
IFRS 17: best estimate assumptions
- Expenses need to be directly attributable to individual/group of contracts. General overheads not related to fulfilling insurance contracts are excluded e.g. marketing expenses or executive salaries.
- Interest and inflation rates should be derived so that they’re consistent with market yields to maturity for fixed-interest securities and considered future investment returns of a portfolio of assets appropriate to the liabilities.
- Any tax CFs included in BEL. Allow for changes to future tax positions and effect of tax on future investment return. Accounting policy could be: direct+indirect tax CFs vs. direct tax CFs only.
What are the two ways to derive IFRS interest and inflation rates?
Top down: interest rates are based on expected returns on reference portfolio with similar liquidity characteristics to liabilities. Adjust to remove factors N/A to liabilities e.g. market and credit risk.
Bottom up: Look at highly liquid, high quality bonds (government bond yield curve), adjust to include premium for illiquidity in underlying insurance contracts. Ultimately your underlying liability is more illiquid than liquid government bonds. This is because PH cannot demand payment immediately, and the cashflows are quite predictable so you don’t need cash on hand at all times. As a result, add an illiquidity premium because you can invest in less liquid assets.
What are the two ways a loss component can arise?
- The policy/group of contracts is loss making for the beginning
- After inception, the CSM is no longer big enough to absorb the increase in BEL+RA, so loss component = shortfall. The increase in BEL+RA which adjust CSM could be due to: assumption changes/non-financial variances (not changes in interest or inv returns).
What is the major difference between VFA and GMM?
The discount rate. If the discount rate increases then BEL + RA could fall.
For profitable groups:
- Under GMM this goes directly to profits (shown in P+L statement), the CSM isn’t involved at all as it only concerns non-financial variances.
- Under VFA, this fall is absorbed by the CSM (increases the CSM), the only released in future as CSM unwinds. As a result BEL+RA+CSM remains unaffected)
For loss-making groups:
- For both VFA and GMM, the fall in BEL+RA reduces the loss component
What are the reasons PAA approach is used?
- Simplified methodology won’t materially affect liability value if GMM/VFA used
- Contract boundary is <=1 year
What is the difference between free assets and BSR?
BSR is actually part of BEL, whereas free assets are assets less liabilities
BSR can increase or decrease, based on the bonus philosophy of the insurer and how much surplus is being made year or year
If BSR becomes too negative, can transfer from free assets as a “loan” which needs to be repaid back later
Excess BSR can only be transferred to free assets if it is a “loan repayment”
The company is solvency as long as there are enough free assets to cover statutory requirements.
