What are the reasons for calculating provisions in financial products?
- To determine liabilities for published accounts and reports.
- To ensure solvency supervision.
- For internal management accounts.
- To value the provider for mergers or acquisitions.
- To assess excess assets over liabilities.
- To set future contributions to benefit schemes.
- To value benefit improvements.
- To calculate discontinuance/surrender benefits.
- To influence investment strategy.
- To disclose information for beneficiaries.
- To provide for expected credit losses for a bank.
What is the purpose of calculating global provisions?
- Provide additional protection against insolvency.
- Cover risks not attributed to individual contracts.
- Reflect mismatching of assets and liabilities.
What are the different types of bases for calculating provisions?
Best estimate basis: Equal chance of overstating or understating provisions.
Optimistic basis: High asset value or low liability value assumptions.
Cautious basis: Low asset value or high liability value assumptions.
What factors affect the choice of basis and method for calculating provisions?
Purpose of calculation.
Client needs.
Regulation and legislation.
How are assumptions set for published accounts?
Follow legislation and accounting principles.
Consider going concern or break-up basis.
Reflect a true and fair view.
Decide between best estimate or prudent basis.
What is the principle of fair valuation of assets and liabilities?
Fair value definitions:
* Exchange or settlement between knowledgeable, willing parties.
* Payment to a third party to take over the liability.
* Use market-based assumptions for insurance liabilities.
How can sensitivity analysis be used to check values?
Determine margins for adverse future experience.
Set up global provisions.
Steps:
* Start with central assumptions.
* Vary each assumption to quantify effects.
* Test multiple assumption changes simultaneously.
How are provisions calculated for demonstrating solvency to the regulator?
Requires a degree of prudence.
Follow prescribed methods/assumptions.
If actuarial judgement is used, disclose assumptions.
What basis is typically used for internal accounts?
Internal accounts are usually prepared on a best estimate basis.
What considerations are involved when calculating provisions in liability transfers?
Achieving fairness requires fair value for benefits and assets.
Best estimate is common, but other bases may be used due to:
* Power imbalance between parties.
* Stronger desire to proceed by one party.
* Need to hold margins for security.
How should the calculation of provisions for discretionary benefits be approached?
Use a cautious approach to avoid overstating the surplus.
What factors influence setting contribution levels for a benefit scheme?
Trustees: Concerned with member benefit security, prefer cautious basis.
Sponsor:
* Does not want to pay more than necessary,
* may pay more in the short term or might have alternative uses of capital so happy to underpay now.
* Flexibility over future contributions may be a key requirement
How is the basis used for setting investment strategy typically approached?
Use realistic basis with sensitivity and scenario testing.
Stochastic approach can be valuable because it assesses the range and likelihood of investment returns.
What is important in disclosing information to beneficiaries?
Assumptions reflect legislation.
Use realistic basis with range of results.
Communicate uncertainty effectively.
What methods allow for risk in cash-flows?
Traditional discounted cashflow with:
* Best estimate with margins in assumptions.
* Contingency loading.
* Reduce discount rate representing opportunity cost.
What methods account for uncertainty in present values of liabilities?
- Market-consistent or fair valuation.
- Financial risk through replicating portfolios or stochastic models.
- Non-financial risk adjustments in cashflows or discount rates.
- Extra provisions like Solvency II risk margins.
What is the purpose of equalization reserves?
Smooth results for low probability risks with high financial outcomes.
Methods:
* Statistical analysis for known claim patterns.
* Case-by-case estimates for few claims.
* Proportionate approach based on net premium.
Why might the assumptions and methods for valuing guarantees and options differ from those for accounting provisions?
- A cautious valuation basis does not automatically produce cautious terms for options or guarantees.
- Provisions for cash transfers may overstate cash value, but high cash value doesn’t mean cautious terms.
- Guarantees and options are interdependent; they should be valued together
What influences the option exercise rate assumption?
Assume highest cost option is always exercised, assuming holder exercises in-the-money option.
Cash attraction influences immediate exercise, potentially overlooking long-term value.
Tax lump sums may lead policyholders to choose them over annuities at guaranteed rates.
Take-up rate varies with valuation purpose and prudence level.
What is the risk of selection against the provider with options?
Anti-selection risks arise, e.g., renewing term assurance without underwriting can increase fraudulent claims.
Guard against selection risk by setting eligibility criteria or terms favouring one option over another.
What factors affect the value of options?
State of the economy.
Demographics: age, health, occupation.
Cultural bias: preference for immediate cash over future savings.
Consumer sophistication.
What considerations should be taken into are account when valuing guarantees?
Use stochastic approach to estimate likelihood and cost of guarantees being applied.
Guarantees may become more or less onerous over time as experience develops.
Value varies widely with economic scenarios and market sophistication.
Why must the fair value of insurance liabilities be estimated using market-based assumptions?
There is no market for insurance liabilities, fair falue requires estimation through market-based assumptions.
What are replicating portfolio methods?
Liabilities are valued as the market value of a portfolio of assets replicating the duration and risk characteristics of the liabilities.
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1. Actuarial Advice15
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2. Meeting the needs of stakeholders8
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3. The Actuarial Control Cycle9
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5. Risk Identification and classification7
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4. Risk governance21
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6 Risk measurement and monitoring15
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7.1 Responses to risk (Reinsurance)15
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7.2 Responses to risk (Alternative risk transfer)7
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7.3 Responses to risk (other risk controls)9
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7.4 Responses to risk (Accepting risk)3
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8. Capital Management22
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9.1 Regulatory environment16
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9.2 External environment11
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9.3 Investment Environment27
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11.1 Modelling12
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11.2 Setting Assumptions7
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11.3 Mortality and Morbidity9
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11.4 Expenses3
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11.5 Pricing and financing strategies5
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11.6 Investment Management20
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11.7 Provisioning28
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11.8 Relationship between assets and liabilities16
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12. Living with the solution0
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13. Monitoring0
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15. Banking0
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Acronyms/mnemmonics29
