33. Valuations

Question 1

Methods of valuation

Answer 1

1. Traditional discounted cashflow
2. Market-based/Fair valuations
   • Replicating portfolio (Mark to market)
   • Replicating porftolio (Bond yield + risk premium)
   • Asset based discount rate

Question 2

Discount rate: Traditional DCF

Answer 2

Assets and liabilities are valued using the same long term discount rate based on actual holding/notional portfolio

Question 3

Discount rate: Mark to market

Answer 3

Assets: Market value

Liabilities: Discount rate implied by the market price of investments that match the liabilities

Question 4

Discount rate: Bond yield + risk premium

Answer 4

Assets: Market value

Liabilities: Same discount rate as in mark to market adjusted for higher expected return in other asset classes

Question 5

Discount rate: Asset-based discount rate

Answer 5

Assets: Market value

Liabilities: Discount rate is expected return on assets, weighted by proportions held in each asset class

Question 6

Uses of sensitivity analysis

Answer 6

1. Determine extent of margins needed in assumptions to allow for future adverse experience
2. Determine extent of global provisions

Question 7

Factors affecting assumptions used to price options

Answer 7

1. Economic state
2. Demographic factors
3. Cultural bias
4. Customer sophistication

Question 8

Uses of sensitivity analysis

Answer 8

1. Determine extent of margins needed in assumptions to allow for future adverse experience
2. Determine extent of required global provisions

Question 9

Allowing for risk in cashflows

Answer 9

1. Best estimate + margin
2. Contingency loading
3. Discounting cashflow at a risk margin

Question 10

Allowing for financial risk in market-based valuations

Answer 10

• Implicit if a replicating or stochastic model is used

- Adjustment for mismatching risk not made»_space;> independence of liability valuation from actual assets held

Question 11

Allowing for non- financial risk in market-based valuations

Answer 11

• Adjust discount rate/cashflows

- Extra provisions/solvency capital

Question 12

Methods for calculating provisions

Answer 12

1. Statistical analysis
   If claims follow a known pattern (e.g. ruin prob)
2. Case by case estimate
   Individual claim assessment if few claims
3. Proportionate approach
   Set provision on basis that premium charged is fair assessment of risks, expenses and profit.

Question 13

Equalisation reserve

Answer 13

Set up to smooth results over years when there are low probability risks with high and volatile financial outcomes

Question 14

Fair value

Answer 14

• Amount for which assets could be exchanged/liabilities settled between knowledgeable and willing parties in an arms-length transaction
• Amount enterprise would pay a 3rd party to take over liabilities