IFRS 17-DR

Question 1

Define the IFRS 17 term: Discount Rate

Answer 1

The rate used to discount the estimates of future cash flows which is consistent with the timing, liquidity and currency of the insurance contract cash flows.

Question 2

Define the IFRS 17 term: Fulfilment Cash Flow (FCF)

Answer 2

FCF = PV(future cash flows) + (risk adjustment for non-financial risk)

Question 3

Define the IFRS 17 term: Liquidity Premium

Answer 3

• adjustment made to a liquid-free yield curve
• reflects differences between:
  
  • liquidity characteristics of the financial instruments that underlie the risk-free rates
    AND
  • liquidity characteristics of the insurance contracts

NOTE: highly liquid investments have low liquidity premium (and vice versa)

Question 4

Define the IFRS 17 term: Reference Portfolio

Answer 4

• a portfolio of assets used to derive discount rates based on current market rates of return
• the portfolio rate of return is then adjusted to remove returns related to risk characteristics that are not in insurance contracts

Question 5

Is the liquidity of a government bond High or Low?

Answer 5

High.

Question 6

Is the liquidity of an investment in a messenger RNA research facility High or Low?

Answer 6

Low.

Question 7

Identify considerations in deciding whether to use net or gross and ceded data for analysis. (3)

Answer 7

• Data availability: if data is sparse, it may not be possible to directly estimate the present value of ceded cash flows
• Cash Flow Volatility: different approaches may be warranted for different segments of business depending on the volatility of cash flows by segment
• Reinsurance held: consider the type and consistency of reinsurance held

Question 8

identify considerations in segmenting data for selecting payment patterns. (3)

Answer 8

• business segments used for analyzing undiscounted data
• payout period
• existence of a predetermined schedule of payments

Question 9

Identify characteristics that an IFRS 17 discount rate should possess. (3)

Answer 9

1) the discount rate should reflect the:
- time value of money
- characteristics of cash flows
- liquidity characteristics of insurance contracts
2) the discount rate should be consistent with:
- market prices for financial instruments with similar cash flow characteristics as insurance contracts
3) the discount rate should exclude:
- factors that affect market prices but do not affect cash flows for insurance contracts

Question 10

Identify methods for selecting a discount rate for valuation of insurance contract liabilities under IFRS 17 (2).

Answer 10

• Bottom up approach: a liquid, risk-free yield curve is adjusted to reflect the differences between the liquidity characteristics of market financial instruments and the liquidity characteristics of the insurance contracts
• Top down approach: the yield to maturity of a reference portfolio of assets is adjusted to eliminate any factors that are not relevant to insurance contracts

Question 11

Identify Risk factors that may differ between a reference portfolio and insurance contracts. (4)

Answer 11

• liquidity
• investment risk (ex: credit risk, market risk)
• timing
• currency risk

Question 12

Identify examples of credit risk adjustments.

Answer 12

• default risk

- downgrade risk

Question 13

Calculate the market risk adjustment if the reference portfolio consists solely of bonds.

Answer 13

No adjustment is necessary.

Question 14

Identify 1 or more insurance contract features that increase liquidity.

Answer 14

• low inherent value of contract

- high exit value of contract (large portion of the inherent value is already paid out)

Question 15

Identify 1 or more insurance contract features that decrease liquidity.

Answer 15

• high exit costs for contract (ex: surrender penalties)

Question 16

Which set of insurance contract liabilities is more liquid: LIC or LRC?

Answer 16

LRC is more liquid:

• since no claims have yet occurred, it’s easier to cancel or otherwise get rid of the contract
• recall that LIC stands for Liability for Incurred Claims

Question 17

Identify the steps in a ‘combined approach’ for estimating the Liability Liquidity Premium (LLP). (3)

Answer 17

1) create a reference portfolio and calculate the rate of return
2) subtract the risk-free rate to get the indicated asset liquidity premium (ALP)
3) then LLP = r * ALP + (constant liquidity premium difference)

Question 18

Under IFRS 17, what is a reference curve?

Answer 18

It is a ‘standardized’ curve used to facilitate comparison among entities in the unobservable period.

Question 19

Under IFRS 17, should discount rate vary with the timing of cash flows?

Answer 19

Yes, this is main purpose of the yield curve (vs the spot rate).

Question 20

Under IFRS 17, what is a ‘locked-in’ yield curve?

Answer 20

It is a yield curve determined at the initial recognition of the group of contracts.

Question 21

Under IFRS 17, when would a ‘locked-in’ yield curve be used for discounting?

Answer 21

• when an entity uses the GMA to determine the LRC for some or all groups of insurance contracts
  AND
• when an entity elects the OCI option for some or all portfolios of insurance contracts

Question 22

Under IFRS 17, identify 2 lines on the Income Statement where insurance expenses are reported.

Answer 22

• insurance service expense

- insurance finance expense

Question 23

Under IFRS 17, what do ‘insurance expenses’ refer to?

Answer 23

They refer to the change in the carrying amount of the group of insurance contracts arising from:

• the effect of the time value of money and the changes in the time value of money
• the effect of financial risk and the changes in financial risk

Question 24

Under IFRS 17, what is meant by the ‘unwinding of discounts’?

Answer 24

The difference between discounting the cash flows to the beginning of the period and discounting the cash flows to the end of the time period.

Question 25

Under IFRS 17, identify methods for calculating the unwinding of discounts. (3)

Answer 25

• constant yield curve: uses the same discount curve at the beginning and end of the period
• unwinding using spot rates: uses an end of period discount curve that is equal to the beginning discount curve, but shifted by 1 period
• expectation hypothesis: proposes that the term structure of interest rates is solely determined by market expectations of future interest rate changes

Question 26

Under IFRS 17, what level of aggregation should be used for calculating FCFs?

Answer 26

Any level of aggregation, provided, estimates of LIC can be allocated back to portfolios and groups.