Chapter 32 - Provisions

Question 1

Define provisions/reserves.

Answer 1

Provisions are the calculated amounts that need to be set aside to meet a provider’s future liabilities. The value of the provisions will depend on the assumptions used to value the future expected cashflows.

(Don’t worry too much about differences between provisions, liabilities and reserves)

Question 2

What is required to calculate reserves/provisions

Answer 2

Data

Models (or some method)

Assumptions
- Set of assumptions are collectively called a basis

Question 3

Discuss the purposes of calculating provisions/reserves

Answer 3

Accounting purposes

• Published financial information
• Supervisory accounts for regulators
• Internal management accounts

Determining surplus for distribution

• Discretionary benefits or bonuses
• Dividends in the case of proprietaries
• Note slight difference in surplus and surplus arising (Change in value of assets and liabilities over time results in surplus/deficit)]

Merger, acquisition or transfer

Value benefits and benefit options, such as

• Discontinuance benefits
• Benefit improvements
• Options
• Guarantees

Set contribution rates
- Contributions are often tax deductible, which is slight incentive to increase contributions

Determine investment strategy
- Do some stress testing and scenario analysis on reserve values

Disclosure of information
- for regulators and beneficiaries

Question 4

What does it mean to use a best estimate basis for valuing reserves

Answer 4

Theoretical concept which means basis implies there is an equal provability of overstating or understating reserve values.

This would generally include some margin for downside uncertainty in practice.

Concept of best estimate basis also depends on:

• Who is performing the valuation
• Purpose of the valuation

Question 5

Outline the factors influencing the choice of basis to use when valuing reserves.

Answer 5

Key factors:
Purpose of valuation
- See slides and notes for which reserves are typically used for each purpose

Needs of the client

Regulatory requirements
- Where applicable

Other factors:
Risk appetite

Requirement for quality of risk management

Nature of the assets

• When liabilities are linked to underlying assets
• When the covenant of the sponsor has no value
• For market-consistent valuation of liabilities

Previous basis/consistency

Actuarial or accounting standards or guidance

Going concern or closed to business assumptions