Chapter 32: Provisions Flashcards
What are provisions?
Calculated amounts set aside to meet providers’ future liabilities. The value of the provisions depends on the assumptions used to value future cashflows
What are the reasons for setting up provisions? (8/7)
Insurance company
- To determine the value of the liabilities to be shown in the provider’s
- Published accounts and reports
- Supervisory solvency accounts
- Internal management accounts and reports
- Excess of assets over liabilities to determine if any discretionary benefits can be awarded
- Calculate discontinuance (surrender) benefits
- Valuing the liabilities for merger or acquisition
- Influence investment strategy
Benefit scheme
- To determine the value of the liabilities to be shown in the scheme/sponsor’s accounts
- Disclose information to beneficiaries
- Set future contribution rates
- Value of benefit can be improved
- Calculate discontinuance benefits, e.g., transfer values
- Valuing the liabilities for merger or acquisition
- Influence investment strategy
Why set up global provisions?
- Asset-liability mismatching
- Default of reinsurer
- Operational risks
- Regulation fines
How are provisions set determined for:
- Life insurers
- General insurers
- Benefit schemes
- Banks
- Life insurers - Formula or discounted cashflow (EPV of assurance - outstanding premiums)
- General insurers - Run-off triangles
- Benefit schemes - DC: Contributions - Charges
DB: Formula + Discount Cashflow - Banks - ECL = EAD * EL * PD * discounting factor
What is a basis?
A set of assumptions
What is the best estimate basis?
The basis that has an equal probability of overstating and understating the value of the assets and liabilities
What is the optimistic basis?
The basis that poses a high value on the assets and a low value on the liabilities
What is the prudent basis?
The basis that poses a low value on the assets and a high value on the liabilities
What is the cautious basis?
The basis that poses an even lower value on the assets and an even higher value on the liabilities
What reasons affect the choice of valuation method?
- Reason for the valuation, e.g., use a different basis for valuing statutory accounts and for valuing internal management accounts
- Need of the client
- Legislative or regulatory requirements (method can be prescribed)
What strength of basis to use in the valuation of the adequacy of a general insurer’s assets to meet liabilities in order to demonstrate statutory solvency (client: regulator)
Prudent (legislation can be involved)
What strength of basis to use in the projection of benefits for a defined contribution pension policy (client: policyholders)
Best estimate
Range of estimate as you are far from retirement
What strength of basis in assessing the appropriateness of provisions to meet the benefits promised in a defined benefit scheme (client: sponsor)
Best estimate
Depend if they want to use capital in short term = optimistic
Can wish to make higher contributions now and less later = prudent
What strength of basis in assessing the appropriateness of provisions to meet the benefits promised in a defined benefit scheme (client: trustees and beneficiaries)
Prudent
What strength of basis in valuing the liabilities of a DB pension scheme in order to determine an investment strategy (client: trustees)
Range of scenarios using different basis.
Can use a stochastic model to get a range of outcomes
