Chapter 32 - Provisions

Question 1

Why calculate provisions

Answer 1

The reasons for calculating the provisions needed by a provider include the following:

1. Determine Liabilities
   - to determine the liabilities to be shown in the provider’s published accounts and reports
   - if separate accounts and reports are prepared for the purpose of supervision of solvency, to determine the liabilities to be shown in those accounts
   - to determine the liabilities to be shown in internal management accounts and reports of the provider
2. Value the provider for merger or acquisition
3. Determine the excess of assets over liabilities and whether any discretionary benefits can be awarded
4. To set future contributions to a benefit scheme to value benefit improvements for a benefit scheme
5. To calculate discontinuance / surrender benefits to influence investment strategy
6. To provide disclosure information for beneficiaries to provide for expected credit losses for a bank

Question 2

Different Bases for Provision Calculation

Answer 2

1. Best Estimate Basis
   As the timing and level of benefits, contributions and asset income is not certain, an actuary can never be certain that a set of assumptions will be correct.
   The actuary can consider information and apply judgement to produce a set of assumptions that they feel to be their ‘best estimate’ of future experience. This can be defined as the set of assumptions that has equal probability of overstating or understating the values
2. There is a range of ‘non-best estimate’ bases that could be used, including:
   - optimistic (or weak) – assumptions are chosen which result in a high value of assets and/or a low value of liabilities
   - cautious (or prudent or conservative or strong) – assumptions are chosen which result in a low value of assets and/or a high value of liabilities

Question 3

Factors Affecting Choice of Basis

Answer 3

The following factors will usually dictate the strength of the basis on which values should be produced:
- Reason a value needs to be determined
- Needs of the client
- Requirements of any legislative or regulatory authority
- Nature of the assets

Question 4

Setting Assumptions with regard to Purpose

Answer 4

1. Assumptions for Published Accounts (mainly for shareholder decisions)
   - Preferable for values to be included in the accounts that represent an actuary’s ‘best estimate’ of the future experience
   - Use of assumptions that are more likely to overstate or understate the liabilities or assets may lead to wrong decisions being made
2. Assumptions used for demonstrating supervisory solvency (decisions by regulators)
   Regulators may wish to consider values that present a realistic picture of a provider’s finances. Alternatively, they may wish to consider values that intentionally understate (or perhaps overstate) the financial strength of the provider. The assumptions used may be dictated by legislation or left to actuarial judgement with a requirement for disclosure of the assumptions used
3. Assumptions for Internal Accounts (decisions by directors)
   - likely best estimate basis
4. Assumptions for Liability Transfer
   - It may become necessary to transfer liabilities and assets from one provider to another , eg. in the event of a merger or acquisition
   - In such cases, the values being placed on benefits and assets have a monetary worth. It is important that both the transferring and receiving parties view the terms of the transfer as being fair
5. Assumptions for awarding of discretionary benefits
6. Assumptions for setting benefit scheme contributions
7. Assumptions to calculate discontinuance/surrender benefits
8. Assumptions used to set Investment Strategy
   - A decision relating to financing, including any investments held to meet future liabilities, will involve the consideration of realistic and cautious values for a potentially large number of options
   - It is likely that a stochastic approach can add significant value in assessing the risks and values under each possible strategy