Flashcards in 13 Valuation of Liabilities Deck (15):

1

## What rules apply to the Peak 1 valuation of non-linked contracts (other than group life)?

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For regulatory-basis only life firms:

Either a net premium or gross premium method can be used. But if a gross premium method is used on a with-profits contract, a check must be made that this is at least as high as if a net premium method was used.

For realistic basis life firms:

- There is no requirement to hold a minimum of the net premium valuation because a 'Twin Peaks' assessment of Peak 1 and Peak 2 reserves is required.

- Discretionary benefits may be ignored in the prospective calculation.

- No RCR is required.

For both types of firm:

- Withdrawals may be allowed for in the gross premium valuation, even if this has the effect of reducing reserves.

- Contracts with no guaranteed surrender value can have a negative reserve (i.e. be treated as an asset).

2

## What are the factors to consider regarding the Peak 1 valuation of group life contracts?

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An approach similar to valuing general insurance business is taken because group life contracts are normally annually renewable with no or only short-term premium guarantees.

The following reserves would be calculated:

1. An unexpired premium reserve, taken as the fraction of the premium corresponding to the proportion of the premium up to the next premium payment date.

2. An IBNR claims reserve to cover claims that have occurred but no yet reported.

3. A deficiency reserve to cover any expected future inadequacy in the premiums the company is charging.

4. An experience refund reserve if the contract gives an experience refund.

3

## How may non-linked minor classes of business be treated when valuing Peak 1 liabilities?

### Approximate valuation methods may be used as long as the resulting reserves are at least as high those that would otherwise be calculated in accordance with the rules.

4

## What are the rules for calculating Peak 1 reserves for accumulating with-profits contracts (UWP)?

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1. Unitised contracts should be valued as a unit reserve plus a non-unit reserve.

2. For regulatory-basis only life firms, where future premiums secure guaranteed benefits, a net premium method check is required to ensure this is not higher. The net premium check is not required for realistic-basis life firms.

3. The reserve must also must at least exceed the higher of (on the valuation basis and in resilience scenarios) the current surrender value, allowing for any discretionary adjustments, and the discounted value of any guaranteed benefits using a bonus reserve valuation.

5

## How should options and guarantees be treated when valuing Peak 1 reserves?

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1. Assume that the guarantee will be exercised when it is in the interests of the policyholder to do so.

2. If it is in the interests of the policyholder to exercise an option in a less costly way for the company, allowance may be made for this.

3. Stochastic modelling should be used where appropriate, using a market consistent asset model.

4. If stochastic modelling is not used, market option prices should be used to value an option, or the nearest equivalent benefit for which a market exists.

6

## What are the three elements of the realistic liability of a with-profits fund?

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1. The WPBR.

2. The FPRL.

3. Realistic current liabilities.

7

## Give 5 principles to be followed when valuing realistic liabilities under Peak 2.

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The method and assumptions should:

1. Be consistent with the method of valuing assets.

2. Allow for TCF considerations.

3. Allow for future management actions and policyholder actions.

4. Take into account shareholder transfers out of the fund.

5. Be consistent with the firm's PPFM.

8

## What are the factors to consider when calculating a WPBR?

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1. A retrospective or prospective method may be used.

2. The retrospective method must be consistent with the firm's PPFM and reflects the firm's policy on the distribution of surplus. The exact method used will depend on admin systems and historical data.

3. A prospective method may be used where bonus rates are not determined by asset share methods or where asset shares are calculated for specimen policies only and not in aggregate.

9

## What retrospective cashflows should be taken account of when calculating a WPBR?

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1. Premiums

2. Expenses/Charges

3. Any partial benefits paid

4. Investment income and changes in asset values.

5. Tax paid or payable

6. Reinsurance arrangements

7. Shareholder transfers

8. Enhancements to or deductions from the asset share

10

## What are the elements of FPRL?

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1. Cost of guarantees

2. Cost of financial options

3. Cost of smoothing

4. Cost of planned future enhancements

11

## What are the factors to consider when calculating FPRL?

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1. TCF obligations such as mortgage endowment promises and the non-operation of MVRs.

2. Future financing costs.

3. Mis-selling compensation.

4. Future tax on assets backing the FPRL.

5. Provision for future shareholder transfers.

6. Distribution of inherited estate (particularly for closed funds).

12

## What are the three allowable calculation methods for Peak2 cost of guarantees, options and smoothing?

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There are three ways of calculating them:

1. Stochastically using a market-consistent asset model.

2. Use the market cost of hedging.

3. Deterministic projections with appropriate probabilities.

13

## How do you calculate reserves for unit-linked business?

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1. A unit reserve and a non-unit reserve must be calculated separately.

2. The unit liability must be matched as closely as possible and so the unit reserve is taken as the number of units allocated to the policy multiplied by the unit price at the valuation date, reduced by the impact of any actuarial funding used.

3. The non-unit reserve is calculated by projecting all the cashflows arising from the contract and discounting back to the valuation date.

4. The non-unit reserve should be calculated on a policy by policy basis to avoid cross-subsidy between policies.

5. A negative non-unit reserve may be held for a policy under certain conditions, but not in aggregate.

6. Must make an allowance for the mismatching risk associated with the use of negative non-unit reserves.

7. Allowance for discontinuance rates is permitted, even when this may reduce the reserves.

8. If there are any investment guarantees a stochastic model should be used to calculate the additional liability.

14

## List and discuss individual valuation assumptions.

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1. Firstly note that Peak 1 assumptions are prudent and Peak 2 assumptions are realistic.

2. Mortality assumptions depend on the nature of the benefit (e.g. low mortality is prudent for annuities).

3. Withdrawals. Lapse assumptions can be made even where this might reduce reserves. But need to understand whether high or low lapses would be prudent.

4. Discount Rate.

For Peak 1 this would the expected return on the assets backing the contracts. For with-profits contracts, this would be reduced to allow surplus to emerge. The chosen rate must not exceed the maximum allowed by the PRA rules.

For Peak 2 the starting point for the discount rate would be a market consistent yield curve.

5. Unit Growth Rate. Based on the expected return on the mix of assets in which the units are invested. A low assumption is prudent if management charges depend on the value of units.

6. Inflation. Should be consistent with the discount rate and the unit growth rate, based on market observation and economic reasoning.

7. Expenses. An explicit assumption is required for a gross premium valuation. For a net premium valuation, the margin between office and net premium should be checked to ensure it is sufficient to meet future expenses, allowing for inflation.

8. Tax. Depends on the tax status of the contract in question. For BLAGAB, need to take into account the future expected tax basis of the company's BLAGAB fund. For unit linked contracts, the tax liability on unrealised gains may be allowed for in the unit price and hence the unit reserve.

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