CIA.IFRS17-DR

Question 1

Briefly describe discount rate

Answer 1

• rate used to discount the estimates of future CFs
• consistent with the timing, liquidity and currency of the insurance contract CFs

Question 2

Briefly describe liquidity premium

Answer 2

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

HIGHLY liquid investments have low liquidity premium

Question 3

Identify considerations in deciding wether to use net or gross & ceded data for analysis (3)

Answer 3

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 type and consistency of reinsurance held (may not be appropriate to use the net basis if the entity’s retention has changed significantly over the experience period)

Question 4

Identify considerations when selecting a payment pattern (3)

Answer 4

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

Question 5

Identify characteristics discount rate should possess (3)

Answer 5

(a) reflect the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contracts
(b) be consistent with observable current market prices for financial instruments with similar cash flow characteristic as insurance contracts
(c) should exclude factors that affect market prices but do not affect cash flows for insurance contracts

Question 6

Identify and briefly describe methods for selecting the discount rates to be used for the valuation of insurance contract liabilities (2)

Answer 6

bottom-up approach
* a liquid, risk-free yield curve is adjusted to reflect:
→ 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 7

Formula discount rate bottom-up approach

Answer 7

discount rate = (risk-free rate) + (liquidity premium)

Other notes:
advantage: availability of risk-free yield curves
disadvantage: the need to derive a liquidity premium

Question 8

Formula discount rate top-down approach

Answer 8

discount rate = (reference portfolio yield) - (credit risk) - (market & other risks)

Other notes:
advantage: does not require the explicit derivation of a liquidity premium
disadvantage: potential complexity of the derivation of a reference portfolio rate

Question 9

Identify factors that may differ from a reference portfolio and insurance contracts (4)

Answer 9

LITU
- liquidity
- investment risk (e.g. credit risk, market risk)
- timing
- currency risk

*The credit risk adjustment may include default risk and downgrade risk. Note also that a market risk adjustment would not be necessary if the reference portfolio consists solely of bonds.

Question 10

Formula discount rate combined approach

Answer 10

discount rate = (risk-free rate) + (reference portfolio liquidity premium)

Question 11

Formula reference portfolio liquidity premium

Answer 11

reference portfolio liquidity premium = (top-down discount rate) - (risk-free rate)

Question 12

Identify 1 contract feature that decrease the liquidity of an insurance contract

Answer 12

• exit costs (surrender charges/penalties)

Question 13

Identify 2 contract features that increase the liquidity of an insurance contract

Answer 13

• negligible/no inherent value other than any exit costs
• high exit value of contract (large portion of inherent value is paid out)

Question 14

Is LIC considered liquid or illiquid?

Answer 14

Illiquid, no potential avenue for the policyholder to obtain the exit value yet there is tangible inherent value (else a claim would not have been made)

Question 15

Is LRC considered liquid or illiquid?

Answer 15

liquid, no claims have yet occurred, the policyholder can cancel the policy before expiry date and receive value without significant exit costs

Question 16

What is a reference curve

Answer 16

a standardized yield curve used to facilitate comparison among entities in the unobservable period

Question 17

What is a locked-in yield curve

Answer 17

yield curves determined at the initial recognition of the group of contracts

Question 18

When would a locked-in yield-curve be used for discounting (2)

Answer 18

In the context of financial reporting for P&C insurance contracts, locked-in yield curves are typically not used unless:
* the entity uses the GMA to determine the LRC for some or all groups of insurance
contracts; or
* the entity elects the OCI option for some or all portfolios of insurance contracts.

Question 19

Identify the two seperate lines of the income statement where the insurance expenses are accounted for

Answer 19

• insurance service expense (claims)
• insurance finance expense

Question 20

What does insurance finance expenses comprises (2)

Answer 20

comprises the change in the carrying amount of the group of insurance contracts arising from:
- the effect of the time value of money and changes in the time value of money
- the effect of financial risk and changes in financial risk

Question 21

Define the unwinding of discount

Answer 21

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

(release of the effect of discounting)

Question 22

Briefly describe 3 different methods for calculating unwinding

Answer 22

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 shifted by one period

expectation hypothesis:
* proposes that the term structure of interest rates is solely determined by market expectations of future interest rate changes