C31 : Provisions Flashcards
(19 cards)
Define the term ‘provisions’
- Provisions are calculated amounts that need to be set aside to meet a provider’s future liabilities.
- Value of the provisions will depend on the assumptions used to value the future expected cashflows.
List ten reasons for calculating provisions
ACID DIVIS
Accounts (published) - to value liabilities
Contributions - to set future contributions for the scheme
Internal management accounts - to value liabilities
Discontinuance - to calculate surrender benefits
Discretionary benefits - determine excess of assets over liabilities
Improvements - to value benefit improvements
Value provider for merger or acquisition
Investment strategy
Solvency purposes - to value liabilities
Individual v Global Provisions
- Individual provisions relate to an individual contract or scheme member
- Global provisions cannot be allocated to individual contracts or members and relate to a provider’s liabilities as a whole
Risks requiring global provisions (additional provisions)
Risks requiring global provisions: (that cannot be attributed to individual contracts)
1. Mismatching assets and liabilities
2. Operational risk
3. Credit Risk
4. Cost of guarantee and options
5. Acts as additional protection against insolvency
What key factors, related to the provider of benefits, affect the level of global provisions it has to hold?
- Provider’s risk management strategy: A detailed and effective risk analysis and management system, that is regularly monitored and updated, will reduce exposure to some financial and non-financial risks, and can thus justify holding a lower level of provision against these risks.
- Risk appetite
Why can an actuary never be certain that a set of assumptions will be correct.
As the timing and level of benefits, contributions and asset income is not certain
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.
List factors that Factors affect the strength of basis
Factors affecting strength of basis:
1. Reason why a value needs to be determined
2. Needs of the client
3. Requirements of any legislative or regulatory authority
Explain, with example, how results should be presented to a client in order for them to make a decision.
- present a range of values, or values for alternative scenarios
e.g. before making a long-term financial commitment a retirement benefit scheme’s sponsor may wish to know the actuary’s ‘best estimate’ of the costs and also the
costs assuming a worse scenario for future experience.
List 3 occasions when it will be appropriate to take account of the nature of the assets in valuing liabilities
- When the liabilities are specifically linked to the underlying assets e.g. unit trust or internal investment fund
- When the covenant of the sponsor has no value, e.g. when a pension fund is set up by a sponsor, but the sponsor makes no commitment to provide funds to make up any shortfall should the assets held turn out to be insufficient to meet the benefits promised. In this situation the benefits paid may need to be reduced to reflect the actual assets available.
- For the market-consistent valuation of liabilities in relation to financial guarantees on life insurance contracts, since the value will depend on the volatility of returns on the assets held.
Explain the type of basis to be used for published accounts (decisions by shareholders)
- an actuary’s ‘best estimate’ of the future experience
- The use of assumptions that are more likely to overstate or understate the liabilities or assets may lead to wrong decisions being made.
Outline aspects to consider in setting assumptions used to value the liabilities to be shown in a provider’s
published accounts and reports
Consider:
Accounting principles and legislation in territory concerned
Consider whether:
- Accounts are to be prepared on a going concern basis
- They are required to show a true and fair view
- Basis is prescribed by accounting standards, which often encourage a slightly prudent side of best estimate
- consistency in approach from year to year.
Outline aspects to consider in setting assumptions used to value the liabilities for the purpose of
demonstrating supervisory solvency
Regulators may wish to consider values that either
1. present a realistic picture of a provider’s finances.
2. Values that intentionally understate (or perhaps overstate) the financial strength of the provider.
Consider:
1. Regulation and legislation in territory concerned
2. Accounts are to be prepared on a going concern basis
3. Basis is prescribed or left to actuarial judgement
4. There are any relevant rules and actuarial guidance
4. Degree of prudence: best estimate with solvency capital or with low solvency capital
Other rules governing the preparation of these accounts and reports might concern the:
1. method of valuation used to value both the assets and the liabilities, e.g. market-based, discounted CFs
2. assumptions used to value both the assets and the liabilities
3. types of assets that can be held
4. level of global provisions to hold.
Outline aspects to consider in setting assumptions used to value the liabilities to be shown in a provider’s
internal accounts
Best estimate, to give realistic picture for decision making
Outline aspects to consider in setting assumptions used to value the liabilities for the purpose of
liability transfer
- Transferring company will prefer optimistic assumptions
- Receiving company will prefer cautious assumptions
- Best estimate basis is fair
- Basis will depend on the relative bargaining power of both sides and the relative supply and demand for liability transfers
- Possible that two sides agree that the transfer should not reflect a best estimate of future costs
Outline aspects to consider in setting assumptions used to value the liabilities for the purpose of
discretionary benefits
e.g.
1. benefit improvements in a benefit scheme
2. the declaration of a bonus on with-profit contracts.
- Discretionary benefits dilute security of existing benefits compared with the situation where they are not awarded.
- Assumptions used in deciding on whether or not to award discretionary benefits will err on the side of caution
- Cost of benefit may prove to be higher than expected
Outline aspects to consider in setting assumptions used to value the liabilities for the purpose of
Setting contributions in a benefit scheme
From perspective of trustees and beneficiaries:
- Cautious basis to ensure better security of benefits
- But not so cautious that the sponsor is crippled by the contributions and becomes insolvent, or stops providing benefits.
From the perspective of the sponsor:
- Optimistic(Cautious) if there is a high(low) opportunity cost of capital
- Cautious if greater contributions now may lead to greater flexibility in the future
- Cautious if greater contributions may result in tax deferral
- Cautious if sponsor wants to be viewed as paternalistic
- Cautious if better investment returns can be earned within the scheme leading to lower long-term costs
Best estimate for stability of cost and a compromise between the above factors
Outline aspects to consider in setting assumptions used to value the liabilities for the purpose of
Discontinuance/surrender benefits
Best estimate for
1. fairness between those discontinuing, those remaining and the provider
2. Realistic value of benefits
Outline aspects to consider in setting assumptions used to value the liabilities for the purpose of
Making decisions about investments
- Large number of different scenarios should be examined – cautious, best estimate and optimistic
- best estimate basis might be the most appropriate, together with sensitivity and scenario testing.
- Use a stochastic model
Outline aspects to consider in setting assumptions for
Communication of information to beneficiaries (decisions by individuals)
Individuals may need to make decisions about the
1. Level of benefits required
2. Contribution needs
2. Return that they gain on contributions
3. Security of benefit provision.
Assumptions should
1. Allow for individual circumstances
2. Be realistic (best estimate)
