Chapter 32: Provisions Flashcards
(19 cards)
Define the term provisions
Provisions are the calculated amounts that need to be set aside to meet a provider’s future liabilities.
The value of the provisions will depend on the assumptions used to value the future expected cashflows.
List 10 reasons why a provider calculates provisions
BAD MEDICS
* Benefit improvements for a benefit scheme
* Accounts and reports - published and internal
* Discontinuance / surrender benefits
* Mergers and acquisitions
* Excess of assets over liabilities and so whether any discretionary benefits can be awarded
* Disclosure of information for beneficiaries
* Investment strategy
* Contribution / premium setting
* Statutory solvency reports
Can also be used by a ank to provide for expected credit losses.
What is the difference between individual and 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
Give an example of one financial and one non-financial risk for which a provider might calculate global provisions
Financial risk - mismatching assets and liabilities
Non-financial risk - operational risk
Basis
The term given to a collection of assumptions
Best estimate basis
Set of assumptions that have an equal probability of overstating and understating the value of the assets and the liabilities
Optimistic (or weak) basis
Assumptions are chosen which collectively result in a high value of assets and/or a low value of liabilities
Cautious (or prudent / stong) basis
Assumptions are chosen which collectively result in a low value of assets and/or a high value of liabilities
State the 2 main factors that usually dictate the strength of the basis on which values should be determined
- Purpose and client:
- The reason that a value needs to be determined
- the needs of the client
- the requirements of any legislative or regulatory authority - Nature of the assets:
- when the liabilities are linked to underlying assets
- when a covenant of the sponsor has no value
- for a market-consistent valuation of liabilities w.r.t. financial guarantees on life insurance contracts (since the value of the liabilities will depend on the volatility of returns on the assets held)
Regulation is very important
Give 3 examples of how the nature of the assets held can impact the liability valuation
- The liabilities may be specifically defined in terms of the performance of the assets (e.g. unit-linked contract, unit trust)
- Where the sponsor will not make up any shortfall in a pension fund, the benefits paid must have to be reduced to reflect the actual assets available
- For a market consistent valuation of life insurance financial guarantees the liability value will depend on the volatility of returns on the assets held.
Outline the factors to consider when valuing the liabilities to be shown in the provider’s published accounts (best estimate)
- Consider accounting principles and legislation in the country concerned
- Consider whether the accounts are to be prepared on a going concern basis (or is discontinuance happening)?
- Consider whether they are required to show a true and fair view
- Consider whether the basis required is the best estimate or some other basis and how this is to be interpreted (One of the accounting principles is prudence and this often results in the basis used being on the slightly prudent side of best estimate)
Shareholders and potential shareholders make decisions using information in a company’s accounts. It is, therefore, preferable for values to be included in the accounts that represent an actuary’s best estimate of the future experience.
Outline the factors to consider when valuing the liabilities to demonstrate supervisory solvency (prudent)
- Consider the regulation and legislation in the territory concerned
- Consider whether the accounts are to be prepared on a going concern basis or a discontinuance basis.
- Consider whether the basis is prescribed or left to actuarial judgement
- Consider whether there are any relevant rules and actuarial guidance
- Regulators may wish to consider values that present a realistic picture of the provider’s finances. Alternatively, they may wish to consider values that intentionally understate (or perhaps overstate) the financial strength of the provider
What basis should be used when valuing the liabilities to be shown in the provider’s internal accounts?
Best estimate, to provide a realistic picture for decision-making by management
Outline the factors to consider when valuing the liabilities for a transfer of liabilities between two providers
- The transferring company will prefer optimistic assumptions
- The receiving company will prefer cautious assumptions
- A best estimate basis is fair, and the need to agree may result in a best estimate basis being used
- However, the basis will depend on the relative bargaining powers of both sides and relative supply and demand for liability transfers
- It is possible that the 2 sides agree that the transfer should not reflect a best estimate of future costs, for example, if they recognise a need to hold a margin to protect the security of the benefits
What basis should be used when determining whether discretionary benefits can be awarded or benefit improvements made?
The provider may want to use assumptions that do not overestimate the surplus available in order to avoid being pressurised into distributing it as discretionary or additional benefits. Similarly, proposed benefit improvements should not be undervalued.
This is because such benefits may prove in practice to be more expensive than had been anticipated.
The most realistic indication will be based on best estimate assumptions, but a cautious basis (or range of assumptions) may be used.
Outline the factors to consider when valuing the liabilities to set contributions for a benefit scheme.
The trustees are primarily concerned with the security of members’ rights, so they might want to overstate future contribution requirements - i.e. use a cautious basis. However, this must be balanced against the basis not being so cautious that it would discourage the employer from providing the scheme because the contributions were so high.
For benefit schemes, the structure of the membership (open or closed scheme) can also have an effect on the assumptions used.
What basis should be used when setting discontinuance terms, in order to be “fair” to all parties?
When setting discontinuance benefits it may be appropriate to use a best estimate basis. This means that the discontinuance benefit will reflect the realistic value of the benefits.
However, other bases may also be appropriate, depending on the circumstances
Outline the factors to consider when valuing the liabilities to set an investment strategy
A best estimate basis might be the most appropriate, together with sensitivity and scenario testing. It 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.
Outline the factors to consider when setting a basis to illustrate the level of benefits to which an individual is entitled, the level of investment return they might expect to receive and the contributions they might be required to make to target a specific level of benefits
In order to make decisions relating to their benefit and contribution needs, they will need to consider values that take account of their individual circumstances. These values may be most informative if they present a realistic picture. However, the uncertainty of the values should be communicated so that the individual is aware of the risks of under- and over-contributing.
