CIA.IFRS17-2 Flashcards
Briefly describe the concept of risk adjustment under IFRS17
RA adjust the (present value of the future cash flows) to reflect the (compensation the entity requires) for bearing (uncertainty about the amount and timing of cash flows)
Identify 4 methods for calculating RA under IFRS17
- quantile method
- cost-of-capital method
- margin method
- a combination of methods
Briefly describe the quantile method for calculating the RA
Quantile methods, including VaR and CTE, use distributions of the fulfilment cash flows to determine the RA for a given probability
** Is it important for the actuary to recognize that the VaR calculation may not capture the risk for a particularly skewed distribution of cash flows, which are common for P&C risks, and this may not be an appropriate method to use
Identify 1 advantage and 1 disadvantage of the quantile method for calculating the RA
advantage: the mathematics enable risks to be represented graphically which creates ease and convenience in understanding the result
disadvantage: if misrepresented, it may introduce spurious accuracy
Identify methods to generate a distribution of the underlying future cash flows (quantile methods to calculate the RA) (4)
- apply a suitably skewed probability distribution (lognormal or gamma)
- Monte Carlo simulation
- Bootstrapping
- Scenario modeling
Identify 2 disadvantages of using the bootstrapping method to generate future cash flows
- may be a poor approximation for small samples and relies heavily on the fact that each sampled variable is independent from another (ex. new LOB)
- variability of outcomes for future CFs may not be adequately represented by historical observations in a particular data set, particularly for low frequency, high severity outcomes
Briefly describe the Cost of capital method for calculating the RA and its 3 components
In a cost of capital method, the RA is based on the compensation that the entity requires to meet a target return on capital
3 components:
- projected capital amounts (used to determine the level of non-financial risk during the duration of the contract)
- cost of capital rates (represent the relative compensation required by the entity for holding this capital)
- discount rates (used to obtain present value of future compensation required)
formula = sum((rt x Ct)/(1+dt)^t)
rt = cost of capital @t
Ct = average capital amount @t
dt = discount rates @t
Identify 1 advantage and 1 disadvantage of the cost-of-capital method for calculating the RA
advantage: allows allocation of the RA at a more granular level
disadvantage: method is more complex (projection of capital requirements is an input to the liability calculation)
Briefly describe the margin method for calculating the RA
Select margins that reflect the compensation the entity requires for uncertainty related to non-financial risk
Identify 5 principles for calculating the non-financial RA
Risk adjustment should be higher for
- risks where less is known about current estimate and its trend
- low frequency/high severity risks
- longer duration contracts
- risk with wide probability distributions
Risk adjustment should be lower with emerging experience
Identify methods for calculating RA for reinsurance held (4)
- quantile methods
- cost of capital method
- catastrophe models
- proportional scaling
Briefly describe the catastrophe models method for calculating RA for reinsurance held
outputs from a CAT model could be used to asses the ceded RA
*if output tailored to the entity’s book of business, the actuary could select a percentile directly from the given distribution
Briefly describe the proportional scaling method for calculating RA for reinsurance held
proportional scaling ‘‘(works well for proportional or quota-share reinsurance)’’
→ use the same percentage of FCFs for the ceded RA as for the direct RA
→ but percentage could be modified for considerations such as: ‘‘ceding commissions, expense allowances, reinstatement premiums’’
→ method may also work for non-proportional reinsurance if the ceded RA can consistently be expressed as a portion of the gross RA
Why might the actuary estimate the ceded RA separately from the net RA
catastrophe reinsurance covers low frequency/high severity events, a standard quantile method may produce an RA that is too small or even 0
Describe a method for calculating the RA for upper layer of a reinsurance treaty (high percentile events)
cost of capital method with an assumption for required capital set at a higher percentile (captures compensation required at higher levels of the treaty)
