Flashcards in Valuation Methods for Liabilities (Pillar 1) Deck (14):

1

## How do you value unit-linked business (15 points)

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1. Unit/non-unit reserve (unit/monetary)

2. Project monthly/annual cashflows

3. Project individually to avoid taking credit for cross subsidies

4. Allow for discontinuance rates in valuation

Unit:

1. Match unit liabs as close as poss (PRA req)

2. Unit liab is number of units reduced for actuarial funding

3. Where mismatching permitted e.g. index linked, then requirement to match as close as possible

Non-unit:

1. Includes:

continuing expenses

claims over unit reserve

purchasing units in actuarial funding

2. Dependent on factors related to discontinuities

a. unit allocation % with specified variations

b. AMC related to unit values

3. Bonus units added at certain times

4. Conversion of capital to accumulation units

5. Negative non-unit reserve possible, must be >=0 in aggregate

6. If negative unit reserve possible mismatch risk

2

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Give 2 examples of investment guarantees.

How do you value maturity guarantees?

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Examples:

1. Guaranteed annuity option (guaranteed terms converting lump sum to annuity)

2. Guaranteed minimum maturity value of endowment

Valuing maturity guarantee

1. Stochastic simulation

2. Using appropriate stochastic investment model

3. Set up reserve such that probability of guarantee not being covered by total reserve at maturity is sufficiently prudently low (ie. before setting up this reserve, might be high chance of not meeting that guaranteed amount)

3

## Method for realistic basis firms to value with-profits in Peak 1

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1. Some exemptions versus regulatory basis:

a. Take account of gross premiums received

b. Consider only guaranteed benefits in calc

c. No RCR

4

## Method for WPBR for realistic basis firms to value with-profits in Peak 2

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1. Calculate WPBR using retrospective (asset share) or prospective method

2. Method depends on admin/account systems and historical data

3. Prospective used where bonuses not determined by AS or AS is not calculated in aggregate

4. Prospective must take account of all guaranteed benefits

5. Prospective must account for TCF

6. Retrospective must take PPFM into account

7. Any projection must be long enough to take into account all material cashflows

5

## Method of calculating future policy related liabs for Peak 2?

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1. Market consistent

2. Cost of gtees/financial options/smoothing/future enhancements to benefits not already allowed for in WPBR

3 methods to calculate the FPRL:

1. Stochastically in MC model

2. Market cost of hedging (justification needed)

3. Deterministic with appropriate probabilities (justification needed)

6

## How would the stochastic asset model be set up?

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Based on market prices of over the counter options

Use this to construct series of curves reflecting time vs. market price

These curves then reflect market consistent view of future investment returns

7

## Other than cost of options/guarantees/smoothing/enhancements, what else will be included in the FPRL?

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1. TCF related commitments like mortgage endowment promises

2. Liability through non-operation of MVR's

3. Future financing costs

4. Compensation reserves

5. Future tax on assets backing FPRL

6. Future SHT provisions

7. Realistic current liabs

8

## What is special about the working capital in a closed firm, why?

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WC=0

As all of it is expected to be paid out in future enhancements to asset share (bonuses!)

RCM can take this into account too, adjusting the future enhancements

9

## What 4 types of reserve would be calculated in a group life contract? Describe them each in 1 sentence

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UPR (fraction of their premium until next premium date)

IBNR - incurred but not reported claims at valuation date

Deficiency reserve - cover difference between what it should be charging and what it is, including for guarantees

Experience refund reserve - accumulated until next refund given

10

## How would minor classes of business be reserved for?

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Approximate methods like multiple of premium

As long as higher than what calculation would be under normal rules

Time saved doing simple method outweighs extra prudence

11

## How would guarantees be treated for a firm with less than 500m WP liabs? What time wouldn't you choose the highest reserve for an option?

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Optional retirement date - assume retirement at highest reserve

GAO -

A) Highest reserve of lump sum/guaranteed annuity on valuation assumptions

B) Value the lump sum and calc GAO reserve using stochastic invesment model and sims

might take credit if policyholder interests may mean exercise option in a less costly way, this must be sufficiently prudent to account for changes in future experience.

12

## INSPRU requires a reserve for policyholder options, how might a company do it?

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1.. Appropriate to use stochastic modelling if can be considerable and material changes in value of an option

2.. Prices from the asset model should be benchmarked against appropriate assets to determine option value

3.. If no stochastic modelling, take market option prices

4.. If no market for these options, take nearest equivalent and adjust

13

## Explain how non-linked non group life contracts are to be valued in a company with under 500m WP liabs. How are discontinuance and guaranteed surrender values dealt with?

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NP or GP valuation

Reg basis firm:

GP Method must produce reserves > NPM in WP contract (so may as well use NP)

Realistic basis firm:

Can use GP without any minimum

Both reg/reali basis firms:

1. discontinuance allowed for within GP valuation even if reduces reserves

2. If policy has no gtee SV, negative reserve can be held

14