VALUATIONS Flashcards
(16 cards)
How are insurance contracts grouped?
Class of business: whole of life, annuity, term assurance etc.
Inception dates: need to be at least 12 months apart
Profitability
1. Loss making at inception
2. No significant probability of being loss-making
3. Neither 1 or 2
When will insurance contracts being recognised initially?
The earliest of:
1. The beginning of the coverage period of the group of contracts
2. Date when first payment from PH in the group becomes due
3. For group of onerous contracts, when group becomes onerous.
Why would BEL be different IFRS 17 vs. prudential regulatory reporting purposes?
- the acquisition and maintenance expenses allowed to be included in expense assumptions
- discount rate used
- contract boundary
- tax-related flows included in fulfilment cashflows
- requirement to unbundle certain contracts under IFRS 17
What are examples of non-hedgeable risks used to calculate the risk margin?
- mortality/morbidity/lapses
- operational risk (IT failure etc.)
- credit risk (reinsurer default)
- non-hedgeable market risk (illiquidity risk [cannot realise illiquidity premium] , long dated interest rate risk [up to certain point don’t get bonds anymore so all cashflows outside of that term is unhedged] )
What is the difference between EV and VNB?
- VNB is basically EV for new business written during a specific reporting period (typically one year)
- VNB is forward-looking whilst EV is comprehensive measure for all in-force business
- VNB measures sales productivity and new business profitability
- EV measures overall company value is is the basis for M&A valuations
What important assumptions are included in EV calculation?
- premium growth and attrition rates in the future
- expense assumptions
- economic assumptions (investment returns, risk discount rate, inflation, tax)
IFRS 17: best estimate assumptions
- Expenses need to be directly attributable to individual/group of contracts. General overheads not related to fulfilling insurance contracts are excluded e.g. marketing expenses or executive salaries.
- Interest and inflation rates should be derived so that they’re consistent with market yields to maturity for fixed-interest securities and considered future investment returns of a portfolio of assets appropriate to the liabilities.
- Any tax CFs included in BEL. Allow for changes to future tax positions and effect of tax on future investment return. Accounting policy could be: direct+indirect tax CFs vs. direct tax CFs only.
What are the two ways to derive IFRS interest and inflation rates?
Top down: interest rates are based on expected returns on reference portfolio with similar liquidity characteristics to liabilities. Adjust to remove factors N/A to liabilities e.g. market and credit risk.
Bottom up: Look at highly liquid, high quality bonds (government bond yield curve), adjust to include premium for illiquidity in underlying insurance contracts.
What are the two ways a loss component can arise?
- The policy/group of contracts is loss making for the beginning
- After inception, the CSM is no longer big enough to absorb the increase in BEL+RA, so loss component = shortfall. The increase in BEL+RA which adjust CSM could be due to: assumption changes/non-financial variances (not changes in interest or inv returns).
What is the major difference between VFA and GMM?
The discount rate. If the discount rate increases then BEL + RA could fall.
For profitable groups:
- Under GMM this goes directly to profits (shown in P+L statement), the CSM isn’t involved at all as it only concerns non-financial variances.
- Under VFA, this fall is absorbed by the CSM (increases the CSM), the only released in future as CSM unwinds. As a result BEL+RA+CSM remains unaffected)
For loss-making groups:
- For both VFA and GMM, the fall in BEL+RA reduces the loss component
What are the reasons PAA approach is used?
- Simplified methodology won’t materially affect liability value if GMM/VFA used
- Contract boundary is <=1 year
What is the difference between free assets and BSR?
- BSR is an IFRS 4 concept, which was an allowance for future bonuses
- BSR is actually part of BEL, whereas free assets are assets less liabilities
- BSR can increase or decrease, based on the bonus philosophy of the insurer and how much surplus is being made year or year
- If BSR becomes too negative, can transfer from free assets as a “loan” which needs to be repaid back later
- Excess BSR can only be transferred to free assets if it is a “loan repayment”
- The company is solvency as long as there are enough free assets to cover statutory requirements.
What does regulatory balance sheet for cell captive insurers look like?
- Individual cell balance sheets (assets, liabilities, regulatory capital)
- Promoter cell balance sheet
- Interactions between cells in case of shortfalls
- Limitations on diversification benefits between cell
Why is there a loss component run-off in both the insurance revenue and insurance expenses?
- we immediately recognize the full expected loss in PnL
- we set up a “loss component” within the insurance contract liability
- this loss component is then systematically released (“run off”) over the coverage period as and when insurance service provided
- the run off is a mechanism to ensure total service revenue equals the total premium over the contract lifetime.
- it is included in revenue and expenses to ensure net effect is zero
Why is the amortisation of insurance acquisition cashflows in both insurance revenue and insurance expense?
- acquisition costs (like commissions, underwriting costs) are not immediately expensed, they are recognised as an asset called DAC
- these costs are spread over the lifetime of the policy i.e. amortised
- it appears in revenue because part of the premium paid is supposed to go toward these costs
- it appears in expenses because that represents the cost of providing the insurance service for that year
Why is EV still relevant in IFRS 17 world?
> EV is simpler to calculate
EV is more comprehensive
> more than just directly attributable expenses
> include renewals of contracts even if repricable
> includes operational risk, company-wide risk not just insurance risk
> shows what can be distributed to SH
> designed to show what company is worth
> shows full impact of economic changes, whilst IFRS 17 staggers the impact
Not all companies adopt IFRS 17 so EV still relevant
