Chapter 22 - Setting assumptions (2)

Question 1

What should be considered when setting the assumptions used to determine the liabilities shown in a company’s published accounts

Answer 1

• Whether the accounts are prepared on a going concern basis or a break-up basis
• Whether the accounts are required to show a true and fair view
• Whether reserves are required to be assessed as best estimates or on another basis,

Question 2

What is the difference in setting the reserving basis compared to pricing basis

Answer 2

An important difference in setting the assumptions for the reserving basis as opposed to a pricing basis is that the policies are already in force which can provide important information for the purpose of setting assumptions

Eg, we have the demographic assumptions as we now know who the policyholders are

Question 3

How to calculate the embedded value

Answer 3

It is the sum of:
- The shareholder-owned share of net assets, where net assets are defined as the excess of assets held over those required to meet liabilities
- The present value of future shareholder profits arising on existing business

Question 4

What is the appraisal value

Answer 4

It is the sum of the embedded value and goodwill.

Goodwill is the brand value of the company

Question 5

Increasing the discount rate increases the degree of prudence?

Answer 5

YES

Question 6

What is the difference between a best estimate valuation and an embedded value

Answer 6

• For Best estimate valuation, the present liability is calculated for each policy using realistic assumptions. The sum over all policies is compared with the total asset value to give a measure of realistic solvency
• An Embedded value calculation will consider the cashflows across the portfolio in each time period, rather than the present value of cashflows for each policy. The focus of embedded value calculation is shareholder profit

Question 7

Principles to consider when setting an EV basis

Answer 7

CREST
C – Consistency
(with previous EV bases, between assumptions, and with published accounts)
R – Risk Margin
(allow for unpredictability of profit emergence)
E – Expected Experience
(reflect best estimate future experience)
S – Standards & Legislation
(comply with professional guidance and accounting principles)
T – Tie to Pricing Basis
(consider pricing assumptions to avoid unexpected EV movements)