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3 bases in valuing general insurance liabilities
- non-discounted basis: preferred under many branches for internal reporting
- actuarial present value: basis proposed by CIA; group payments by timing, select assets backing claim liabilities; use average yield of selected assets; add MfAD
- APV = "amount of consideration agreed upon in an arm's length transaction between knowledgeable willing parties who are under no compulsion to act"
- fair value: similar except discount rate may be different (use Canada strip bonds) and some assets may be reclassified as held-to-maturity (so not carried at market value)
- fair value is at best a surrogate for market value because:
- there is no secondary market to trade claim liabilities
- regulatory approval are required for large portfolio transfers
- transaction cost is material and cannot be ignored
- fair value is the logical choice because it recognizes time value of money, risk margin, and facilitates inter company comparison because yield is independent of original cost
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Provision for Adverse Deviations (PfAD)
- discount rate: credit risk, interest rate risk, timing risk
- credit risk: extra yield over Canada bond; reflect investment quality
- interest rate risk: (L/A) x |DA - DL| / DL x ∆yield
- timing risk: average yield x timing risk
- claims development: line of business and company specific considerations
- LOB considerations: duration of liability
- company specific considerations: data quantity and volatility
- reinsurance collectibility: examine recent experience, look for delay in payments, disputes in coverages, unsigned contracts, etc.
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Limits (bounds) of MfAD
- discount rate: 50bp to 200bp
- claims development: 2.5% to 20%
- reinsurance collectibility: 0% to 15%
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