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MfAD - Defn
- Difference between the assumption for a calculation and corresponding BE assumption
- A factor applied to PV of a BE or to BE of an assumption to reflect its uncertainty
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PfAD - Defn
- Difference between the actual result of a calculation and corresponding result using BE assumptions
- The additional provision resulting from the application of MfAD
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APV - Defn
APV = PV + PfAD
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APV vs. FV
- similarity: both recognize time value of money and risk margin for claim liabilities
- differences (discount rate): FV uses market yield; APV uses avg yield on BV of selected assests under APV
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Considerations for selecting which of net / gross / ceded to estimate policy liab directly and then compute the 3rd
- Data availability: if sparse cede data can't directly estimate ceded; estimate gross and net directly
- Discount rate: if cede dif from net; estimate net and cede directly or gross and cede directly (assuming that know cede and gross/net are similar)
- Payment Pattern: If dif between cede and net; estimate gross and net directly (may not have a good view of cede payment pattern)
- Reinsurance program: if net retention changed significantly over the years can't use net as starting point; estimate gross and net directly
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Considerations for dividing claims into homogeneous groups for selecting payment patterns
- Groupings used for valuation on undiscounted basis
- Length of payout period
- Existence of a predetermined schedule of payments
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Methods to derive payment patterns
If undiscounted amounts based on: - paid development, derive directly from paid LDFs
- other methodologies, use historical ratios
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Payment patterns - Future claim cost (premium liabilities)
Consistent with those from claim liabilities. Adjustments required to reflect: - AAD and average payment date underlying future claim costs
- Legislative or product changes
- Other considerations similar to those affecting claim liabilities
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Payment patterns - Maintenance expenses / future reinsurance costs (premium liabilities)
- Paid over earning period of unexpired term of IF policies
- Time value of money may not be material and APV = undiscounted value
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Considerations for CF of future reinsurance costs (premium liabilities)
- Timing of payment of applicable reinsurance premiums
- Earning period of the unexpired portion of IF policies
- Potential for future reinsurance costs to change due to market pressures, changes in the underlying portfolio, etc.
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Defn of portfolio yield rate
IRR, that when applied to CFs of company, produce BV of assets
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Consideration rate of return on assets supporting liabilities
- Method of valuing assets and reporting investment income
- Allocation of those assets and income among LOB
- Return on the assets at BS date
- Yield on assets acquired after BS date
- Capital G/L on assets sold after BS date
- Investment expenses, and credit risk (losses from default)
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Criteria for selection of asset portfolio for deriving discount rate
Selected assets would be - sufficient to support net policy liabilities
- generate a CF consistent with CFs from net policy liabilities
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Considerations in selection of discount rate for net policy liabilities
- Reinvestment Risks and Asset Liquidation (if assets and liability CFs don’t align):
- Effect of reinvesting positive net CF / asset liquidation to address negative net CF
- blend of current portfolio yield, expected future reinvestment rates and expected G/L from liquidation
- Investment Expenses: reduce
- Credit Risk: reduce to reflect
- Expected losses due to defaults
- Impact of concentration of investments
- Asset depreciation risk (in credit risk of investment return MfAD)
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Options for discount rate of ceded liabilities
- Discount rate for net (i.e., a portfolio yield rate) appropriate if company's investments
- sufficient to support gross
- similar to reinsurer's
- Risk-free rate based on market yield on gov bonds with duration matching expected liability duration (conservative)
- Reinsurer discount rate
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Reasons for considering dif than portfolio yield
- Mismatch in duration of assets and liabilities (Reinvestment Risk, Liquidation of Assets)
- Investment Expenses
- Credit Risk
- Future Assets
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Risk free rate
- Reflect current or new money return rate for risk-free portfolio of assets with appropriate duration
- May be determined using avg market yield on gov bonds that match expected liability duration
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Porfolio yield (formula)
sum [(eff market yield x duration x market value) / (duration x market value)]
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