CIA Discounting

  1. 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
  2. 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
  3. APV - Defn
    APV = PV + PfAD
  4. 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
  5. 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
  6. 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
  7. Methods to derive payment patterns
    If undiscounted amounts based on:
    • paid development, derive directly from paid LDFs
    • other methodologies, use historical ratios
  8. 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
  9. 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
  10. 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.
  11. Defn of portfolio yield rate
    IRR, that when applied to CFs of company, produce BV of assets
  12. 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)
  13. 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
  14. Considerations in selection of discount rate for net policy liabilities
    1. 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
    2. Investment Expenses: reduce
    3. 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)
  15. Options for discount rate of ceded liabilities
    1. Discount rate for net (i.e., a portfolio yield rate) appropriate if company's investments
      • sufficient to support gross
      • similar to reinsurer's
    2. Risk-free rate based on market yield on gov bonds with duration matching expected liability duration (conservative)
    3. Reinsurer discount rate
  16. 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
  17. 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
  18. Porfolio yield (formula)
    sum [(eff market yield x duration x market value) / (duration x market value)]
Card Set
CIA Discounting
CIA Discounting (Discounting and Cash Flow Considerations)