INSURANCE
Technical provisions
Methods and statistical techniques
to calculate the best estimate
Imrich Lozsi
4. December 2009
ADVISORY – ACTUARIAL SEVICES
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Agenda
The valuation process
Cash flow projections
Options and guarantees
Policyholder behavior
Discretionary benefits
Assumptions
Validation methods
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The valuation process (1)
It should not rely solely on models but also requires
Expert judgment with sound reasoning and business
logic
Analysis of the underlying liabilities
Collection of qualitative and quantitative information
Components of the valuation process
Collection and analysis of the data
Determination of assumptions
Modeling, parameterization and running the models
Assessment and appropriateness of estimations
Documentation and controls
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The valuation process (2)
Requirements for an individual performing the process
Knowledge of actuarial and financial mathematics
Ability to demonstrate this with applicable professional standards
Revision by person with adequate knowledge and skills and
independent of the valuation process
Upon request from the supervisory authority to demonstrate
The robustness of the valuation process
Appropriateness of the level of technical provisions
Applicability and relevance of the methods used
Adequacy of the underlying statistical and financial data
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Cash flow projections
All cash in- and out-flows required to settle the obligations
Best estimate is calculated gross, without deduction of amounts
recoverable from reinsurers and SPVs
Expected realistic future demographic, legal, medical,
technological, social or economical developments
Appropriate assumptions about future inflation
Identification of the type of inflation to which particular cash flows
are exposed
Projection horizon to cover the full lifetime of all obligations
To be determined on up-to date and credible information and
realistic assumptions
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Cash in-flows
Future premiums
Receivables for
salvage and subrogation
Should not take into account
investment returns!
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Cash out-flows
Benefits
Claims payments
Maturity benefits
Death and disability benefits
Surrender benefits
Annuity payments
…
Expenses
Other cash flow items
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Expense items
Cash flows from all expenses that will be incurred in
servicing all obligations related to existing contracts
over their lifetime
This shall specifically include
Administrative expenses
Claims handling expenses
Investment management expenses
Acquisition expenses including future commissions
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Expense allocation (1)
Expenses include
Allocated, i.e. directly assignable to individual claims, policies or
transactions; and
Unallocated (overhead) expenses
Principles of allocation to LOBs, homogeneous risk groups …
According to professional judgment and realistic assumptions
Based on realistic and objective principles
Principles and their application shall be documented and the
undertaking should be able to explain their changes over time
Changes in the pre-defined split permitted only if the new split will
better fit the current situation
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Expense allocation (2)
For non-life insurance obligations and where appropriate,
expenses shall be allocated between
Premium provisions; and
Claim provisions
Premium provisions
Administrative expenses including maintenance commissions
Claims administration expenses related to future claims from in
force contracts
Claim provisions
Claims administration expenses related to unsettled claims incurred
before the valuation date
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Expenses – other considerations
Own experience and any relevant market data
Inclusion of expenses directly related to administration of
obligations related to existing contracts, together with share of
relevant overhead expenses
Liability: how much to pay to transfer, how much to receive to
accept => Share of overheads on a going concern basis. Run off
basis only if it is very likely in the near future
Allowance for expected future cost increase but no allowance for
cost reductions where these have not yet been realized
May anticipate an expected cost reduction to the five years after
licensing of the undertaking
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Life insurance obligations
Cash flow projection should be based on policy-by-policy
approach (cash flows depend on biometrical risk of each
policyholder) but suitable model points are permitted
The grouping shall not
Misrepresent the underlying risk and significantly misstate the costs
Result in the loss of significant attributes of the valued portfolio
…
No surrender value floor (… no need to increase the value of
insurance liabilities to the surrender value)
Negative reserves permitted (… undertakings are not required to
set zero the value of best estimate)
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Non life insurance obligations
The valuation of the claim and premium provisions shall be
carried out separately
Claim provisions
All future claim payments
whether reported or not
Claims management and
claims administration
expenses associated with
these claims
Premium provisions
Future premium payments
Future claim events
Allocated and unallocated
claims management
expenses
Expenses associated with
ongoing administration of
in-force policies
Policyholder behavior, time
value of the money
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Options and guarantees (1)
Identify all contractual options and financial guarantees (“right
to change the benefits to be taken at the choice of its holder,
on terms that are determined in advance”)
For each type of contractual options identify all risk drivers,
which have the potential to materially affect
Option take up rates
Level of moneyness
Capture the uncertainty of cash flows
Consider a sufficiently large set of
scenarios, including adverse ones
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Options and guarantees (2)
Best estimate should reflect both the intrinsic and the
time value
Assumptions on policyholder behavior should be
appropriately founded by statistical and empirical
evidence to the extent that this is deemed
representative of the expected future behavior
Consideration should also be given to an increasing
future awareness of policy options as well as
policyholders’ possible reactions to reduced solvency
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Policyholder behavior
Policyholder behavior which change the expected future cash
flows of the contract, if exercised in line with options contained in
the policy should be taken into account
When assessing past policyholders behavior, appropriate
attention should be given to whether the option is out or barely
into the money …
Policyholders’ behavior should not be assumed to be
independent of financial markets, an undertaking’s treatment of
customers or publicly available information, unless proper
evidence assumption can be observed.
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Discretionary benefits (1)
When calculating technical provisions participants
should take account of all payments to policyholders
and beneficiaries, including future discretionary
bonuses, which they expect to make, whether or not
these payments are contractually guaranteed, unless
those payments fall under surplus funds
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Discretionary benefits (2)
Guaranteed benefit
The value of the liability, which does not take into account any
future declaration of future discretionary bonuses
Conditional discretionary benefit
This is a liability base on declaration of future discretionary benefits
influenced by legal or contractual declarations and performance of
the undertaking/fund (performance-related)
Pure discretionary benefit
This is a liability based on the declaration of future benefits which
are at discretion of the management (decision-related)
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Discretionary benefits (3)
Detailed documentation of the mechanism for distributing
discretionary benefits
When valuation of discretionary benefits depends on the assets
held by the firm
Assets assumed in valuation to be consistent with the assets held
at the valuation date
Changes in asset allocation should be taken into account if
requirements on management actions are met
The valuation of the discretionary benefits should be consistent
with the choice of the risk-free rate for discounting
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Assumptions (1)
Assumptions shall be set consistently with
Information provided by the financial markets
Generally available data on insurance and reinsurance
technical risks
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Assumptions (2)
General principles for assumption setting
In a realistic manner and consistently from year to year without
arbitrary changes
Changes of assumptions from one period to another shall be
traced, explained and documented …
Assumptions shall be appropriately documented including the
suitability of data sources, derivation of assumptions and the
limitations in the results
The underlying data shall be credible and meet the relevant
standards
When based on external data
Available to the extent that they may be validated
Produced sufficiently frequently to permit analysis
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Assumptions – Information provided by the
financial markets
Where an assumption is produced by a market consistent asset
model, that model shall satisfy the following criteria
Shall deliver prices for the assets and liabilities that can be
directly verified by the market
Shall be arbitrage free
A market consistent asset model shall be calibrated to
Reflect the nature and term of the liabilities particularly those
giving rise to significant guarantee cost
The current risk free term structure
An appropriate volatility measure
Deep liquid and transparent market
If not, insurer shall be capable to demonstrate that the calibration
is appropriate
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Assumptions – Data on insurance and
reinsurance risks
Assumption shall be derived consistently
Across homogeneous risk groups or lines of business
With the undertaking’s knowledge of the business and
practices for managing the business
Credible information which is relevant to the cash flows
Undertakings shall consider whether assumptions adequately
reflect the underlying uncertainty
Appropriate allowance for future trends or changes both in the
portfolio and external socio-economic factors
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Assumptions – Use of expert judgment (1)
Scope
Data, assumptions and in respect of the applied
method
General conditions
Compatibility with CEIOPS advices, in particular it
shall not replace appropriate collection processing
and analysis of data according to advice on data
quality standards
Shall not be applied in isolation
Should be prudent if applied in isolation
or to an assumption with significant impact
Expert with relevant knowledge, understanding and
comprehension of the subject
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Assumptions – Use of expert judgment (2)
Documentation in a manner which makes possible the
accountability and verification of the expert judgment
Inputs
Objectives and decisional criteria
Any material limitations and the
steps to be taken to eliminate them
The envisaged validation
and back testing
Back testing
Against additional experience
or emergent information
Compared to external information
Sensitivity analysis
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Validation methods
Validate the amounts of technical provisions
Ensure applicability and relevance of the methods
and assumptions applied and appropriateness of the
level of technical provisions
Ensure that the actuarial methods and statistical
techniques are appropriate to the nature, scale and
the complexity of the risks
Compare the best estimate against experience,
understand and explain sources of differences
At least once per year but significant changes may
necessitate ad-hoc checks more often
Appropriate documentations
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Imrich Lozsi
Senior Manager, Actuarial Services
KPMG in the Central and Eastern Europe
c/o KPMG Česká republika, s.r.o.
+420 222 123 627
ilozsi@kpmg.cz
www.kpmg.cz
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