Current Estimates of Expected Cash flows Under IFRS X

Transcription

1 Current Estimates of Expected Cash flows Under IFRS X Scope Q1 A1 Q2 A2 What is the scope of this International Actuarial Note (IAN)? This IAN provides information concerning the estimates of future cash flows for use in calculating liabilities for contracts under International Financial Reporting Standard (IFRS) X Insurance Contracts, both at contract inception and at subsequent measurement (re-measurement). What subjects are not addressed in this IAN? The following topics are not covered in this IAN but are covered in other IANs: Contracts that do not qualify for measurement under IFRS X, e.g., o financial instruments, particularly derivatives, both stand-alone and investment components separated from a host insurance contract, subject to IFRS 9 o service contracts and service components separated from a host insurance contract, subject to IFRS 15 o workers compensation and other post-employment benefits for an entity s own employees, subject to IAS 19 o self-insurance liabilities, subject to IAS 37 Discount rates [IAN?] Recognition and de-recognition [IANs 1 & 2] Identification of contract boundaries [IAN?] Contractual service margins [IAN?] Risk adjustments [IAN 3] The simplified (Premium Allocation) approach [IAN 7] Ceded reinsurance (e.g., counter-party risk) [IAN?] Consequences of contract modifications [IAN 11] Peculiarities of cash flows under participating, performance-linked or other indexdependent features [IAN?] IFRS X disclosures, including Other Comprehensive Income [IAN?] Transition requirements [IAN?] Q3 A3 What references, other than this IAN, are relevant to this topic? The IAA has published a monograph on Current Estimates that actuaries should be familiar with before reading this IAN. It has also published a monograph on stochastic methods that could be useful for this purpose. In general we will not repeat material from either of the above monographs in this note.

2 In addition, the general educational material of IAA members provides significant guidance on how to estimate future cash flows. All of this guidance could be relevant. General Issues: Q4 A4 Q5 A5 Q6 A6 What is a cash flow? Cash flows as measured under IFRS X include not only those receipts and payments that are made in cash during the period being considered but may also include cash equivalents and allocations (e.g. certain expense overheads such as pension costs). Furthermore, some payments may be considered on an incurred, rather than cash, basis if the incurred measurement is more relevant or conveniently measured (e.g. for death claims). At what level are cash flows determined? In principle, cash flows are measured at the individual policy level for the purposes of IFRS X. In practice, policies may be grouped together to measure cash flows where this would give substantially the same result. (See also the IAN on Loss recognition.) How does IFRS X define the cash flows to be used in calculating the liabilities? 22. The estimates of cash flows used to determine the fulfillment cash flows shall include all cash inflows and cash outflows that relate directly to the fulfillment of the portfolio of contracts. Those estimates shall: (a) be explicit (i.e. the entity shall estimate those cash flows separately from the estimates of discount rates that adjust those future cash flows for the time value of money and the risk adjustment that adjusts those future cash flows for the effects of uncertainty about the amount and timing of those cash flows); (b) reflect the perspective of the entity, provided that the estimates of any relevant market variables do not contradict the observable market prices for those variables (see paragraphs B43 B53); (c) incorporate, in an unbiased way, all of the available information about the amount, timing and uncertainty of all of the cash inflows and cash outflows that are expected to arise as the entity fulfils the insurance contracts in the portfolio (see paragraph B54); (d) be current (i.e. the estimates shall reflect all of the available information at the measurement date) (see paragraphs B55 B61); and (e) include the cash flows within the boundary of each contract in the portfolio (see paragraphs and B62 B67). Q7 A7 Issues concerning this definition are discussed below. What is a current estimate? A current estimate at the report date is the entity s estimate based on currently available information in a manner consistent with relevant accounting guidance. The term current

3 estimate is used in this IAN as a short form for the current unbiased estimate of the expected value of contractual cash flows. This IAN does not refer to issues regarding calculating present values but focuses on the identification of cash flows and estimating unbiased expected values of those cash flows. Q8 A8 Q9 A9 Q10 A10 What is the meaning of expected value? For IFRS purposes, expected value of cash flows represents the mean of the (typically unknown) distribution of cash flows. Does this mean that the distribution function of cash flows needs to be determined? Not necessarily. The accounting purpose is to derive a current unbiased estimate of the expected value of cash flows. IFRS X does not provide any guidance regarding by which statistical approach the estimate is to be made. Any approach applied in determining figures for an IFRS X report needs to comply with general accounting requirements as outlined later in this IAN. There is a variety of approaches that can be used for determining unbiased estimates of expected values without a need to know the underlying distribution function. If the cash flows depend significantly on circumstances which cannot be described statistically but requires the choice of scenarios, as, for instance, for future market prices or interest rates affecting the (value of the) cash flows, stochastic modeling might be needed to estimate the expected values. In simpler cases, it may be acceptable to use deterministic projections, provided that care is taken to avoid bias arising from the parameters and structure of the projection model. What does unbiased mean? An estimator is unbiased if its mean value equals the mean of the value to be estimated. As this may be difficult to establish in the context of many actuarial valuations, it is acceptable if the estimator is intended to be free from bias and is not subject to any known bias. It should also be noted that, for IFRS X purposes, it is the overall answer that should be free from bias. Depending on the model(s) used, it may be possible for unbiased parameters to yield a biased answer. This is particularly true when the model contains non-linearities. Q11 A11 What are some examples of current estimates as intended by IFRS X and other possible objectives (e.g. best estimate vs. median vs conservative estimate) Current estimates can be developed by a single or multiple approaches, in part depending upon the type and quality of data available that are relevant to expected future conditions. IFRS X calls for an estimate of the statistical mean, rather than the statistical median or mode. In addition, such an estimate takes into account changes in condition between the historical period and the period during which the relevant future cash flows are payable and does not reflect implicit margins for conservatism or prudence (that should be

4 reflected in the risk adjustment). As the future is uncertain, the entity s judgement may be required in the development of such an estimate. Q12 A12 Q13 A13 Q14 A14 Q15 A15 Q16 A16 Q17 A17 Q18 A18 Q19 What is a contract? See IAN Classification Does a contract include all or any supplementary benefits, e.g. waiver of premium? See IAN Classification What are contractual cash flows? Contractual cash flows are those cash flows which are incurred in fulfilling the terms of the contracts to be measured. They do not include cash flows associated with other contracts or liabilities of the entity, nor any cash flows associated with contract obligations outside the contract boundary. What cash inflows are to be considered beyond premiums? All cash inflows associated with the insurance contracts; however, investment income is not included since it is not part of the contract terms. Cash inflows considered include such items as salvage, subrogation, contract charges such as cost of insurance charges and claw-backs of agent commissions. Benefits and commission reimbursements related to ceded reinsurance contracts would be considered in the context of the associated reinsurance asset. How are policy loans and repayments handled? Payments and repayments of policy loans are not considered as fulfillment cash flows; rather they are treated as investments and investment income. How are premiums prepaid with interest accretion treated? Prepaid premiums are treated the same as premiums paid at their due date. They are part of the cash inflows and the frequency and effect of their occurrence should be estimated as part of future cash flows. In most cases, however, their occurrence and effect is likely to be immaterial. If necessary, a minor adjustment to the discounting could be made for this purpose. How are extra premiums paid for impaired lives included? Extra premiums for impaired lives are treated identically to other premiums. Are all cash flows associated with the insurance policy to be considered, even if they are subject to another IFRS??

5 A19 Q20 A20 Although the IFRS X refers only to cash flows, in the case of cash flows provided under other contracts (e.g. employment contracts, intermediary contracts, contracts acquiring equipment etc.) those are measured under other IFRSs. In such cases, the measurement of the insurance contract would not refer to the incurrence of actual cash flows but to revenues or expenses as measured under the other IFRS. [How are cash flows that are not directly determined by the contract, but are contractual, distinguished from cash flows belonging to the entity in general?] Cash flows belonging to the contract are those that are specifically generated because the contract is in existence (e.g. benefits, commissions, direct administrative expenses). Indirect administrative expenses, including general overheads, are included only if they are directly attributable to a portfolio of contracts. If they are not, they are general expenses of the entity, not belonging to the contract, and are thus not considered in measurement of the expected cash flows of the contracts. When investment expenses are estimated, only expenses that are required by the contract are included, not the expenses of the actual investments of the company. Under normal circumstances, investment expenses are rarely included in the cash flows. [Can anyone give an example of when this question applies?] Q21 A21 To what extent do the expected values have to differentiate contracts with different characteristics (e.g. age, gender), and other known peculiarities of contracts? According to the standard, groupings can only be made between contracts that respond similarly to key drivers of change and that have similar profitability. This may require separate assumptions for most characteristics, particularly those that directly affect the cash flows. Mortality is a prime example of where the cash flow should reflect all known material characteristics (age, sex, underwriting category). On the other hand, those characteristics might have no material effect on other coverages where geographic location might be more important. Where characteristics are fully reflected in pricing, however, it may be appropriate to adopt assumptions that reflect the pricing, rather than the underlying characteristics. Q22 A22 Do expected values have to reflect all known characteristics or only those used as a parameter in pricing (for example, in the case of unisex products)? Expected values should reflect those characteristics that are expected to impact cash flows whether used in pricing or not. There are many characteristics that may affect expected cost that are not reflected in pricing, due to their expected non-materiality or because they are too detailed for consideration (to take an extreme example, mortality rates may vary by attained month, although it is usual practice only to vary them by integral ages). It is not necessary to recognize all such characteristics in the estimated cash flows, only those for which we have experience, are known in the regular course of business, and are relevant. Likewise, it is not necessary to search out and incorporate

6 characteristics that are unknown to the insurer, even though such characteristics might be reasonably be expected to influence the experience under a contract. Q23 A23 What is the definition of a portfolio (and provide examples)? A portfolio is defined in the IFRS X (para??) as???. Within this definition, an entity has considerable freedom to define a portfolio in a way that best reflects how it manages its business. Examples of portfolios might be: All whole life insurance policies sold during 2014 All auto policies sold in a jurisdiction or location (e.g. in Florida or in New South Wales All annuities sold to females over 65 Specific Methods to estimate expected future cash flows. Consult the stochastic monograph and the monograph on current estimates published by the IAA for more a detailed discussion of this topic. Q24 A24 Q25 A25 What constitutes an internal experience study? A study of the experience of the particular block of business, related blocks of business, or prior business written. For example, a calculation of mortality experience written by the entity or loss development for a similar coverage. What is actuarial credibility and how should it affect the use of an internal experience study? If the internal experience is not of sufficient size (i.e., due to volume of business or that it has not been written for a sufficient period of time), it is said not to be fully credible, that is, not sufficient in and of itself to form the sole basis for expected future experience. Partial credibility is the extent to which such historical experience should be used as such a basis. In some cases, assessed credibility may be used to assess whether an experience assumption should be revised. In others, it is more appropriate to adopt an updating process, in which newer experience data is combined with older experience or external data, using credibility weighting. Long-Duration Business Q26 A26 What methods are appropriate to estimate expected future mortality cash flows? In most cases, expected mortality cash flows will be projected using an expected table of mortality rates. The approaches and other sources of information used to develop future

7 mortality cash flows should be identical to those used to develop mortality assumptions for any other actuarial purpose for which an unbiased estimate is made. This would also generally incorporate an assumption regarding expected mortality improvement. Stochastic projections (see IAA book on Stochastic Modeling) are possible but are not required and will generally produce a result that is not materially different from a single scenario projection using the expected mortality rates stochastic methods will more likely be used to develop estimates of a risk adjustment (see IAA book on Risk Adjustments). Q27 A27 Q28 A28 Q29 A29 Q30 A30 What methods are appropriate to estimate expected future morbidity (e.g., incidence, termination) cash flows? The same methods should be used as for pricing the product except that the probabilities need to be neutral (i.e. unbiased). What methods are appropriate to estimate other benefit rates (e.g. term conversions, annuitization)? The same methods should be used as for pricing the product except that the probabilities need to be neutral (i.e. unbiased). What methods are appropriate to estimate expected future voluntary lapsation (i.e. policyholder behavior)? The same methods should be used as for pricing the product except that the probabilities need to be neutral (i.e. unbiased). What needs to be considered in estimating policyholder behavior (e.g., surrender rights, options to switch types of contracts if such option exists in a contract e.g. between a unit-linked and participating contract)? Basis for the expected value is the actual expected behavior based on experience, not financial rational behavior. Risks from that assumption are to be considered in the risk adjustment. The expected value considers both, advantageous and disadvantageous behavior of policyholders. Short-Duration Business Q31 A31 What methods are appropriate to estimate expected future cash flows on reported claims? Estimates of future cash flows on reported claims need to consider some or all of the following matters, depending on the nature of the business and the claims. Numbers of reported claims. In many cases, case estimates of quantum are available. It is important to understand why and how such estimates are made and what matters are considered in their

8 construction, in order to assess whether to and how they should be used in estimating future cash flows. Bulk estimates of quantum can be made ab initio, relying solely on experience analysis of claim payments. More usually, it is appropriate to incorporate available case estimates into this analysis. While some claims do not develop, in many cases claims develop as further information comes to light and as external circumstances vary. Current estimates under IFRS X include appropriate allowance for such development. A particular aspect of this development is claim inflation. In many cases, it is appropriate to make use of a suitable standard index of inflation (AWE, CPI, CPI subgroups, etc.). In others, it may be necessary to analyze the experience, possibly after adjustment using a standard index, to develop a specific index. Some techniques (e.g. chain ladder) implicitly project forward past trends, including inflation. It is necessary to consider whether it is appropriate to accept these implied trends or to adjust historical claim severity patterns. Except in the case of immediate payment, settlement and payment patterns are needed as the basis for cash flows. These often interact with development and inflation. Some insurance coverages are subject to a degree of recovery from the insured, in the form of deductibles, maximum loss limits, excesses, cost sharing, etc. These need to be allowed for, whether in the data analyzed or explicitly. Expected contractual policyholder recoveries are part of the expected contractual cash flows. Many general insurance contracts are subject to reinsurances, which can take many forms. Projected reinsurance recoveries need to properly reflect both the reinsurance terms and the actual past and expected future direct cash flows. While reinsurance recoveries are reported separately, it is important to consider whether the net result is appropriate. Other recoveries include salvage (sale of damaged property) and subrogation (recoveries from third parties). The treatment of such recoveries is not specified in IFRS X. o In the case of salvage, it seems reasonable to regard the value of the damaged property as part of the contractual cash flows, at the date of acquisition of the damaged property. From that point on, the damaged property is an asset and its subsequent disposal lies outside the contractual cash flows. o In the case of subrogation, where an existing right of recovery is acquired from the insured, it seems reasonable to regard the subrogated rights as assets, similarly to salvage. o Note that the rights to both salvage and subrogation pass in consequence of payment of the associated part of the claim. o A further category is rights to recovery that the insured did not have, but arise directly in favour of the insurer, as a result of the insured event. Such rights do not give rise to and are accounted for outside the contractual cash flows. All of the above are subject to uncertainty and variability in both timing and amount. Q32 What methods are appropriate to estimate expected future pre-claim cash flows (when the BBA is used)?

9 A32 Q33 A33 All of the factors discussed above for reported claims are relevant to pre-claim cash flows, except that there are no individual claim details. In their place, it is necessary to adopt a bulk estimation process, based on expected claim frequency and quantum (or their product, expected claim cost). It is necessary to allow for occurrence and reporting delays in the settlement and payment patterns. In some circumstances, such as bad weather, there may be an unusual level of claims arising around the reporting date. In accordance with IFRS??, the expected future cash flows at the reporting date should reflect what is known at the reporting date. If material, it may be appropriate to also determine a post-reporting date adjustment. For some purposes, it is necessary to consider seasonal and secular patterns. What methods are appropriate to estimate expected future cash flows on IBNR claims? IBNR claim liabilities are an intermediate case between reported claim liabilities and preclaim liabilities. They are liabilities for incurred claims but insufficient knowledge is available to make a single claim estimate. Expected reporting patterns can be used to estimate expected IBNR claim cost. In some cases, event information can be used to anticipate the level of, or even particular, claims. For example: o information on storm severity can be used to estimate percentage insured losses in the affected area; o news reports and photographs may provide direct evidence of unreported losses. IBNR claim cash flows are part of claim cash flows, along with reported claim cash flows. In the extreme, where there is little useful detail on reported claims, it may be necessary to estimate total future cash flows and apportion into pre-claim and claim. Expenses Q34 A34 Q35 What methods are appropriate to estimate expected future expenses? Estimates of future expenses should make use of any forecasts the entity makes including budgets and business plans. Using those projections, unit costs will generally be used to forecast the expenses on a per policy or other applicable unit (such as premium) basis. Those future unit costs should anticipate inflation consistent with the discount rates being used. How are expenses that are paid or expected to be paid prior or subsequent to contractual due date handled?

10 A35 Q36 A36 Q37 A37 Q38 A38 Q39 A39 Q40 A40 For contracts that have been recognized, the measurement considers the expected payment date, not the due date of payments that lie within the contract boundary, and any consequence from premature or delayed payment (e.g. pre-paid or annualized commissions, interest accreted, penalties charged). For practical purposes, certain aspects of measurement could be based on due dates and additional estimates or accounts could be added, reflecting any difference. What is the definition of acquisition expenses? Acquisition expenses are defined (Appendix A) as the costs of selling, underwriting and initiating an insurance contract. These include direct payments, such as commission, for underwriting, certain stamp duties and other expenses of policy issue specific to a particular contract, but also [reference needed] include such expenses incurred on a portfolio basis. Other expenses associated with an insurance contract are administration expenses. For example, if there is an obligation to provide continued service under the contract, this cost is administration expenses. If a payment is contingent on subsequent persistency beyond the contract boundary, it is actually acquisition cost but associated with that part of the contract beyond the contract boundary. If it is contingent on persistency within the contract boundary it is administration cost. How are acquisition expenses reflected if paid prior to initial measurement? Acquisition expenses paid prior to initial measurement are reflected as paid but otherwise treated identically to other acquisition expenses. How are acquisition expenses reflected if paid in a reporting period (in the same year, in a subsequent year) after initial measurement? Acquisition expenses are reflected in the same way, no matter which year they are paid. They are included in the contract s cash flows whether paid in the period in which the contract was incepted or in a subsequent one For long-duration contracts, can there be acquisition expenses (e.g. renewal commissions) incurred after the first contract year? If so, how are they treated? There can be acquisition expenses after the first year for long-duration contracts. Those expenses are treated the same as other expenses. If agent/agency compensation is contingent upon agent/agency survival, should those expenses be reflected (and if so, should agent/agency turnover be considered?)? These expenses should be included in expected cash flows in the same way as for other contingent cash flows, e.g. claim handling costs. Hence if agent /agency turnover materially affects expected cash flows, this needs to be considered in determining expected cash flows whether the expenses are for acquisition or maintenance of the contract.

11 Q41 A41 What are some examples of expenses that are or are not acquisition expenses? Acquisition Expenses Commissions Managerial overrides Underwriting costs Policy set up expenses Non-Acquisition Expenses Agency override Managerial bonuses for persistency Premium and commission processing costs Overheard of underwriting units Claim management General contract administration Q42 A42 Q43 A43 Q44 A44 Q45 A45 Q46 What other expenses are or are not included in cash flows? See ED B67 Are any taxes included in cash flows? All transaction based taxes (such as premium taxes, value added taxes and goods and services taxes) and levies (such as fire service levies and guarantee fund assessments) are included in cash flows (see ED B66(h)) Also included would be any taxes paid on behalf of the policyholder, (B66(i))???. If the impact of certain of these taxes is only the small difference of the time values of the incoming and outgoing cash flows, those impacts could be ignored based on materiality considerations but noted in disclosures. Income taxes are not included as a cash flow in contract measurement. Are there any special considerations for performance-linked or index-linked payments? See IAN Participating Contracts Are there any special considerations for discretionary or voluntary payments to policyholders? For policyholder bonuses or dividends see IAN Participating Contracts. For other discretionary cash flows of the entity, including any fair dealing in determining claims payable, whether their consequences are within or beyond the contract boundary needs to be considered. If they are within the contract boundary, they are measured at the expected value. Otherwise, they are not included. How are policyholder dividends or bonuses projected for traditional participating contracts?

12 A46 Q47 A47 Q48 A48 Q49 A49 Q50 A50 Q51 Policyholder dividends, bonuses and other discretionary payment are projected based on the company s best estimate of future payments. To the extent possible, they should be in a manner consistent with other assumptions used for estimating future cash flows and discount rates. For instance, if the discount rate assumes an increase in interest rates in the future, dividend payouts should also. How are delayed benefits, benefits which are expected never to be paid, for events that create rights contingent on future events (e.g. annuitants to persons under third party liability, or joint life) accounted for? These benefits should be included taking into account their expected probability of payment. How are interest credits paid to policyholders projected? See A45. For interest credits, it is particularly important that the projection be consistent with the discount rates used. How are available inputs from financial markets and from other external sources applied to cash flow estimates? Available inputs from financial markets and from other external sources may not represent characteristics of the cash flows of a certain portfolio; if that is the case, the entity s estimate or adjustment to financial market information should be used, as applicable. However, if for example the portfolio has new elements on which the entity has no or not much experience, external inputs, such as industry experience, could be used. As the entity obtains sufficiently robust experience of its own, it will supplement or substitute its own experience. How should validation, tests for relevance and actuarial credibility be applied to internal experience studies and external study results? There are no special requirements for IFRS 4. Tests of both relevance and actuarial credibility would be applied to the results of internal experience studies. The extent of relevance is normally determined on the basis of experienced judgment, reflecting the characteristics of the contracts in which the experience is based and the characteristics of the contracts for which cash flows are being estimated. In addition, changes in conditions between the historical period from which experience is gathered and the period being projected are also considered. The volume of the experience is considered in determining the actuarial credibility level assigned. What methods are appropriate to estimate trends or shocks in mortality, morbidity or other benefit rates? A51 [Same as A49] Q52 What methods appropriate to estimate trends or shocks in policyholder behavior?

13 A52 [Same as A49] Q53 A53 Q54 A54 Q55 A55 Q56 A56 What are available inputs to estimate inflation and its effects on inflation-sensitive benefits and expenses? A range of statistics are available in different countries. General living cost index might be useful for many cash flows, but also salary, building, medical and other insurance relevant expenses may have their own indices or may be responsive to specific factors other than general inflation. In addition, as inflation applies to entity expenses, the relative change in productivity and changes in the number of units can also influence trends in unit expenses. As long as observations can be made regarding (neutral) expected values of inflation in market prices, those observations have priority compared with entity s expectations. How can blocks of business with no prior experience or no relevant experience (e.g. new line of business for entity, mortality past age 90 or policy durations longer than the product has been issued) be estimated? The best available relevant experience is considered. This will likely be supplemented by judgment. How should contracts covering multiple perils be accounted for? The basic unit of account is the contract, so multiple perils in a single contract must be combined for reporting purposes. This, however, need not constrain the actuarial analysis and projections, provided the results are combined as required. Perils may be analyzed and projected separately, if this makes sense, or together. How to account for multiple risks, particularly open number of insureds in a contract, e.g. a group contract, for added or removed insureds? The basic unit of account is the contract, so multiple insureds in a single contract must be combined for reporting purposes. This, however, need not constrain the actuarial analysis and projections, provided the results are combined as required. Insureds may be analyzed and projected separately, if this makes sense, or together. Where insureds may added or removed, the basic principle is that the contract valued is the contract, as at the valuation date. For the most part, additions and removals are considered to be contract modifications, to be accounted for as and when they arise. The exception is where an existing insured is scheduled to leave, for example on reaching retirement age. For the most part, this gives the same result as where the group contract is an agreement to issue individual contracts on group terms. Changes in estimates Q57 How often should estimates be re-evaluated?

14 A57 Q58 A58 At any reporting date, except if there is no positive indication that anything that significantly affects the expected cash flows in the aggregate has changed. When should a change be reflected in financial statements (i.e. materiality requirement)? See IAN Materiality Governance of assumption setting Q59 A59 What controls should be in place regarding data used for internal experience studies or other areas? Where possible, actuarial data should be reconciled to the corresponding accounting data. Because of timing issues, it is unusual to be able to rely on audited data, at the time of analysis, but the actuary should be satisfied that the data relied on is not changed in the audit. However, this is only applicable to cash flow data. For descriptive data, it is usual to rely on the entity s operational data. Data analyses should use the same data sources as are the basis for the valuation cash flow projections. The extent of detailed checking needed is a matter of actuarial judgement. Internal audit processes can add a level of comfort. Q60 A60 Q61 A61 Q62 A62 Q63 A63 What controls should be in place on the assumptions used to project future cash flows? Several contract processes have been used. Included are documentation of the basis for the assumptions, especially where judgment is applied, peer reviews, a multi-disciplinary assumption acceptance committee, How should assumption recommendations prepared by external firms (e.g. consultants, reinsurers) be validated? The same validation process should be followed as in Q59. In addition, assurance that the external firm has devoted appropriately qualified personnel to the process is usually obtained, either at the beginning of the relationship or on an ongoing basis. What types of controls should be in place on models? Should they differ if developed internally or by outside vendors? The same controls that apply to estimates developed by use of models for any accounting structure. How are current estimates typically audited by either internal or external auditors? The same as for other estimates in financial statements that are audited, although often auditors are usually assisted by actuaries in the review of the estimates of cash flows for insurance contracts.

15 Q64 A64 How should surrenders be allowed for? Surrenders should be allowed for on the basis of expected policyholder behavior. It should not necessarily be assumed that policyholders will make uniformly rational choices. When projecting surrenders, it is important that the projection assumptions should be consistent with other valuation assumptions, particularly market assumptions. For example, surrender rates are typically higher when economic conditions are tight. It is also important to reflect the surrender values that are likely to be payable. These are constrained by guaranteed surrender scales, but also reflect management decisions, made in the light of policyholder expectations and marketing considerations. Q65 A65 What general requirements should assumptions satisfy? Paragraph of ISAP 4 sets out general requirements for assumptions. Paragraphs to explore the factors to be considered in setting assumptions for longduration business, short-duration business and claims respectively. It should be noted that consideration does not necessarily imply detailed analysis, much less explicit inclusion in the valuation assumptions. The actuary should be aware that such factors may be relevant and consider whether they are likely to be worthy of specific inclusion. In many cases, the influence of a particular factor may be stable. Internal practices, for example, may remain unchanged over extended periods or may develop slowly, in which case they will be embedded in the experience analyzed and require no further attention. A change in policy, however, might upset the current pattern and require explicit attention. For general insurance, many of the factors are considered as part of underwriting and pricing and are adequately represented in the premiums charged. Others are part of a stable mix of business and only require active attention if that mix changes. It is only where pricing does not fairly reflect known differences, such as unisex rating that explicit consideration may be needed. [Further discussion may be needed, depending on the final form of IFRS X. This interacts with the CSM.] Q66 A66 Q67 How should management behavior be allowed for? Management behavior can have a considerable impact on cash flows through a variety of channels. These include claim management, participation benefits, experience rating and premium and commission adjustments. These discretions are exercised in the context of economic conditions and policyholder expectations and can have significant marketing implications. Projected cash flows should reflect how management is likely to behave, and should be consistent with the rest of the valuation. How should inwards reinsurance be allowed for?

16 A67 Inwards reinsurance is another source of business and should be treated consistently with comparable direct business. There may, however, be differences that should be reflected in the valuation assumptions. These include: different underwriting; different claim management; notification delays; and policy forms (e.g. excess of loss) not found in direct business. Q68 A68 Should assumptions be consistent between successive valuations? Unless there is good reason, the valuation approach should be consistent from valuation to valuation. Any non-trivial changes in approach should be discussed in the actuary s report. Material changes will normally require disclosure by the entity and the actuary s discussion should bear that in mind. Changes in assumptions will often flow from the application of the same approach in different circumstances. It may be sufficient to quantify the overall impact of such changes on the projected cash flows. Any notable changes should, however, be quantified individually. Again, material changes will normally require disclosure by the entity. Q69 A69 Q70 A70 How should currency conversions be treated? Where transactions occur in one currency and are reported in another, the actuary needs to be satisfied with the basis of conversion. [What are the accounting requirements for future cash flows? Is there a convention that a current conversion rate is used? Or must future cash flows assume future rates?] What matters should be disclosed in the actuary s report? In addition to matters specifically required by IFRS X, the body of report should provide information and commentary to assist the entity s management and Board to understand what the actuary has done and how the valuation results have been arrived at. In respect of current estimates, this might typically include some or all of the following. Commentary on the data used Commentary on experience Commentary on trends Discussion of methods Commentary on differences from the previous report How to strike the balance between too little and too much detail is a matter of actuarial judgement.

17 In addition, as required in ISAP 1, the report must contain sufficient detail, perhaps in appendices, to allow another actuary to make an appraisal of the reasonableness of the work.