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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
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.
Limits (bounds) of MfAD
- discount rate: 50bp to 200bp
- claims development: 2.5% to 20%
- reinsurance collectibility: 0% to 15%
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