CHAPTER 32 – PROVISIONS
PROVISIONS:
Calculated amounts that need to be set aside to meet a provider’s future
liabilities
TO DETERMINE THE APPROPRIATE PROVISIONS : NEED TO
o Choose a valuation method
o Make assumptions about the future ( different basis )
REASONS FOR CALCULATING PROVISIONS FOR INDIVIDUAL
CONTRACTS
• To determine the value of liabilities for published accounts and reports
• To demonstrate supervisory solvency
• To determine the value of liabilities for internal management accounts
• To value the provider for a merger or acquisition ( transfer of liabilities )
• To determine whether the discretionary benefits can be awarded
• To set future contribution levels for a pension scheme
• To value benefit improvements for a pension scheme
• To calculate discontinuance / surrender benefits
• To influence investment strategy
• To provide disclosure information to beneficiaries
• To provide for expected credit losses for banks
GLOBAL PROVISIONS
It is necessary to make global provisions looking at the provider’s liability in aggregate.
THIS IS DONE FOR MULTIPLE REASONS :
For solvency purposes
The provider will be exposed to financial and non-financial risks which may merit an
additional provision in excess of the sum of provisions of each contract :
Mismatching of assets and liabilities – where the investment conditions
result in liabilities cashflow increasing more than asset cashflows
Credit risks – default of third party
, Operational risks – anti-selection, regulatory fines or compensation for mis-
selling
Provisions for guarantees
FACTORS AFFECTING THE LEVEL OF PROVISIONS REQUIRED FOR
ADDITIONAL RISKS
• The provider’s risk management strategy – whether it is detailed, effective , how
frequently monitored and updated will justify how much provisions should be held for
additional risks
• Risk appetite
• The regulatory requirements and
• how the regulator views its supervision on the provider
NUMERICAL CALCULATION OF PROVISIONS :
LIFE INSURANCES :
Use the standard formulae or the discounted cashflow approach
GENERAL INSURANCE :
Statistical methods ( run off triangles ) or case estimates
BENEFIT SCHEMES
Depends on whether the fund is a DC or DB:
DC : value of main benefits = amount of accumulated contributions net of charges
DB : value of benefits = we first determine the benefits using the formulae and then use the
discounted cashflow model to value the benefits
BANKS
Need to estimate and provide for the expected credit losses due to any credit product
issued.
Expected credit loss = probability of default * estimate of the loss given default * estimate
of the exposure at default
PROVISIONS:
Calculated amounts that need to be set aside to meet a provider’s future
liabilities
TO DETERMINE THE APPROPRIATE PROVISIONS : NEED TO
o Choose a valuation method
o Make assumptions about the future ( different basis )
REASONS FOR CALCULATING PROVISIONS FOR INDIVIDUAL
CONTRACTS
• To determine the value of liabilities for published accounts and reports
• To demonstrate supervisory solvency
• To determine the value of liabilities for internal management accounts
• To value the provider for a merger or acquisition ( transfer of liabilities )
• To determine whether the discretionary benefits can be awarded
• To set future contribution levels for a pension scheme
• To value benefit improvements for a pension scheme
• To calculate discontinuance / surrender benefits
• To influence investment strategy
• To provide disclosure information to beneficiaries
• To provide for expected credit losses for banks
GLOBAL PROVISIONS
It is necessary to make global provisions looking at the provider’s liability in aggregate.
THIS IS DONE FOR MULTIPLE REASONS :
For solvency purposes
The provider will be exposed to financial and non-financial risks which may merit an
additional provision in excess of the sum of provisions of each contract :
Mismatching of assets and liabilities – where the investment conditions
result in liabilities cashflow increasing more than asset cashflows
Credit risks – default of third party
, Operational risks – anti-selection, regulatory fines or compensation for mis-
selling
Provisions for guarantees
FACTORS AFFECTING THE LEVEL OF PROVISIONS REQUIRED FOR
ADDITIONAL RISKS
• The provider’s risk management strategy – whether it is detailed, effective , how
frequently monitored and updated will justify how much provisions should be held for
additional risks
• Risk appetite
• The regulatory requirements and
• how the regulator views its supervision on the provider
NUMERICAL CALCULATION OF PROVISIONS :
LIFE INSURANCES :
Use the standard formulae or the discounted cashflow approach
GENERAL INSURANCE :
Statistical methods ( run off triangles ) or case estimates
BENEFIT SCHEMES
Depends on whether the fund is a DC or DB:
DC : value of main benefits = amount of accumulated contributions net of charges
DB : value of benefits = we first determine the benefits using the formulae and then use the
discounted cashflow model to value the benefits
BANKS
Need to estimate and provide for the expected credit losses due to any credit product
issued.
Expected credit loss = probability of default * estimate of the loss given default * estimate
of the exposure at default
