Technical provisions: appropriate amount Regulations: background
The regulations are The General Insurers’ Technical Provisions (Appropriate Amount) Regulations 2009, SI2009/1926, referred to here as the ‘appropriate amount Regulations’. They apply to technical provisions as defined in the accounting Regulations SI2008/410, consisting of provisions for unearned premiums, unexpired risks and unpaid claims. It is the last category which is the main focus of this guidance.
The determination of provisions is a skilled task, usually in the first instance performed by an actuary though sometimes legal or engineering expertise is required. Methods mainly focus on understanding the business and assessing provisions development patterns and claims ratios. From this a best estimate may be calculated applying mathematical techniques of varying degrees of sophistication. Sometimes a range of best estimates may be quoted, depending on different assumptions. It is impossible to be prescriptive about the methods to be used in such a complex area. Moreover, it is normal and sound practice to add a risk margin to the best estimate, reflecting the uncertainties.
There are various ways of doing this. Traditionally, the best estimate is not discounted for the time value of money. As the liabilities the provisions are designed to reflect will be paid over a period of time, in theory it might be appropriate to discount them at a suitable rate. Not doing so is standard industry practice and is consistent with legal requirements. This has the effect of building in an implicit risk margin, though the size of it will vary with the prevailing interest rate environment and claims payment patterns, and it may well be inadequate, particularly for more volatile classes of business. For this reason additional risk margins based on experience are often added. Alternatively, the actuary may construct a probability distribution and allow a risk margin by choosing say the point at which there are three chances in four of the estimate proving sufficient (known as the 75t h percentile) rather than one in two (the mean). A further method developed over the last 20 years seeks to calculate the cost of the additional capital a purchaser of the business would require to take on the liabilities and run them off - known as the ‘market value method’.
Rather than attempt to specify any such methods the appropriate amount Regulations focus upon obtaining an assurance that the figure appearing in the accounts reflects best actuarial or other suitable practice. This is achieved in most cases by obtaining a confirmation in writing from the insurer that the amount of the liabilities stated in the accounts, that is, the provisions, is not excessive. This confirmation must be founded on or supported by an opinion in writing given by an actuary or other suitably skilled person. Taken with the regulatory requirement for the provisions to be sufficient, this gives confirmation that the provisions are as accurate as they can reasonably be in this uncertain area.
This is the main condition, but if it or other supporting conditions (see GIM6610) are not satisfied, there is a straightforward alternative. The appropriate amount is then the undiscounted best estimate without any further adjustment.