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Draft for discussion at ICAEW IISC meeting, 20th June 2005 - page 38 / 51





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regulatory purposes) was introduced). However a speaker from a leading mutual observed that his company would not mind disclosing its capital if it could also disclose how much is needed, i.e. a risk-based capital approach to solvency is also needed. As to how different all this would be from what is done at the moment, his answer was that, in the case of his company, the face of the accounts would not look very different. The words would differ, but the numbers would be much the same. The internal management accounts would not be changed much, because they already use EV techniques and FVs for these ‘as I suspect do most companies in this country.’

The ASB representative noted, with regard to the conflict between the traditional P&L accounting approach and the ‘Asset/Liability’ approach, that the traditional approach ‘is trying to base itself on the added value that the particular reporting entity is bringing to the process, whereas FV is looking to the outside and is saying: “Have we got something here?”, where the outside market is itself changing the value, and we have to recognise that as we go through the reporting process.’

Our overall review comment: Forfar & Masters’ paper starts by pursuing the FV of liabilities in terms of the IASC’s definition as a ‘settlement’ amount but, recognising the thin nature of the market, is driven to various forms of discounted cash flow estimate of what another insurer would need (including profit margins/cover for risk) to take on the business—which then elides into what the current insurer would need to continue to run it. This process ends with the ‘FV’ of liabilities being determined by what is needed to get the desired profit pattern (by fixing the amount of the deferred profit/risk margin on top of the basic policy-payment liability (as in the excellent and clear Examples in Appendix B using a discount rate of 0)), which (given the articulation of the financial statements) allows the changes in FV to go through P&L account. 68

However, after allowing for risk (in the discount rate) and/or required profit margins, any remaining surplus ‘pure profit’ appears ‘upfront’, without specific discussion of either what the risk/profit deferrals represent or when the ‘pure profit’ is to be regarded as earned: this appears to be seen as a matter for ‘accounting principles’ to resolve.

b) Hairs et al., 2002 ‘Fair Valuation of Liabilities’ This paper is the report of the UK actuarial profession’s ‘Fair Valuation of Liabilities Working Party’ and was presented on 21 November 2001. Paul Coulthard reports on the profession’s website that ‘The November sessional meeting saw a packed hall debate the paper prepared by Chris Hairs' working party. This is a subject that will have significant implications for actuaries and insurers, and will require the use of new tools and techniques in the profession. Remarkably, nobody objected to the fundamental principles set out in the paper: much of the debate focused instead on how we work out the practicalities.

The meeting was unusual for the number of non-actuaries who attended, with contributions from the regulators, accountants and a market analyst. A recurring theme was the need for actuaries to work closely with these groups. It was made clear

68 So, as the authors observe, one can view DAC as a partial (‘constrained’) recognition of PVFP at beginning: a special case of EV.


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