Reserving for Periodical Payments under the Courts Act Anthony Carus

© Carus Consulting Actuaries Ltd Governing Principles FSA’s Prudential Sourcebook (PRU) – International Accounting Standards Board: IFRS 4 Institute /Faculty Guidance Notes – Company philosophy and practice

© Carus Consulting Actuaries Ltd PRU PRU R –A firm must carry out regular assessments of the adequacy of its financial resources using processes and systems which comply with PRU R. PRU R –The processes and systems required by PRU R must be proportionate to the nature, scale and complexity of the firm's activities.

© Carus Consulting Actuaries Ltd PRU – cont. PRU R –The processes and systems required by PRU R must enable the firm to identify the major sources of risk to its ability to meet its liabilities as they fall due, including the major sources of risk in each of the following categories: –(1) credit risk; –(2) market risk; –(3) liquidity risk; –(4) operational risk; and –(5) insurance risk.

© Carus Consulting Actuaries Ltd PRU – cont. PRU R –For each of the major sources of risk identified in accordance with PRU R, the firm must carry out stress tests and scenario analyses that are appropriate to the nature of those major sources of risk, as part of which the firm must: –(1) take reasonable steps to identify an appropriate range of realistic adverse circumstances and events in which the risk identified crystallises; and –(2) estimate the financial resources the firm would need in each of the circumstances and events considered in order to be able to meet its liabilities as they fall due.

© Carus Consulting Actuaries Ltd Example Male life aged 20 RTA – traumatic brain injury (TBI) Care costs £10,000 p.a. inflating in line with RPI

© Carus Consulting Actuaries Ltd Mortality General Population By age Male / Female Pension policyholder / no policy Annuity policyholder / no policy Traumatic Brain Injury / well

© Carus Consulting Actuaries Ltd Population Ogden Tables Projected or not? Projected –2002-based –Calculated as at 2005 –England and Wales Source data: Manipulation required

© Carus Consulting Actuaries Ltd Population Table

© Carus Consulting Actuaries Ltd Annuity / Pensioner Which? ’92 Series Adjusted Continuous Mortality Investigation Working Paper 1 – New ’00 Series Say: –IMA92 Select –Base projected as CMIR 17 –Scaled at younger ages tapering to no scaling at older ages

© Carus Consulting Actuaries Ltd Discount Rate Is discounting permitted? Close matching –PRU to Only applicable to long-term business funds –Arising through the definition of “index-linked liabilities” But how much risk do you want to assume?

© Carus Consulting Actuaries Ltd Investment ILGS –Limited spread of maturity dates –Longest currently 2035 –Speculation surrounding the issue of an ultra- long (50 year) ILGS in 3 rd quarter 2005 Derivatives –Inflation swap Something else?

© Carus Consulting Actuaries Ltd If ILGS Discount rate set according to returns available

© Carus Consulting Actuaries Ltd Source: ILGS Yields

© Carus Consulting Actuaries Ltd Historic Yields (with a bit of interpolation)

© Carus Consulting Actuaries Ltd ILGS Discount rate set according to returns available Might work from yield on ‘Over 15’ stocks, with an assumption of 2.5% inflation, giving a real yield of 1.62% Might take a 7.5% margin and use 4%.

© Carus Consulting Actuaries Ltd Other bases Expenses –£75 p.a. ? Tax –Gross ?

© Carus Consulting Actuaries Ltd Values Ogden at 2.5% –£10,000 x = £313,000 Ogden at 1.5% –£10,000 x = £402,300 Reserve –Prudent £467,679 –Mid-range £429,463 –Aggressive £408,477

© Carus Consulting Actuaries Ltd Extra Mortality Rate life +20 years Ogden multiplier > –£10,000 x = £256,100 Calculate reserve for 40 year-old?

© Carus Consulting Actuaries Ltd

© Carus Consulting Actuaries Ltd

© Carus Consulting Actuaries Ltd Extra Mortality Maybe rate life +20 years Ogden multiplier > –£10,000 x = £256,100 Calculate reserve for 40 year-old? Calculate the current extra rate of mortality and let that – or a proportion – continue as the extra mortality throughout In the example; current extra (ultimate) mortality is I would take 50% / 75% / 90% of this

© Carus Consulting Actuaries Ltd Values Ogden at 2.5% –£10,000 x = £256,100 Ogden at 1.5% –£10,000 x = £309,500 Reserve –Prudent £466,133 –Mid-range £427,434 –Aggressive £406,224

© Carus Consulting Actuaries Ltd Summary of Values UnratedRated Ogden 2.5%£313,000£256, %£402,300£309,500 Reserves Prudent£467,679£466,133 Mid-range£429,463£427,434 Aggressive£408,477£406,224

© Carus Consulting Actuaries Ltd Other Issues Variation Order Reinsurance

© Carus Consulting Actuaries Ltd Reinsurance Initial layer £250,000 Revaluation prior to claim settlement in line with earnings index Revaluation in payment in line with RPI Reinsurer commences payment when layer expires

© Carus Consulting Actuaries Ltd Reserves UnratedRatedPayment Prudent Cedant£240,473£240,1211 Aug 2033 Reinsurer£227,206£226,012 Total£467,679£466,133 Mid-range Cedant£232,702£232,1961 Sep 2033 Reinsurer£196,761£195,238 Total£429,463£427,434 Aggressive Cedant£228,076£227,4841 Oct 2033 Reinsurer£180,401£178,740 Total£408,477£406,224

© Carus Consulting Actuaries Ltd IFRS 4 Is this an insurance contract? –“A contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.” Some insurance contracts cover events that have already occurred, but whose financial effect is still uncertain… In such contracts, the insured event is the discovery of the ultimate cost of those claims. APPENDIX B4

© Carus Consulting Actuaries Ltd IFRS 4 Is there an embedded derivative that must be identified and measured at fair value? –Is the embedded derivative itself an insurance contract? See Implementation Guidance Example 2.16 … –Contractual feature that provides a return contractually linked (with no discretion) to the return on specified assets –Treatment: the embedded derivative is not an insurance contract and is not closely related to the contract. Fair value measurement is required. See also para. AG30(h) of IAS 39

© Carus Consulting Actuaries Ltd Contact Details Carus Consulting Actuaries Pound House 23 Shottery Village Stratford-upon-Avon Warwickshire CV37 9HD T: F: E: W: