HI, in April 2021 past paper question 8 part (i) asking about the factors to consider when discounting claim liabilities , there is one point I am not following at all , can someone help me please "an illiquidity premium will then need to be applied to allow for the difference between the liquidity characteristics of assets back insurance contracts and liquidity characteristic of the assets used to arrive at the selected yield curve " discounting factors may based on investment return , rate of investment return may contain a risk premium for illiquidity , therefore need to reduce the rate of return when derive the discount rate to reflect illiquidity? also i was mentioning need to consider the non-investible assets when derive investment return as it is likely to distort the investment return , but it is not in the marking scheme . is that relevant point ? thank you Hope everyone have a happy easter
Hi If you pick your yield curve based on assets that you think have similar characteristics to the liabilities, you need to adjust the yield curve by adjusting the rate for the illiquidity premium for the liabilities. This would likely be a higher number than the liquidity premium since we want a higher return to hold less liquid assets. Regarding the last two paragraphs, it implies that you are picking the return of the assets held as the starting point for your discount rate. I am not sure this is a valid way of determining the discount rate especially if the assets are not matched to the liabilities but the notes are silent on that. The notes refer to the risk-free yield curve if you have no guidance. I would stick close to that.
Thank you very much , always very helpful . just to clarify "If you pick your yield curve based on assets that you think have similar characteristics to the liabilities, you need to adjust the yield curve by adjusting the rate for the illiquidity premium for the liabilities. This would likely be a higher number than the liquidity premium since we want a higher return to hold less liquid assets." - is that meaning need to charge higher discounting factor to reflect illiquidity of liabilities ?
Hi My response arises from your statement that we may need to reduce the discount rate to reflect the illiquidity premium. It is more likely the illiquidity premium is higher than the liquidity premium because we would require more compensation for us to hold illiquid assets. All else being equal you may end up with higher discounting factors for the liabilities.
Hi, in the answers, I'm also not fully sure why a paid payment pattern needs to be used to derive the ultimate and not an incurred pattern?
You can use any method / data you like to derive the ultimate (eg paid or incurred triangle), but you will need to use a paid claims development pattern in order to estimate when the amounts will be paid, so that you can discount them.
Thanks Darren, much appreciated. From memory, do you recall any numerical past question on this topic that I can practise?
