Thanks mugono. I wasn't sure whether I was allowed to reproduce the question from the core reading here but I see others doing similar things so I'm going to risk it!
"An expert witness is advising on a suitable discount rate to calculate the value of a lump sum award to a 50-year old individual in compensation for his claim for loss of earnings following an injury at work.
The amount of the award is based on the annual earnings lost and the number of years out of work and makes use of a discount rate in order to create a present value.
In previous cases the discount rate has been the real yield available on an index of long-dated index-linked government securities.
i) Give reasons why the real yield on a long-dated index-linked government securities index could be an inappropriate discount rate at this time.
ii) It has been suggested that a more reasonable discount rate would be the expected return above inflation on a portfolio of mixed assets. List the type of assets that a typical individual investor would hold in such a portfolio and the factors that would be considered in determining an appropriate discount rate."
So we're not actually talking about policyholder benefits, we're talking about a negligent party having to commute a risky liability, equal to the lost earnings. My argument is that since the value of the liability is unknown and contingent on whether the claimant is able to stay in work until normal retirement age, this is a non-hedgeable risk and so should be commuted at a value above the expected NPV.
Thanks for your help.
(By the way, I appreciate S2 and TAS I are not universal, but they say what they say for a reason. Surely those reasons are universal?! Risk margins are not unique to S2. Versions of them exist in SST and IFRS proposals.)
Last edited by a moderator: Mar 30, 2012