runoff basis

[Gousgounis]

In Assignment Q2.1 under a recommended statutory valuation of liabilities the solution says that the UPR should be valued under a wind-up basis- i.e. gross of DAC. Shouldn't it be valued under a runoff basis i.e. net of DAC ?

Also, what is the impact of producing the statutory returns under a runoff basis (rather than ongoing basis)?

Thanks!

 

[Ian Senator]

The paragraph at the bottom of page 2 of the solutions sums it up.

If the company is being valued on an on-going basis, it would best to use net of DAC, but if using a wind-up basis, gross of DAC would be suitable, unless there is some commission clawback arrangement.

This is also mentioned in the Subject ST3 course notes somewhere, if I remember rightly!

Depends on what you're trying to 'prove', as to which basis you use. If you want to show solvency if the company ceased trading altogether, then use a wind-up basis and choose suitable assumptions. If you want to show solvency if the company closed to new business, then use a run-off basis and choose other assumptions.

 

[Gousgounis]

Thanks for the reply.

My understanding is that the statutory returns are required to be produced on a runoff basis. So you don't have the option of producing the returns on a break-up basis. Isn't that right?

What are examples of suitable assumptions for a runoff basis?

 

[Ian Senator]

That's right, Statutory Returns in the UK are on a run-off basis (but note the question is not UK-specific in this instance).

In a run-off basis, think about how the situation differs from an ongoing company. So for example:

Investment starts getting restricted, so less investment income.
Expenses get spread over fewer and fewer policies, so your expense assumptions will change.
Premiums will obviously decrease (and eventually disappear!).
etc.