2013 Fall Q21 b
Hi,
The exam asking the ways of Accounting for Time Value of Money in calculating excess (deficiency) ratio?
I understand that when calculating discounted excess ratio, we need to discount the Unpaid and calculate the PfAD to reach to the APV of Unpaid Claim and Adjustment Expense and I also know that we need to calculate the Investment Income as well and add to the Excess Amount.
My question is: These 2 steps are Mandatory when calculating the Discounted Excess Ratio.
Why in the exam, they are considered different "ways" to account for Time Value of Money?
I am a bit confused.
Cheers,
Wilson
Comments
Hi Wilson,
These 2 methods are basically the same. This was not a good exam question. This is actually from the CIA.Runoff reading, but I put it in CCIR.ARinstr because it was closely related to part (a) of that same question. Here's the direct link to the CIA.Runoff reading. It is very short:
Oh, I am so sorry I am even more lost after reading the material.
Time Value for Excess Ratio
I can sort of understand when being asked the 2 ways of accounting time value of money in calculating excess ratio:
1. Explicitly calculate investment income and add to excess amount (like the discounted formula? "APV(beg)-APV(Closing)-Paid+II"?)
2. Discount the Undiscounted amounts to beg (i.e t-1)
meaning APV(beg)-PV(APV(Closing))-PV(Paid), and no need to add II again?
Time Value for Runoff
I cannot understand why we need to substract the II as mentioned by CIA. 2 ways mentioned by CIA to account for the time value (i.e. to calculate the discounted runoff):
1. Claim Liab(t-1) - Paid(t) - Claim Liab(t), to discount 2nd and 3rd term to Time t-1, which I can kind of understand
2. Substract term for portion of investment income earned during CY(t) on assets supporting the liab. On the excess, it is a plus, and I am really lost here why it's a minus
Thanks,
Wilson
Hi Wilson,
I'll try to briefly answer your question below, but the best advice I can give you here is to just memorize the answer and move on.
The reason I say this is that CIA.Runoff is a very low ranked topic. That means you are unlikely to see a question from this reading on your exam, and if you do, it will probably be exactly the same question or something very similar or easy. I appreciate your perseverance in trying to understand this on a deeper level but your primary goal is to pass the exam. And there are lots of other topics that we know will be asked on the exam so that's the best place to allocate your time. If you were doing actuarial research, I'd say you're doing exactly the right thing. But for passing this exam, you have to be strategic on where you to spend your time.
Anyway in my understanding of this, the first option (discounting back to t-1) restates all amounts to t-1 before there is any time for investment income to accrue. The second option explicitly removes the investment income that would have accrued prior to time t. These are 2 different ways of restating the components so that they are comparable.
Beyond that, you would have to construct a numerical example to to really see what's going on. (There are numerical examples of other things in the reading, but I don't think they are worth studying. As long as you understand what runoff means, and know a few simple facts, you should be fine.) In any case, I don't think the source reading explains it particularly well.
So, that's my advice. Don't get bogged down on this very tiny topic. Aim for spending your time on the higher ranked readings. Hope that helps!
Thanks for the advice Graham!
You're welcome!