PAA eligibility - Significant variability in the FCF
An expectation of significant variability in the FCF would not by itself make a group ineligible for
the PAA, but would disqualify the group from PAA eligibility if such variability is expected to
create a material difference between the PAA and GMA estimates of the LRC. (Page 8 of PAA)
Battle card #3:
is a group PAA eligible if an insurer expects significant variability in the FCFs? The Battle card answer simply says no.
Does this mean, ultimately we are still trying to measure the difference between PAA and GMA LRC? Take appendix 1 for example, say my difference between PAA LRC and GMA LRC is less than the materiality threshold, do I still need to check for "expectation of significant variability in the FCF"?
Comments
Well if you have the difference between PAA and GMA LRC then that means you have also already checked for significant variability in FCF
Can you have instances where you expect significant variability in the cash flows but this may not necessarily translate to a material difference between the GMA and PAA estimates?
I'm guessing no but just want to confirm. After reading the text, it mentions the variability in CF's would only disqualify use of PAA if this variability causes a material difference in the GMA and PAA estimates. I'm assuming 'significant variability' here would imply a material difference? Is this right?
No, I think it would be possible. Examples would be significant variability from uneven premium earnings pattern (catastrophic reinsurance) during periods of low interest rates. As an extreme example, if interest rates are 0 and the only source of variability is the earnings pattern, then the GMA and PAA estimate would not differ materiality as discounting would have no impact
As per the text, variability is significant if it is reasonably expected to result in significant differences in the measurement of the LRC between the PAA and GMA at any point during the coverage period. So yes, material difference seems to fit the description
One of the battlecard quiz questions asks: is a group PAA eligible if an insurer expects significant variability in the FCFs?
The answer states: no, this disqualifies use of PAA
However in the textbook it states that: An expectation of significant variability in the FCF would not by itself make a group ineligible for the PAA, but would disqualify the group from PAA eligibility if such variability is expected to create a material difference between the PAA and GMA estimates of the LRC.
The answer you have provided is the most correct answer, but you would probably get marks for the former also. The idea here is that insurers would like to use PAA as much as possible. To use PAA for contracts with term > 1 year, you would always need to test for PAA eligibility which is incredibly cumbersome. If you expect significant variability, you would not even test for eligibility and use the GMA method anyways. The idea of most of the Battle Cards is to make the shortest statement that captures the idea of the concept in order to get full marks