Question 17 Clarification
I think most of the comments by BA in this question really help to understand, but there is one thing that isn't mentioned that I would like clarification about.
On row 52, calculating LRC (PAA) = UEP - DAC
UEP = Direct UEP - Premium Receivable --- this is because we are only concerned with UEP for policies that are written AND active, and NOT concerned with written but not yet active (these premiums would be included in the premium receivable amount), correct?
DAC: we use the GROSS Deferred Acq Costs, rather than the NET DAC... is this because the LRC (PAA) is determined at the beginning of the policy period, so we don't account for the cancellations yet?
Also on a similar note for UEP when we subtract Premium Receivable, we are using the UNDISCOUNTED GROSS amount, rather than the Discounted Net Amount calculated on row 50. Is this also because LRC (PAA) is determined at the beginning of the policy period and we are ignoring both discounting and the effect of cancellations at that time?
Hopefully my question makes sense. I just want to understand the calculations rather than memorize them.
Thanks!
Comments
"UEP = Direct UEP - Premium Receivable --- this is because we are only concerned with UEP for policies that are written AND active, and NOT concerned with written but not yet active (these premiums would be included in the premium receivable amount), correct?"
Yes that's correct but with an additional nuance. The LRC under PAA only reflects the remaining unearned premium less DAC and does not depend on whether the premiums have been collected. If you haven’t received the premium yet, it doesn’t increase the insurer’s liability—it just means the cash is still owed to you. Remember, no coverage is owed if premiums are not yet received. The liability is not based on cash flow timing.
Under GMA though, all expected cash flows affect the FCF and premiums receivable must be included since the liability is based on expected future cash flows which include both claims payments and premium inflows (whether collected or not).
Under PAA, the LRC is a proxy for unearned premium and is treated more like a deferred revenue liability. Unearned premium is recognized based on coverage provided, not on whether cash has been collected. Also, premiums receivable represent cash that will be collected separately, they are accounted for under IFRS 9 and excluded from LRC (This is out of the syllabus)
"DAC: we use the GROSS Deferred Acq Costs, rather than the NET DAC... is this because the LRC (PAA) is determined at the beginning of the policy period, so we don't account for the cancellations yet?"
This ties into the above. The LRC under PAA is a proxy for unearned premium and we do not consider any expected cash flows, which is why we focus only on the gross amounts and not any expected variations in cash flows.
"Also on a similar note for UEP when we subtract Premium Receivable, we are using the UNDISCOUNTED GROSS amount, rather than the Discounted Net Amount calculated on row 50. Is this also because LRC (PAA) is determined at the beginning of the policy period and we are ignoring both discounting and the effect of cancellations at that time?"
Not quite. We don't discount the PAA estimate generally as this is meant to be a simplification which means we want to keep it simple. You can consider the calculation of a "significant financing component" as discounting though so it's also not really correct to say we don't discount the PAA estimate of the LRC.
I think these are good questions though
Awesome, so just to summarize for myself:
Thanks so much for your response, was very helpful!
Always glad to help
Very Confused here:
A - Premium Received
B - Insurance Revenue
C - Premium Receivable
D - Direct Unearned Premium
Questions:
1) A is premium you actually received in the reporting period?
2) B is the premium you earned?
3) C is premium you were supposed to receive but didn't? OR premium you are expected to receive (i.e. monthly payments from live contracts)
4) Explain to me the difference between UEP and D UEP? Seems like D UEP looks at receivables whereas UEP does not.
5) For GMM - you use premium receivables, because this is a projection of future CF?
6) PAA is A - B? And You are saying that C is not accounted for because for PAA doesn't look at coverage that hasn't been paid for?
1) Yes
2) Yes
3) I's the latter, premiums that you are supposed to receive, but they are still with the policyholder
4) D UEP? Could you clarify what you mean by that please
5) Yes exactly. For GMM you are strictly looking at FUTURE cash flows. Premiums that have already been received are not part of future cash flows
6) I don't know what you are referring to with regards to A,B and C so you got to help me with more detail here
4) Direct UEP is just related to direct contracts whereas UEP relates to gross written premium (Which includes assumed reinsurance in addition to direct written premium)
6) Technically it is UEP = premiums received + premiums receivable - earned premium
But for the purpose of the exam and their examples, just remembering UEP = Prem Received - EP is sufficient. It is usually assumed that prem received already nets out the receivables (see the CAS example)
is LR = losses/EP? why we use ELR*Direct Unearned Premium net of cancellations to get the losses? why Direct Unearned Premium?
Losses/ EP is a retrospective view of losses, but if you want a prospective view of a cohort of business that has not been fully earned then you need to use ELR*UEP. What do you mean by why Direct Unearned Premium?
1) L50 - Premium Receivable Discounted: I understand we have to rmv the cancels, but why is it (adj for cancels) x DirUEP.
Is it because it also accounts for policies that are live?
2) FCF -> you are using Prem Receivable, but the losses based on DirUEP. Doesn't seem consistent to me.
Is it because: FCF is looking at future premiums ONLY & claims that will be paid (both live and future live contracts?)
1) It's just because we assume that of the portion of premium that is unearned, some will be cancelled and need to be refunded
2) Conceptually, the FCF is all about at a given snapshot in time, all FUTURE cash flows. This means any claim that has yet to be paid on this group of contracts would be considered, as long as coverage has not been provided. When a premium has been received, it immediately drops out of FCF which is why we only use premiums receivable
This is regarding one of your comment above:
"6) Technically it is UEP = premiums received - premiums receivable - earned premium", in the solution Direct Unearned Premium = Premium received + premium receivable - insurance revenue. Why the difference?
Yeah that is a typo. I have fixed my earlier comment
Just pasting this here in case people are confused about the UEP used in the PAA LRC: https://battleactsmain.ca/vanillaforum/discussion/1740/sample-18#latest