Actuarial Valuation in Insurance

The insurance industry is built on a foundation of managing uncertainty.

To operate successfully, insurance companies must accurately predict future liabilities and ensure they have enough capital to meet these financial commitments.

Actuarial valuation in insurance, which combines actuarial science, statistics, and financial theory, is essential for evaluating financial risks and liabilities.

The insights from an actuarial valuation report provide vital information to management, regulators, and plan sponsors on the insurer’s ability to meet benefit payouts.

What is actuarial valuation?

Actuarial valuation is a systematic process used to estimate the present value of pension obligations and other future financial commitments.

It involves calculating the amount of money an insurer needs to hold today to cover all future claims and benefits promised to its policyholders (including those in a pension plan).

This calculation isn't a guess; it's a detailed analysis based on assumptions about future events like mortality rates, investment returns, and operational expenses.

The core purpose of this valuation is to determine an insurer's liabilities. These liabilities represent the financial promises made to customers.

An actuarial valuation compares these liabilities to the company's plan assets, providing a clear picture of its financial health or solvency.

A positive result indicates the insurer has sufficient assets to meet its obligations, while a shortfall signals a potential risk that needs immediate attention.

Why is actuarial valuation required?

• Policyholder Protection: It ensures that insurers are financially capable of paying out claims, even in unexpected circumstances. This builds trust and maintains the stability of the financial system.
  

• Regulatory Compliance: Insurers must submit regular reports, often annually, that include the results of their actuarial valuation. Failure to meet these standards can result in significant penalties, operational restrictions, or even licence revocation.
  

• Strategic Decision-Making: The insights gained from valuation reports are vital for business strategy. They inform decisions on product pricing, investment strategies, reinsurance needs, and capital management, helping the company navigate risks and pursue growth sustainably.

Actuarial Valuation Methods

• Gross Premium Valuation (GPV): This is a widely used method that projects all future cash flows associated with a block of policies, including premiums, claims, expenses, and investment income. These cash flows are then discounted back to the valuation date using an appropriate discount rate. GPV is considered a realistic approach as it incorporates a company's specific experience and expectations.
  

• Net Premium Valuation (NPV): A more traditional and conservative method, NPV uses assumptions based on the original pricing of the insurance policies. It generally does not account for future profits or losses arising from experience deviating from those initial assumptions. While simpler, it is often used for specific regulatory purposes or for older blocks of business.
  

• Stochastic Modelling: For complex products with guarantees or options, actuaries may use stochastic models. This involves running thousands of simulations based on a range of possible economic and demographic scenarios. This method provides a distribution of potential outcomes rather than a single deterministic result, offering a more nuanced view of risk management.

Actuarial Valuation Process

1. Data Collection and Validation: The first step is to gather comprehensive data on the policies being valued. This includes policyholder information (age, gender), policy details (sum assured, term), and historical data on claims, surrenders, and expenses. The accuracy and completeness of this data are paramount, so it undergoes a rigorous validation process.
   

2. Assumption Setting: Next, valuation actuaries set assumptions about future trends. These are informed judgements based on historical data, industry benchmarks, and expert opinion. Key assumptions include mortality and morbidity rates, persistency (the rate at which policyholders keep their policies), investment returns on assets, and future operating expenses.
   

3. Cash Flow Projection: Using the collected data and assumptions, actuaries project the expected future cash flows. This model forecasts the premiums the insurer will receive and the claims and expenses it will pay out over the entire lifetime of the policies, which can span decades.
   

4. Discounting and Calculation: The projected cash flows are then discounted to their present value using a carefully selected discount rate. This rate typically reflects the expected return on the assets backing the liabilities, often including both financial and physical assets. The sum of these discounted cash flows represents the total liability.
   

5. Analysis and Reporting: The final stage involves analysing the results, assessing the company's solvency, and preparing a detailed report. This report explains the methods, assumptions, and outcomes of the valuation and is shared with management, auditors, and regulators—including essential details for plan sponsors tracking long-term benefit payouts and overall funded status.

Actuarial Valuation Example

Imagine an insurer has a single policy for a 40-year-old individual. The policy will pay out a death benefit of RM100,000.

An actuary would begin by estimating the probability of the individual passing away in each future year, using a standard mortality table.

Let's assume, for the upcoming year, the probability of death is 0.1%.

• The expected claim cost for the next year is the probability of the claim multiplied by the benefit amount: 0.1% * RM100,000 = RM100.

This calculation is repeated annually as the probability of death increases with age. The actuary also projects the policyholder's premiums.

Next, all these future expected cash flows (premiums in, claims out) are discounted back to their present value.

• If the discount rate is 3%, the RM100 expected claim cost in one year would have a present value of RM100 / (1 + 0.03) = RM97.09.

The sum of all these discounted future cash flows, both positive (premiums) and negative (claims and expenses), determines the liability the insurer must hold for this policy today.

Now, scale this process across millions of policies, and you can appreciate the complexity and importance of the actuarial valuation.

Strengthen Insurance Decision-Making with Actomate

Accurate actuarial valuations, especially under complex standards like IFRS 17, are vital for competitive pricing, capital management, and financial stability.

Outdated, manual processes can introduce errors and slow down critical decision-making. This is where Actomate can transform your valuation capabilities.

Our actuarial consultants automates data collection, streamlines calculations, and provides powerful analytical tools to enhance your actuarial processes.

By leveraging Actomate, your team can move from tedious spreadsheets and focus on high-value strategic analysis.