C.3. Principal assumptions

C.3.1. Life insurance liabilities

Actuarial assumptions and their sensitivities underlie the insurance calculation. The life insurance liability (mathematical provision) is calculated by a prospective net premium valuation (see Note C.1.12.2) using the same statistical data and interest rates used to calculate premium rates (in accordance with relevant national legislation). The assumptions used are locked in at policy inception and remain in-force until expiry of the liability. The adequacy of insurance liabilities is tested with a liability adequacy test (see Note C.3.3).

The guaranteed technical rate of interest included in policies varies from 1.9% to 6% according to the actual technical rate used in determining the premium.

As a part of the life insurance provision, an additional provision is established in respect of bonuses payable under certain conditions, referred to as “special bonuses”. This provision corresponds to the value of special bonuses calculated using the prospective method and using the same interest rate and mortality assumptions used to calculate the basic life insurance provision. No allowance is made for lapses.

C.3.2. Non-life insurance liabilities

As at the end of the reporting period, a provision is made for the expected ultimate cost of settling all claims incurred in respect of events up to that date, whether reported or not, together with related claims handling expenses, less amounts already paid.

The liability for reported claims (RBNS) is assessed on a separate case-by-case basis with due regard to the claim circumstances, information available from loss adjusters and historical evidence of the size of similar claims. Case reserves are reviewed regularly and are updated as and when new information arises.

The estimation of claims incurred but not reported (IBNR) is generally subject to a greater degree of uncertainty than reported claims. IBNR provisions are predominantly assessed by the Group’s actuaries using statistical techniques such as chain ladder methods, whereby historical data is extrapolated in order to estimate ultimate claims costs.

To the extent that these methods use historical claims development information, they assume that the historical claims development pattern will occur again in the future. There are reasons why this may not be the case, which, insofar as they can be identified, have been allowed for by modifying the methods. Such reasons include:
a) economic, legal, political and social trends (resulting in different than expected levels of inflation);
b) changes in the mix of insurance contracts incepted;
c) random fluctuations, including the impact of large losses.

IBNR provisions are initially estimated at a gross level and a separate calculation is carried out to estimate the size of reinsurance recoveries.

The assumptions which have the greatest effect on the measurement of non-life insurance liabilities are as follows:

“Tail” factors
For long-tail business, the level of provision is significantly influenced by the estimate of the development of claims from the latest development year for which historical data is available to ultimate settlement. These tail factors are estimated prudently using mathematical curves, which project observed development factors.

Annuities
In motor third party liability insurance (MTPL) and other third party liability lines, part of the claims payment may be in the form of an annuity. The provision for such claims is established as the present value of expected future claims payments.

The key assumptions involved in the calculation are the discount rate, the expected increase in wages and disability pensions which influence the amount of annuities to be paid. The Group follows guidance issued by the Czech Insurers’ Bureau and similar bodies in other countries in setting these assumptions.

Under current legislation, future increases in disability pensions are set by governmental decree and may be subject to social and political factors beyond the Group’s control. The same applies to the real future development of annuity inflation (it is also dependent on governmental decrees).

Discounting
With the exception of annuities, non-life claims provisions are not discounted. For annuities, discounting is used as described in the table below.

XLS

The rates shown above reflect the economic situation in the Czech Republic and are bound to Czech Crown.
 
In addition, the Group takes mortality into account through the use of mortality tables recommended by national insurance bureaus.

C.3.3. Liability adequacy test (LAT)

C.3.3.1. Life insurance
The life insurance liabilities are tested as at the end of each reporting period against a calculation of the minimum value of the liabilities using explicit and consistent assumptions of all factors. Input assumptions are updated regularly based on recent experience. The principle of LAT is a comparison of the minimum value of the liabilities (the risk adjusted value of the cash-flows discounted by risk free-rate) arising from lines of business with the corresponding statutory provision.

Due to the levels of uncertainty in the future development of the insurance markets and the Group’s portfolio, the Group uses margins for risk and uncertainty within liability adequacy tests. Margins are calibrated to be consistent with the result of risk valuation in the internal Economic balance sheet model (EBS).

The principal assumptions used (see Notes C.3.4.1 and C.5.1) are:

Mortality
For mortality assumptions, the analyses of Group’s portfolio past experience and population mortality is used. The experience portfolio mortality rates are calculated separately for each portfolio group, age, and gender.

Persistency
Future contractual premiums are included without any allowance for premium indexation. Estimates for lapses and surrenders are based on the Group’s past experience and future expectations.

Expense
The expenses assumptions are derived from the latest forecasts, following the internal guidance on unit costs. The expenses are increased by the inflation rate.

Discount rate
Risk-free rates are derived from bond yield curve in Asset Liability Management Department consistently with recommendation of a directive of Czech Society of Actuaries for LAT.

Interest rate guarantee
The interest rate guarantee is calculated using internal model calibrated to MCEEV valuation of financial options and guarantees (FO&G), which includes comprehensive view on assets and liabilities of the Group. The calibration is based on the last known time value of FO&G arising from the stochastic model in MCEEV and the expected development of volatilities. The model reflects the actual yield curve.

Profit sharing
While, for most life insurance policies, the amount and timing of the bonus to policyholders is at the discretion of the Group, the assessment of liability adequacy takes future discretionary bonuses, calculated as a fixed percentage of the excess of the risk-free rate over the guaranteed technical interest rate on individual policies, into account. The percentage applied is consistent with the Group’s current business practices and expectations for bonus allocation.

Annuity option
The option to choose between a lump sum payment and an annuity is available to policyholders under annuity insurance. For the purposes of the liability adequacy test, the Group assumes an annuity option take-up rate increasing from the level of 1% – 4% (current level based on internal analysis) to 5% – 10% (future expected market development) in the long-term horizon for all eligible policyholders.

C.3.3.2. Investment contracts with Discretionary Participation Features (DPF)
Investments contracts with DPF are included within the liability adequacy test for life insurance as described above.

C.3.3.3. Non-life insurance
Contrary to life insurance, insurance liabilities connected with non-life insurance are calculated by using current (not historical) assumptions and therefore no additional liabilities are established for outstanding claims as a result of a liability adequacy test.

The liability adequacy test for non-life insurance is therefore limited to the unexpired portion of existing contracts. It is performed by comparing the expected value of claims and expenses attributable to the unexpired periods of policies in force at the end of the reporting period with the amount of unearned premiums in relation to such policies after deducting deferred acquisition costs. Expected cash flows relating to claims and expenses are estimated by reference to the experience during the expired portion of the contract, adjusted for significant individual losses which are not expected to recur.

The test is performed by product groups which comprise insurance contracts with a similar risk profile.

For annuities, the assumptions used to establish the provision include all future updated cash flows with changes being recognised immediately in the income statement. As such, no separate liability adequacy test is required to be performed.

C.3.4. Significant variables

Profit or loss recognised on insurance contracts and insurance liabilities are mainly sensitive to changes in mortality, lapse rates, expense rates, discount rates and annuities which are estimated for calculating adequate value of insurance liabilities during the LAT.

The Group has estimated the impact on profit for the year and equity as at the year end for changes in key variables that have a material impact on them.

C.3.4.1. Life insurance
According to Liability Adequacy Test, life statutory reserves are sufficiently adequate in comparison to minimum value of the liabilities and the changes in variables other than discount rate has no impact on profit for the year and equity.

Life insurance liabilities as at 31 December 2015 according to the Liability Adequacy Test were not sensitive to a change in any variable. Life insurance liabilities as at 31 December 2014 were not sensitive to a change in any variable as well.

The decrease and increase by 10% in mortality rate, lapse rate, expense rate and 100 bp decrease and increase in the discount rates were tested. Changes in variable represent reasonably possible changes in a variable which represent neither expected changes in variable nor worst-case scenarios. The analysis has been prepared for a change in variable with all other assumptions remaining constant and ignores changes in the values of the related assets.

C.3.4.2. Non-life insurance
In non-life insurance, variables that would have the greatest impact on insurance liabilities relate to annuities.

XLS