The purpose of LAT is to verify the adequacy of provisioning for life insurance. The test consists of comparing the amount of provisions with the best estimate of provisions, arrived at on the basis of the present value of the best estimate of the future expected contractual and other cash flows. The calculation is performed for each separate contract while the results are aggregated on the level of homogenous groups. The test is based on a unified methodology that determines, among others, the grouping of policies into homogenous groups, the choice of risk-free discount rates and the type of cash flows being modelled. The portfolio balance is tested as at the last day of the business year.
3.2.1 Segmentation of life insurance products for the purpose of LAT test
Insurance contracts are segmented into homogenous groups which feature similar risks and are kept within the same portfolio. As a rule, insurance contracts are grouped according to their insurance classes:
- traditional life insurance,
- unit-linked life insurance and
- capital redemption insurance (supplementary voluntary pension insurance).
The adequacy of liabilities is measured on the level of a homogenous group. If the test shows that the liabilities are insufficient, the total amount of the difference is recognised as an increase in provisions and an expense in the income statement.
3.2.2 Parameters and assumptions applied to life insurance
Mortality, longevity and morbidity assumptions
Assumptions regarding mortality, longevity and morbidity rates are based on internal analysis of the company's life insurance portfolio, on the data of national statistical offices, the data of reinsurers and other sources.
The model takes into account the lapse rates determined on the basis of analysis of past experience. The Group continuously monitors the persistency of insurance policies by duration and type of insurance, and adapts their assumptions accordingly.
The calculation takes into account policy handling/maintenance expenses, claim handling expenses and asset management expenses, as defined on the basis of an analysis of the individual company's expenses in preceding years. Estimated future expenses are increased every year in line with the expected inflation rate.
Increasing insurance premiums
In the case of insurance policies for which the monthly premium directly or indirectly follows the increase in salaries, the increase is calculated in line with the expected inflation rate.
Expected returns and discount interest rates
The applied methodology determines that the discount rates used should reflect the yield of the local government bonds denominated in the currency of the contract being modelled. For the purpose of the LAT test, the yield curve of Slovene sovereign debt securities denominated in euros as at 30 December 2011 was applied. The reference value for a period of 10 years totalled 6.651%.
The best estimate of provisions was additionally determined on the basis of the yield curve of AAA-rated government bonds, published by the European Central Bank (ECB), which is used to verify the adequacy of the provisioning level as at 31 December 2011. The reference value of the curve for a 10-year period is 2.645%. Zavarovalnica Triglav also used the yield curves published by the ECB to test the adequacy of the provisioning level in the preceding years.
The determination of the profit participation rate is at the discretion of each Group member and regulated by internal rules. The estimated future allocation of surpluses are in line with the expected performance, the previous profit allocation rates and the policyholders' reasonable expectations.
In the model, profit is allocated in an excess of the technical interests for with-profit policies. The allocation is determined on the basis of the mathematical provisions as at the end of the financial year.
Annuity factor guarantee
The liability adequacy test allows for the possibility of a change in annuity factors by the insurer in the event of insurance policies for which the mortality forecasts indicate that life expectancy is likely to increase to such an extent that the contract conditions justify such a change. The calculation also assumes the probability that 80% of the policyholders will choose to receive a pension annuity, while the others will opt for a lump-sum payout.
3.2.3 Results of the liability adequacy test for life insurance
Liability adequacy tests based on available data show that provisions formed at the Group level are adequate.
3.2.4 Sensitivity analysis of LAT test to parameter changes
The valuation of liabilities depends on variables such as mortality, lapse rate, operating costs and the estimated percentage of policyholders deciding to opt for a pension annuity. Parameters are sensitivity tested in order to assess the impact of changes to the above-mentioned variables on future liabilities, the level of provisions and net profit or loss for the year. The changes represent reasonable potential changes in the parameters which could significantly impact the performance of the company.
Individual sensitivity analyses always take into account the change of a selected parameter with all the remaining variables unchanged without accounting for the value of assets backing the liabilities.
The changes under consideration were:
- an increase in mortality rates by 10%,
- a decrease in longevity rates by 10%,
- an increase in lapse rates by 10%,
- an increase in expenses by 10%,
- an increase in the annuisation rate by 10%.
Test results have proven mathematical provisions in all these scenarios of changing key technical parameters to be adequate.