GIM2180 - Accounting framework: discounting of provisions / reserves

In an insurance context discounting is the practice of taking account of the time value of money when estimating a reserve. A liability to pay £1,000 in five years time is less onerous than a liability to pay £1,000 today, and this can be recognised by discounting the distant liability back to its present value, using an appropriate discount rate. The process can also be described (less accurately) as making a deduction from the anticipated ultimate cost of settling a claim, in order to recognise that the amount which needs to be set aside to meet a claim will be less than the ultimate cost because of the income which will accrue on the funds held to meet the claim.

Paragraph 47(7) Part 1 Schedule 9A CA 1985 prohibits “implicit discounting”. This is the practice of recognising implicitly the investment return by placing a current value on a claim which will be settled in the future. Not taking account of anticipated inflation also constitutes implicit discounting.

Paragraph 48 allows explicit discounting of outstanding claims in certain narrowly prescribed conditions. The expected average interval between the date for the settlement of claims being discounted and the accounting date must be at least four years. The discounting must also be on a recognised prudential basis, take account of all possible increases in costs, be based on a reliable model of claims settlement, and be based on a prudential rate of interest.

As a consequence of these requirements, discounting of claims provisions is relatively uncommon.

FA00/S107 contains rules which require an adjustment to the computations of general insurance companies which do not calculate technical provisions on a discounted basis. See GIM6150 for more details.