2020 INTEGRATED REPORT

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) for the year ended 31 December 2020 36. MANAGEMENT OF RISKS (continued) 36.2 Insurance product risk management (continued) b. Sources of uncertainty in the estimation of future benefit payments and premium receipts (continued) Insurance contracts – Short-term (continued) Expenses are monitored by business unit based on an approved budget and business plan. Insurance risk is further mitigated by ensuring that reserve and reinsurance risk is adequately managed. Reserve risk relates to the risk that the claim provisions held for both reported and unreported claims as well as their associated expenses may prove insufficient. The Head of Actuarial Function reviews and attests annually on the reliability and adequacy of technical provisions and the Solvency Capital Requirement. He expresses an opinion on the Underwriting Policy as well as the soundness of the premium rates in use and the profitability of the business. The Group currently calculates its short-term insurance technical reserves on two different methodologies, namely the ‘percentile approach’ and the ‘cost-of-capital approach’. The ‘percentile approach’ is used to evaluate the adequacy of technical reserves for financial reporting purposes, while the ‘cost-of-capital approach’ is used as one of the inputs for regulatory reporting purposes. a. Percentile approach Under this methodology, reserves are held to be at least sufficient at the 75th percentile of the ultimate loss distribution. The first step in the process is to calculate a best-estimate reserve. Being a best-estimate, there is an equally likely chance that the actual amount needed to pay future claims will be higher or lower than this calculated value. The next step is to determine a risk margin. The risk margin is calculated such that there is now at least a 75% probability that the reserves will be sufficient to cover future claims. For more detail on the reserving techniques used in this approach, refer to note 35.2. b. Cost-of-capital approach The cost-of-capital approach to reserving is aimed at determining a market value for the liabilities on the statement of financial position. This is accomplished by calculating the cost of transferring the liabilities, including their associated expenses, to an independent third party. The cost of transferring the liabilities off the statement of financial position involves calculating a best-estimate of the expected future cost of claims, including all related run-off expenses, as well as a margin for the cost of capital that the independent third party would need to hold to back the future claims payments. Two key differences between the percentile and cost-of-capital approaches are that under the cost- of-capital approach, reserves must be discounted using a term-dependent interest rate structure and that an allowance must be made for unallocated loss adjustment expenses. The cost-of-capital approach will result in different levels of sufficiency per class underwritten so as to capture the differing levels of risk inherent within the different classes. This is in line with the principles of risk-based solvency measurement. The net claims ratio for the Group, which is important in monitoring short-term insurance risk is summarised below: Group 2020 2019 Loss history Net claims paid and provided % of net earned premiums 51.00% 69.20% 188 | PPS INTEGRATED REPORT 2020