20. Setting assumptions Flashcards
What are the 5 most important things to consider when setting assumptions?
LUNCH
* Legislative or regulatory constraints
* Use (purpose) to which assumptions will be put
* Needs of the client
* Consistency between the various assumptions
* How financially significant the assumptions are
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Give three examples of where historical data will be a useful starting point for setting economic assumptions
- Past investment data on dividend yields and total returns used in setting assumptions about future investment return
- Past inflation index data used to set assumptions related to benefit growth that is linked to an inflation index
- Past data on salary growth in a country, industry or company=> setting salary growth assumptions
Give four examples of where current data and forecasts may be useful for setting assumptions
- Estimate market levels of future inflation => R Inflation linked bond-R Fixed interest bond
- Economic assumptions=> Statements by government+ banks
- Planned salary increases+ withdrawal rates of benefit schemes can be obtained from benefit sponsors
- Assumptions may be defined in regulation or legislation
What features of past data make it inappropriate to use for projecting into the future/ why past data may not be relavent?
- Abnormal fluctuations
- Changes in experience with time
- Random fluctuations
- Changes in the way in which the data was recorded
- Potential errors in the data
- Changes in the mix of homogeneous groups within the past data
- Changes in the mix of homogenous groups to which the assumptions will apply
What assumptions may be affected by changes in each of the social, economic and fiscal condition?
- Social trends e.g. advances in medicine=> affect mortality data
- Economic condition=> financial assumptions such as dividend yields, salary growth, inflation rates
- Economic conditions such as recession affects demographic assumptions such as withdrawal rates, take up rate + claim rates (due to crime, moral hazard)
- Fiscal changes (tax)=> dividend yields+ salary growth+ investment returns
Give an example of the problems caused by a CHANGE IN THE BALANCE of homogeneous groups underlying the data can lead to a misleading assumption for an employee benefit scheme
- If the data for employee benefit shcme is not subdivided by type of worker (e.g. manual vs professional)
- Then past levels of salary growth will be distorted by changes in the composition of the workforce
What are the main considerations when using data from a standard mortality table to set assumptions?
- Data may not be relevant to the intended population
- e.g Data relate to entire population
- BUT data only related to insured lives required
- Data may be out of date=> need adjusting for mortality trends
What five factors affect the need for accuracy and prudence when setting assumptions?
- The purpose of the valuation
- Significance of each assumption to the overall results
- Whether the individual cashflows are important or whether the overall value resulting from a combination of cashflows is important
- Financial significance of any errors
- Whether the valuation if for a cash transaction which cannot be corrected at a later data
What is an example of an implicit assumption in a pension scheme?
- Whether or not the scheme is closed to new entrantsFor example: Occupational pension scheme may assume that -
- New members continue to join=> age/sex distribution of a pop maintained or,
- No new members=> treat as a closed group
List three ways in which margins for risk can be built into assumptions when pricing
- Margin in the discount rate
- Using a stochastic discount rate
- Applying margins to the expected values
What are examples of profit criteria that could be used when pricing an insurance contract?
- NPV of profits
- IRR
- Discounted payback period
- A ratio involving NPV of profits such as the NPV of profits divided by distribution costs
List six features that will make an insurance contract design riskier
- Lack of historical data
- High guarantees
- Policyholders options
- High overhead expenses
- A complex design
- An untested market
