20. Setting assumptions Flashcards
Factors affecting choice of assumptions
- Purpose
- Consistency between different assumptions
- Care on assumptions that will have most financial impact.
- Legislation + Regulation
- Clients’ needs
Types of assumptions
- Demographic assumptions- size and distribution of population
- Economic assumptions- income and outgo
Information
- Historical data
* Current + forecasts
Use of past data for economic assumptions
- Future investment returns
- Future levels of salary growth
- Future growth of benefit linked to inflation
Extent of usefulness of information
- Relevance + credibility of past data
- Fluctuations over time
- Data recording
- Heterogeneity
- Standard tables
Considerations for past data
- Abnormal fluctuations
- Changes in experience over time
- Random fluctuations
- Changes in methods to record data
- Data errors
- Changes in mix of homogeneous groups within data
- Changes in mix of homogeneous groups to which assumptions apply
Fluctuations and changes over time
- Economic + fiscal changes
- Price inflation
- Use of real values
- Demographic changes
- Other economic adjustments
- One-off impacts
Data recording
- Changes in recorded stats
* Data errors
Heterogeneity
- Changes in constituents of population
* Split into homogeneous groups
Other factors to consider
- Accuracy + prudence
- Effect of assumptions on cash transactions
- Implicit assumptions
Accuracy + prudence
- Purpose
- Accuracy of assumptions
- Significance of errors
Factors affecting pricing
- Margins
- Risk discount rate
- Profit criterion
Allowing for adverse future experience in cash flow models
- Adjust the risk element of risk discount rate
- Use a stochastic risk discount rate
- Apply margins to expected values
Discount rate may be a sum of
Either:
- Risk free rate
- Shareholders’ required risk of return
+
*Risk premium
Factors increasing risk
- Lack of historical data
- High guarantees
- Policyholder options
- Overhead costs
- Complexity of design
- Untested market
Measuring profitability
- NPV
- IRR
- DPP
Considerations when using standard tables
- Relevance of data to intended population
* Adjustments to reflect continuing past trends
Other sources of data
- National statistics
- Industry data
- Actuarial tables
- Past information about contract
Conditions that could have changed thus not reflecting likely future experience of term assurance
- Underwriting practices
- Distribution channels
- Target market
- Product design
- Mortality rates
Setting mortality assumptions with little past data
- Data from similar contract
- Industry data
- Reinsurer’s data
Demographic factors for pension scheme
- Good health retirement rates
- Ill-health retirement rates
- New entrant rates
- Withdrawal rates
- Mortality rates
- Proportion married
- Average age of spouses
- Spouses mortality
- Salary scale
Economic factors for pension funds
- Investment returns
- Discount rate
- Earnings inflation
- Price inflation
- Pension increases
- Expenses
Use of past data for demographic assumptions
- Past mortality used to make assumptions on survival of pension fund members/
- Used to find extent to which benefits will be payable
- Project mortality improvements
- Can be used when finding the probability of leaving employment, retiring etc
Examples of current data
- Statements by government or controlling banks
- Industry forecasts
- Views of directors
- Relationship between current yields on fixed-i and index-linked bonds»>future expected inflation.
