20. Setting assumptions TODO

Question 1

1) What are the 5 most important things to consider when setting assumptions?

Answer 1

• LUNCH
• Legislative or regulatory constraints
• Use to which assumptions will be put
• Needs of the client
• Consistency between the various assumptions
• How financially significant the assumptions are

Question 2

What situations will historical data be useful in setting assumptions?

Answer 2

• Past investment data on dividend yields and total returns=> setting assumptions about future investment return
• Past inflation index data=> 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

Question 3

What situations would current data and forecasts would be useful for setting assumptions?

Answer 3

• 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=> Sponsors IV. Assumptions may be defined in regulation

Question 4

What features of past data make it inappropriate to use for projecting into the future?

Answer 4

• 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

Question 5

What assumptions may be affected by changes in each the social, economic and fiscal condition?

Answer 5

• Social trends=> advances in medicine=> affect mortality data
• Economic condition=> financial assumptions
• Economic conditions=> recession=>demographic assumptions=> withdrawal
• rates, take up rate + claim rates
• 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 in underlying data on the assumptions created.
• Data for an employee benefit scheme
• Not subdivided by type of worker
• Past levels of salary growth will be distorted by changes in composition of the work force

Question 6

What are the main considerations when using data from a standard mortality table to set assumptions?

Answer 6

• Data may not be relevant to the intended population
• Data relate to entire pop
• BUT data only related to insured lives required
• Data may be out of date=> need adjusting for mortality trends

Question 7

What five factors affect the need for accuracy and prudence when setting assumptions?

Answer 7

• I. 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=> cannot be corrected at a later data

Question 8

What is an example of an implicit assumption in a pension scheme?

Answer 8

• I. Whether or not the scheme is closed to new entrants II. For example:
• New members continue to join=> age/sex distribution of a pop maintained
• No new members=> treat as a closed group
• How can margin for risk be built into assumptions when pricing? I. Margin in the discount rate
• Using a stochastic discount rate
• Applying margins to E[.]

Question 9

What are examples of profit criteria that could be used when pricing an insurance contract?

Answer 9

• NPV of profits
• IRR
• Discounted payback period
• A ratio involving NPV of profits such as the NPV of profits divided by distribution costs
• t
• Untested market
• Chapter 21- Mortality and morbidity