21. Setting assumptions I

Question 1

Explain how the assumptions for mortality and morbidity would be set

Answer 1

1. Assumptions must be made for base mortality and mortality trend
2. Use recent experience of contract or related one
3. Industry and reinsurance data can be used if have little data
4. Adjustments must be made for differences between lives that are in data and those for which new assumptions are set
5. Differences may be due to target market, distribution channel or uw
6. Must make allowance for expected changes using combination of expectation, extrapolation and explanatory approaches.
7. Mortality imporvements may vary by birth year or cohort in some regions
8. For health products, claim incidence, duration and amount may need to be considered

Question 2

Explain how the investment return assumption would be set

Answer 2

1. Set based on:
   
   • Significance of reserves
   • Extent of investment guarantees
   • Importance of reinvestment
   • Intended asset mix
2. Must consider tax

If using market consistent:
1. Use RDR regardless of assets held
2. Volatility and correlation assumptions are based on actual assets held
3. Margin is included in other parameters to allow for risk

Question 3

Explain how the expense assumption would be set

Answer 3

1. Based on most recent expense ibvestigation
2. May need to model some expenses for new products
3. Might need cross-subsidy for competitive reasons when splitting expenses into “per policy” and “per X of premium”

Question 4

Explain how the expense inflation assumption would be set

Answer 4

1. Consider:
   
   • Current earnings and price inflation
   • Expected future rates of inflation
   • Differential between government fixed-interest securities and government index-linked securities
   • Recent actual experience of the life insurance company / industry
2. Assumption must be consistent with investment return assumption

Question 5

Explain how the withdrawal assumption would be set

Answer 5

1. Use recent experience
2. If not availablem use industry statistics.
3. Make adjustments for expected changes in experience.
4. Will be influence by distribution channel and economic environment

Question 6

Explain how the margins would be set

Answer 6

1. Necessary to guard against adverse future experience
2. Competition could restrict prudence in pricing basis
3. Can allow for risk in risk discount rate, stochastic modelling or explicit margins in parameters

Question 7

Explain what is meant by the risk dicount rate.

Answer 7

Return on capital of:
1. return obtained from risk free asset
2. plus risk premium to compensate for volatile returns
required by investors

Question 8

Explain how the risk discount rate assumption would be set

Answer 8

1. Must price products to meed RDR to earn that rate
2. Must quantify risk premium appropriate for company
3. Can use CAPM to do this.
4. Must take market availability of capital into account.
5. Can use statistical risk assessed analytically, using sensitivity analysis or stochastic model.

Question 9

What factors affect riskiness of a product

Answer 9

1. Lack of historical data
2. High guarantees
3. Policyholder options
4. Overhead costs
5. Compex product design
6. Untested market

Question 10

Explain how profit criteria would be set

Answer 10

1. Used in pricing basis
2. Prespecified target measures e.g. NPV