C18 - Valuation Assumptions DONE Flashcards
Two types of assumptions the need to be made when valuing liabilities
Economic - affect amounts of investment income, contribution and benefit outgo
Demographic - affect timing and number of benefit payments and contribution income
Examples of economic assumptions
- Discount rate (could be pre/post retirement)
- Price inflation
- General earnings inflation
- Pension increases (guaranteed and discretionary)
- Revaluation rates
- Expenses and expense inflation
- State benefits (if integrated)
Examples of demographic assumptions for a DB scheme
- Retirement rates (normal, early and late)
- Ill health retirement rates
- Withdrawal rates
- New entrant rates
- Mortality base tables (pre and post retirement, members/dependants)
- Mortality improvements
- Proportion married
- Age gap
- Promotional salary scale
- Take up of any options
Historical data to set assumptions
- Global sources of information
- Country wide population statistics and analysis
- Historic data on all pension schemes in the country
- Scheme specific historical data
Describe how to determine a market related inflation assumption
- Relationship between current yields for fixed interest and index linked government bonds over an appropriate term, possibly adjusted for an inflation risk premium (eg if there is excess supply of one type)
- Policy statements by governments or controlling banks
Factors to consider before using past data to project future experience
Credibility and relevance
Issues when using past data
- Abnormal fluctuations
- Changes of experience with time
- Random fluctuations
- Changes in the way the data was recorded
- Errors in the data
- Changes in the balance of homogenous groups underlying the data
- Heterogeneity within groups to while the assumptions relate
Methods of projecting mortality rates into the future
Process based projections - attempt to model trends in the causes of death
Extrapolative methods - historical trends in mortality are sprojected into the future
How are actuaries allowing for the increasing uncertainty surrounding improvements in the future?
- Adopting stochastic approaches to model mortality so a range of scenarios can be modelled eg time taken for improvements to wear off can be set as a random variable
- Should allow for model risk eg where results show a narrow CI it could be due to parameters of the model
Drawbacks of methods of projecting mortality rates
Process based
- problems in death classification
- insufficient understanding of major cause of death processes
- lack of understanding of relationships between diseases
Extrapolating - subjectivity associated with the choice of period over which such trends are to be determined
Market value and how a scheme’s liabilities should be measured in relation to this
Price of the asset resulting from supply and demand for the asset at a point in time
For consistency a market related method for assessing liabilities should be adopted
Name three market related methods for setting the discount rate
- Asset based discount rate
- Mark to market (or market consistent)
- Bond yield plus risk premium
Describe the asset-based discount rate approach
- Assets taken at market value
- Implied market DR calculated for each asset class eg GRY
- DR based on the weighted average of the individual DRs based on the proportions invested
- Can use the actual investment portfolio or the strategic benchmark
- For closed schemes not uncommon to have two DRs, pre and post retirement
Factors to consider when determining assumptions
- Purpose of the valuations
- Needs/objectives of client
- Consistency (eg with funding method)
- Financial significance
- Scheme specifics
- External factors eg regulation
Describe the mark to market approach
- Assets taken at market value
- For the liabilities there is an assumption that a set of bonds can be found to replicate each type of benefit ie a replicating portfolio
- From each set of bonds it is possible to derive a yield curve and apply it to the corresponding projected benefits of each type
- DR is the weighted average of the yields in these matching bonds
