C19 Setting Assumptions

Question 1

Key considerations in setting assumptions for actuarial work

Answer 1

While setting assumptions it is important to :
UFC LN
1. Consider the use to which these assumptions will be put.
2. Take care over the choice of assumptions that will have the most financial significance
3. Achieve consistency between the various assumptions
4. Consider any legislative or regulatory constraints
5. Consider the needs of the client

Question 2

Give examples of where historic data can be useful in setting assumptions

Answer 2

Using historical data for setting assumptions:

1. Past investment data on dividend yields and total returns for setting future yield and return assumptions
2. Past index data for setting inflation assumptions for benefit growth that is linked to inflation
3. Past data on salary levels for setting salary growth assumptions
4. Past demographic data (e.g. Mortality and withdrawals) for setting future rates.

Question 3

Give examples of where current data can be useful in setting assumptions

Answer 3

Using current data and forecasts for setting assumptions:

1. Difference between current yields on government fixed-interest and index linked bonds can be used to estimate market levels of inflation
2. Policy statements by governments and banks can help in setting economic assumptions
3. Sponsors may be able to give indications of planned salary increases or withdrawal rates
4. Assumptions may be defined by legislation

Question 4

List features of past data that actuary needs to adjust for
Or
Why past data may not be relevant in the future

Answer 4

Why past data may not be relevant in the future
1. May be insufficient quantity of past data to be credible – smaller quantity => greater effect of random fluctuations
2. Quality of data may not be perfect since it may contain errors
3. Data may be affected by trends over time or abnormal events
4. May be changes in social, economic and fiscal conditions during/since period of collection
5. Mix of homogeneous groups underlying data may not have been stable during period of data collection – also mix of business to which assumptions will apply may also be different
6. May have been changes in way data is recorded over time

Question 5

How are assumptions affected by social, economic and fiscal conditions

Answer 5

Assumptions affected by social, economic and fiscal conditions:
- Economic conditions and fiscal changes (i.e. tax rates) affect dividend yields, salary growth and investment returns.
- Economic condition affect inflation rates, which fluctuate significantly
- Social trends, such as medical advances, affect mortality rates, take up rates and claim rates (e.g. due to crime, moral hazard)

Question 6

Problems caused by a change in the balance of homogeneous groups
Or
Why it is important to split data into homogeneous groups

Answer 6

Problems caused by a change in the balance of homogeneous groups
- If data for an employee benefit scheme is not subdivided by type of worker (e.g. manual, professional) then past levels of salary growth will be distorted by changes in the composition of the workforce)

Question 7

What considerations should be taken into account when using standard mortality tables?

Or

Why using the standard tables may not be appropriate? Problems using standard tables

Answer 7

Problems in using standard mortality tables

• Data may not be relevant to the intended population, e.g. table may relate to an entire population whereas data is required for a subgroup of insured lives (who generally inhabit a better socio-economic group)
• Data may be out of date and need adjusting for trends in mortality between the data to which data relates and the date to which it is expected to apply

Question 8

Describe the factors to be considered when deciding on the need for accuracy and prudence in setting assumptions

Answer 8

Factors affecting the need for accuracy and prudence when setting assumptions: PEECO

1. Purpose of valuation and needs of the client
2. Significance of each assumption to overall result
3. Financial significance of any errors
4. Whether the individual cashflows or overall value of cashflows is important
5. Whether transaction is a one-off (which cannot be corrected at a later date), e.g. a transfer value, a split of assets on divorce

Question 9

Examples of Implicit assumptions within a model

Answer 9

Implicit assumptions
It is necessary to be aware of any implicit assumptions within a model, and consider any effect of these , e.g. in a pension scheme:

• An implicit assumption is whether the scheme is closed to new entrants
• This will affect the age/sex profile of a scheme and will also affect assumptions such as investment returns and expenses

Question 10

Ways to allow for Risk (adverse experience) in assumptions and Profit Margins

Answer 10

Risk to the provide for adverse experience could be allowed for by:
1. Margin in risk discount rate
2. Using a stochastic discount rate
3. Margins in individual assumptions
4. Profit margin (requirements)

Question 11

Contract design features that increase risks

Answer 11

Contract design features that increase risks
1. Lack of historical data
2. High guarantees
3. Policyholder options
4. High overhead expenses
5. Complex design

Question 12

Describe the term ‘profit criterion’

Answer 12

Profit Criterion: A single figure that tries to summarise the relative profitability of a contract.

Examples of profit criterion:
NPV
IRR
DPP
Ratio involving the NPV of profits such as:
a) NPV of profits / NPV of premiums
b) NPV of profits / distribution costs