Ch 19: Models 2 - F102 dummy deck

Question 1

Summary Card

Answer 1

• Pricing
• Profit criteria
• Capital & solvency
• Valuing assets and liabilities
• Dynamic solvency testing
• Sensitivity testing

Question 2

Profitability: assesing existing business profitability

MPs (2)

Representative MPs (7)

Scaling up (7)

Answer 2

1. Model points
   
   1. May use full policy data set,
   2. more accurate than MPs, but takes time/resources
2. Representative MPs
   
   1. starting point may be previous used MPs, modified for new bus, or
   2. redo MP generation based on in force bus; less prone to errors than adjusting previous MPs
   3. check MP suitability:
   4. run MPs through supervisory model and compare to published value
   5. obtain PV of projected CF using suitable RDR
   • theoretically different RDR for different CFs
   • lower RDR than on pricing as some risks reduced e.g. new business volume and mix
3. Totalling across all policies/scale MPs up
   
   1. PV of future profits: used together with NAV to get EV
   2. Check PV of profits: hopefully positive=> good financial management of product
   3. Breakdown/analysis of future profits to compare relative contr to company profile, by
      
      1. product
      2. class
      3. distribution channel
      4. subsidiaries

Question 3

What is ‘solvency’? (3)

Answer 3

Solvency

1. Solvency relates to insurer’s ability to meet future outgo, both from existing bus and from future new bus may sell
2. Enough reserves for future liabilities on existing bus + extra for anything else (cost of smoothing bonuses, new bus strain)
3. Regular solvency projections required, as part of regular supervisory submission

Question 4

Outline how an insurer should assess its capital requirements (4)

Answer 4

1. Insurer should assess amounts and types of capital needed given
   
   1. amount of liabilities
   2. types of risks inherent in those liabilities
2. Given liabilities span long period of years, necessary to project assets & liabilities into future years, allowing for:
   
   • new business plans
   • management actions e.g. changes in bonus and investment policy

Question 5

Give 2 main bases on which the values of assets and liabilities can be determined, for the purposes of assessing solvency

Answer 5

Company needs to compare assets and liabilities at point in time to assess solvency, can use following bases

1. Supervisory values
   
   • as determined for supervisory reporting
2. Economic values
   
   • based on expected future experience or using a market-consistent basis

Question 6

What is static solvency testing? (2)

List 3 disadvantages of static solvency testing (3)

Answer 6

Static solvency testing

1. Testing solvency at specific point in time
2. Won’t enable assessment of comp’s ability to withstand future changes in external eco environ and particular comp’s experience

3 disadvantages of static solvency testing

1. considers only existing portfolio, no new bus
2. assumes experience for remaining duration
3. guarantees are hard to cost

Question 7

Describe the process of dynamic solvency testing (4, 10)

Answer 7

Dynamic solvency testing

1. testing solvency over future time periods
2. project revenue account/balance sheet far enough ahead to identify full effect of any potential risks
   
   1. e.g. current solvency assess shows A>L, but projecting surplus might show it runs out in few years
3. Requires full model office, with realistic representation of liability portfolio by model points
4. Projections bases either:
   
   • deterministic, using expected assumptions, combined with assumptions with margins to test effect of adverse future experience
   • stochastic (simulations), to assess probability of adverse circumstances occuring
5. take into account existing business only, or also include expected future new business

Question 8

List 5 key uses of dynamic solvency testing (5)

Answer 8

5 key uses of dynamic solvency testing

1. Managing solvency (on both supervisory and realistic bases), by assessing ability of company to withstand changes in environment
2. Setting new business plans
3. Setting investment strategy
4. Setting bonus strategy
5. Setting reinsurance strategy

Question 9

Define the financial strength of a company (3, 1)

Answer 9

1. Usually refers to ability of a life company to:
   
   • withstand adverse changes in experience, including those arising from investment in higher-yielding but more volatile assets
   • fulfil its new business plans
   • meet reasonable expectations of its policyholders
2. Is often measured by level of its free assets or estate

Question 10

Define free assets (2) and the estate (1) of a life company

Answer 10

• Free assets
  
  • part of life company’s assets that are not needed to cover its liabilities
  • opinion differs as to what shuld be included in liabilities, and they may or may not include any solvency capital requirements
• Estate
  
  • excess of realistic value of assets over realistic value of liabilities

Question 11

List external sources of capital (4) and internal sources of capital (1) for a life company

List 7 uses of capital for life company (7)

Answer 11

Sources of capital

1. External: shareholders, financial markets, reinsurance, derivatives
2. Internal: free assets

Uses of capital

1. Enables withstanding of adverse, often unexpected conditions
2. Enables writing of new business (covers product development costs + new business strain)
3. Enables adoption fo less restrictive investment policy
4. Smoothing surplus distributions to policyholders
5. Smoothing divident payments to shareholders
6. Reducing need for reinsurance
7. Allows seizing of profitable business opportunities (e.g. merger, takeover)