CH 21 - 22 (Setting Assumptions) Flashcards
Steps to Setting Assumptions
- Investigate historical experience + make best estimates of the parameters
(start with own experience, use external if low on experience) - Consider likely conditions of future period
- Determine best estimates of assumptions given future conditions
- Experience data will contribute as much as the data credibility + relevance (and predictability of the parameter)
- Consider the margin to be included for prudence
(depends on purpose and degree of risk associated with the parameter) - Sensitivity tests
3 Approaches for Allowing for Trends
- Expectation approach
(expert opinion + subjective judgement) - Extrapolation approach
(based on projected historical trends)
3.Explanatory approach
(Process-based
–> Model trends from bio-medical perspective
e.g. GLM combining external and internal data)
Importance of Investment Return Assumptions
RGRMTM
- significance of Reserves
(contract type + regularity of payments) - extent of investment Guarantees
- importance of Reinvestment guarantees
- intended asset Mix + their returns
(1. context of free assets
2. if market consistent, RFR) - impact of Taxation
- extent of Matching
Considerations for Expense Inflation Assumption
- Current rates of inflation
(mostly earnings since staff-related, but also price) - Expected future rates of inflation
- Differential between rate on govt fixed interest and index-linked securities
(govt. bonds) - Recent experience of life insurance company or industry
- Consistency with future investment income assumption
Factors Affecting Persistency
BEST CP
- Benefits offered
(+changes to benefits and bonuses
+performance of linked funds and charges
+removal of guarantees/options) - Economic and commercial factors
- Surrender benefits
- Target market
- Channel
(who initiates the sale
+ sales information/mis-selling
+ financial sophistication of target market) - regularity of Premium
Factors Affecting Product Riskiness
COMOGH
- Complexity of design
- Overhead costs
- untested Market
- policyholder Options
- high Guarantees
- lack of Historical data
Market Consistent Valuation
Risk-free rate for ALL assets
(term dependent)
Margin included in other parameters (expenses, mortality, persistency) to allow for risk
If deterministic, will just use appropriate term-dependent RFR
If stochastic, will use RFR but additional assumptions will be required for volatility and correlation assumptions (which are dependent on assets)
Morbidity Assumptions
- Claim Incidence
- Duration
- Amount
(indemnity vs fixed)
…may be correlation between incidence and benefit size
**Importance and derivation will depend on product type:
CI, LTCI and IP
Sources of Data
–Tables
–Reinsurers
–Abroad
–Industry
–National statistics
–Existing contract experience
–Regulatory reports and competitor accounts
–Similar contract experience
Factors Affecting Transition Rates
NT PET DG
- nth visit to state
- Type of decrement
- Policyholder profile
(including underwriting controls) - Economic morale
- Tax (on premiums, relief on premium tax, insurer taxes – all will affect marketability + sales)
- Duration in state
- Government provision of welfare
CAPM Formula + Assumptions
Formula:
Ei = r + (Em-r)*Betai
(rewards only for systematic, not specific risk;
proxy used for RF rate;
risk premium/Beta established from past experience)
…Used for determining the RDR
…Alternative to CAPM for RDR is statistical method (risk = statistical Variance)
Assumptions of CAPM:
1. Perfect market (well-diversified portfolio available to diversify risk)
2. Perfect information
3. Investors want RF return + risk premium
Pricing vs Reserving Basis
- Prudent, Prudent
(consistent typical for with-profits) - Best Estimate, Prudent
(not consistent, typical for without profits) - Best Estimate, Best Estimate
(consistent, certain markets)
Mortality Assumption
- Base mortality
(use standard to save resources and protect against errors,
+ adjust for own data) - Mortality Trend
(expected changes in mortality in the future)
Reasons for using base rates
- Saves resources
- Protects against errors
- Sufficient data
(large homogeneous groups) - Getting a sufficient time period of coverage of trends
Types of Assumptions
MM BITE MV
- Mortality
- Morbidity
(incidence, transitions, duration, sum exposure) - Bonus rates
- Investment/interest
- Tax
- Expenses (including inflation)
- Surrenders/lapses/withdrawals (persistency)
- business Mix
- sales Volumes
