Ch 21: Setting assumptions (1) Flashcards
1
Q
Basic methodology for setting assumptions
A
- Investigate historical experience and make the best estimates of the parameters from that experience. (These estimates will be appropriate in the context of the historical conditions and circumstances that applied at the time of that experience)
- Consider what the conditions (including commercial and economic environment) will be like in the future period for which assumptions will be made.
- Determine what the best estimates of assumptions will be given the expected future conditions. (Historical parameters used as a starting point, but adjusted for change in circumstances)
- Extent on which the experience data is relied upon and the extent to which other factors (such as judgement) is allowed for depends on the credibility and relevance of the data and how predictable the parameter is.
- The best estimates may need to be adjusted to include a margin for prudence. (Size of the margin depends on the purpose for which the model is required and the degree of risk (uncertainty) attached to the parameter.
2
Q
Pricing contracts would need assumptions on:
A
- Mortality and morbidity
- Investment return
- Expenses and commission
- Expense inflation
- Persistency
- Margins
- Risk discount rate
- Profit criteria
3
Q
Mortality assumption has two parts:
A
- Base mortality (initial rate of mortality)
- Mortality trend (how the rate of mortality chages over time)
4
Q
Expected future experience on demographic assumptions such as mortality will depend on three things:
A
- Target market for the contract (dependent on the distribution channel involved)
- Underwriting controls
- Expected change in experience since time of the last historical investigation to the point in time at which the assumption will on average apply.
5
Q
Deriving mortality rate assumptions:
A
- Values would likely be based on an adjustment to rates from a standard mortality table.
- Rather use own experience to adjust table than create own table since resources will be saved and less risk of errors arising from model/parameter risks.
- If company has adequate data adjustment would be derived by analysing company’s own experience for the type of contract involved alternatively experience of similar class of business could be used as substitute
- Data used would relate to an appropriate period of years such that volume is adequate but ensure that excessive heterogeneity due to trends over time is not introduced
- Analysis would divide the data into homogenous groups, subject to adequate levels of data being retained witin each cell.
- If the company has insufficient data to produce reliable results, industry sources such as reinsurance companies or industry-wide data schemes may be used instead.
- The adjusted rates may need further adjustments if the assumptions apply to a class of lives who is expected to have different experience from that to which the analysed data relate. (change in underwiting procedures, target market, diistribution channel ect.)
- Considerations to expected changes in rates over time
6
Q
Approaches to determining future rate of mortality improvement
A
- Expectation approaches (involve expert opinion and subjective judgement to specify a range of future scenarios)
- Extrapolation approaches (projecting historical trends in mortality into the future, some subjective judgement in model used and choice of period over which such trends are determined)
- Explanatory approaches (attempt to model trends in mortality from a bio-medical perspective, models underlying causes of death)
7
Q
Estimating transition intensities
A
- Includes claim inception, recoveries and death
- Needs to be calculated for homogenous groups, by duration of claim or type of disability
- Second and subsequent incidences may need to be seperated out too.
8
Q
Factors that would influence transition intensities:
A
- Policyholder characteristics identified in underwriting stage
- Product design features (replacement ratio and rehabilitation benefits)
- Economic morale
- Government provision of welfare
- Tax (tax could influence benefits and premiums)
9
Q
Examples of heterogeneity in IP pooled data which would result in differing claims experience: (3)
A
- Different target markets and sales distribution channels
- Different underwriting startegies including at initial and claims stage
- Different policy wordings and conditions (deffered periods, definitions of disability)
10
Q
Factors that will affect the investment return assumption (6)
A
- Significance of the assumption for the profitablity of the contract (which will depend on the level of reserves built up and the investment guarantees given) - this will also affect the size of the margins required
- Extent of the investment guarantee given - will affect the types of assets in which the premiums will be invested
- Extent of any reinvestment risk and the extent to which this may be reduced by a suitable choice in assets i.e. matching (the less important the reinvestment risk the less account needs to be taken of future reinvestment yields)
- Expected time between changes to the company’s pricing basis.
- The current and expected future return of the intended asset mix.
- Amount of free assets
11
Q
Sensitivity of investment assumption relate to two things:
A
- Size of the reserves built up - larger the reserves, the greater the proportion of total cashflow arises from investment income, hence the greater the sensitivity to investment return.
- Invsetment guarantees given - Higher the guarantee the greater care is needed over setting the level of assumptions
12
Q
Reinvestment risk and its effect on investment rate assumption
A
- Refers to the uncertainty of return which can be obtained from investment in the future
- Best estimate of return available from future investment will differ from the best estimate of the return available from investment now. - may also differ according to how far into the future the investment is made
- Overall best estimate assumption will reflect the expected balance between expected future and current investment yields.
13
Q
Market-consistent approach to setting the investment return assumption (deterministic and stochastic)
A
- Expected investment return is set at the risk-free rate of return, irrespective of the actual underlying assets held for both the deterministic and stochastic approaches.
- Stochastic approach requires additional assumptions for the investment return volatility and correlation assumptions which are dependent on the actual underlying asset types.
14
Q
Determining expense assumptions
A
- Values determined after analysing the company’s recent experience for the types of business concerned.
- Result of the analysis will be a division of the expenses by function and whether the expense is proportonal to the level of premium or benefit, or can be expressed as a fixed amount per contract
- If insufficient data is available:
* Base parameters on similar type of business
* Industry data or data from reinsurer - Expense model would be a projection of the staff structure, suitable overheads, output would be taken in conjunction with expected new business volumes and perhaps the model office output to give expected in-force volumes and assets under management.
15
Q
Two aspects of expense inflation to consider:
A
- Inflation of expenses during the term of the policy from issue to termination
- Inflation of all expenses from the date the assumptions are set and premiums calculated to the dates at which future policies are sold.
