Chapter 12 - Modelling Flashcards
What are the 4 main types of models defined by the business they are modelling
- Single policy profit test model - Projects the expected cash and profit flows from a single policy from the date of issue
- New business model - This projects all the expected cash and profit flows arising from future sales of new business
- Existing business model - Projects all expected cash and profit flows arising from existing business at a particular time
- Full model office - The sum of new business model and the existing business model
What are the main uses of models
- Costing and reserving options
- Model office - new business projections, embedded values, solvency, takeovers
- Reserves - statutory and management accounting
- Pricing - Profit, premium rates
What is the prime objective of building a model
It is to enable the actuary to give a company appropriate advise so that it can be run in a sound financial way.
It will therefore be used to assist in the day-to-day work of the company and to provide checks and controls on its business
What are the basic features required specifically of a health insurance model
SCAPI
- Needs to allow for the cashflow arising from any SUPERVISORY requirements to hold reserves and to maintain an adequate margin of solvency
- Needs to allow for all the CASHFLOWS that may arise, which will depend on the nature of the contract(s), terms of premium and benefits structure, and any discretionary benefits such as options to convert, extend or increase cover without evidence
- Need to allow for the ABILITY to use stochastic models and simulation where appropriate. Eg to simulate the possible distribution of claims outgo
- Need to PROJECT separately the cashflows arising from different states and reflect the transitions between these states. Eg. those paying a LTCI premium and those receiving benefits
- Need to allow for INTERACTIONS, especially where the assets and liabilities are modelled together
Key features of the deterministic modelling process
- Each of the parameters in a deterministic model has a fixed value
- The model produces results in the form of a point estimate
- It is possible to sensitivity test the results of a deterministic model by running the model with different parameter values
Key features of a stochastic model
- Some of the parameters are allowed to vary and have their own distribution functions
- A stochastic model must be run many times using random samples from the distribution functions
- The model produces the results in the form of a probability distribution
When would you choose a stochastic model over a deterministic one
- When you want to assess the impact of guarantees
- When the variable of interest does have a reasonably stable and predictable probability distribution
- For indicating the effect of year-on-year volatility risk
- For identifying potentially high-risk future scenarios. Eg by tracing the sequence of events that have led to tour worst simulated outcomes
Disadvantages of a stochastic model
- Time and computing constraints
- The sensitivity of the results to the assumed values (deterministically chosen) of the parameters involved
What are the 2 types of calibration of stochastic models
- Risk-neutral ( market-consistent) calibration - Used for valuation purposes, particularly when there are options and guarantees. The focus of these calibrations is to replicate the market prices of actual financial instruments as closely as possible, using an adjusted (risk-neutral) probability measure.
- Real world calibration - used for projecting into the future. The focus of these calibrations is to use assumptions that reflect realistic “long-term” expectations and that consequently also reflect observable “real-world” probabilities and outcomes
How can the mis-estimation of parameter values be investigated
By carrying out a sensitivity analysis - Which involves assessing the effect on the output of the model of varying each of the parameter values.
Any correlation between different parameter values should be allowed for when doing this
How can sensitivity testing be used when reserving
- It can be used to assess the need for any additional risk margins, global reserves or capital requirements that may need to be set up to cover potential future adverse experience
What are the drawback of using the formula approach to pricing
Does not allow for
PAISA CVC
- PROPER timing of events
- for the ACCUMULATION of reserves
- for the IMPACT of net negative cashflows in any period
- SEPARATE inspection of premium-related cashflows or claim-related cashflows
- changes in the ASSUMED future experience and cannot measure the sensitivity of profit to such variations
- CAPITAL needs
- VARIATION of assumptions over time
- COMPLICATED product structures. Eg unit-linked
What are the typical elements of cashflow for conventional with-out profit business
- Premiums
- Expenses
- Commission
- Claims
- Contribution to reserves
- Contribution to capital requirements
- Interest on cashflows and reserves
- tax
What is embedded value
The value of the future profit stream from the company’s existing business together with the value of any net assets separately attributable to shareholders
What is multi-state modelling
This is where the policyholder can exist in different states, each state being associated with a different set of cashflows.
In Health and care insurance, this applies to LTCI, where a claim does not terminate a policy. ( so there are at least 2 states: claiming and non-claiming)
