Chapter 12: Modelling

Question 1

What is amodel point?

Answer 1

representative single policy
represents a relatively homogenous group of policies, where each policy is expected to produce similar results when the model is run

Question 2

List6drawbacksof theequation of value/ formula approach (for pricing)

Answer 2

does not allow for:

theproper timing of events - consider if it influences the amount of claim outgo

theaccumulation of reserves - consider size of reserves, time to build up reserves

rate of return required by shareholders on their capital - important when there are significant capital requirements

theimpact of net negative cashflows in any period

theseparate inspection of premium-related cashflows or claim-related cashflows - important when they can vary

variation of assumptions over time - consider term of contract

note:
equation of value/ formula approach mainly used for short-term contracts

Question 3

Discuss thecashflow approach (for pricing)

Answer 3

model can be used to determine premiums/ charges for a new/ existing product that will meet required profit criteria

suitable model points will be chosen to represent new and/ or existing business

assumptions may be needed for mortality/ morbidity, expenses, persistency, investment returns, tax

for each model point, cashflows will be projected allowing for reserving and solvency capital requirements

cashflows include future premiums, claims, expenses, investment income and release of supervisory reserves

important to consider the impact of net negative cashflows

net projected cashflows will then be discounted (if UL case, then net projected cashflows will be for non-unit fund) using appropriate risk discount rate

premiums/ charges will then be set to meet required profit criteria

desired level of profitability can be reached in aggregate with results for each model point may be scaled up to reflect business volumes, without requiring every single model point to be profitable in its own right (business mix risk…)

premiums will then be considered for marketability (might lead to reconsideration of product design, distribution channel, profit requirement)

Question 4

Outline modelling profitability of existing business

Answer 4

modelling may be done on a policy by policy basis

alternatively, model points can be chosen to represent existing business (use previous model points used adjusted for new business taken on and business going off, or start from scratch)

suitability of model points should be checked - use model points to determine supervisory reserves and then compare to the published value of supervisory reserves

future cashflows include future premiums, claims, expenses, investment income and release of supervisory reserves

future cashflows are projected for each policy/ model point using appropriate basis

allowance should also be made for solvency capital requirements and tax

assumptions should be consistent with relationships in reality (high inflation rates with low interest rates)

profit signature discounted using an appropriate risk discount rate (less uncertainty relating to existing business)

Totalling across all policies or scaling up the results of each model point and totalling these

sensitivity testing