Chapter 14,15 Models Flashcards
List the 4 different types of life insurance company models (that differ in the policies that are included in the model).
Briefly descibe what each model does
- Profit testing model
projects expected cash and profit flows on policies from date of issue
key for pricing/product design - New business model
projects all expected cash and profit flows arising from future sales of new business
useful for assessing future capital requirements for new business/overall return on capital achieved from future sales - Existing business model
cash & profit flor projection from all existing business company has in force at particular time point
important for assessing intrinsic value of existing business and testing solvency of company’s existing business - Full model office
sum of new and existing business model
of fundamental importance in assessing impact of future maangement decisions on company’s future financial development
Real vs Notional cashflow
- real cashflows
premiums, investment income, payments to policyholders, commission to agents, expenses, tax - notional cashflows
fund establishment of reserves, by contributing money to reserves from cashflow or initially from company’s free assets
this increase in reserves is negarive from company’s perspective
at maturity/claim, reserves will be released to help pay appropriate benefit => decrease in reserves positive
supervisory solvency capital
this item is the ‘increase in reserves’ and is a negative from the company’s perspective. At maturity or earlier claim the reserves will be released to help pay the appropriate policyholder benefit; this will be a ‘decrease in reserves’ (or ‘release of reserves’) and will be positive.
Stochastic versus deterministic
A stochastic approach may be preferred, because:
we need to value financial guarantees and options
we would wish to see the likely distribution of outcomes, not just a single estimate
the interaction between variables can be explicitly included, enabling the effect of
the interactions to be assessed
we need to estimate a probability.
Deterministic modelling can be used:
with sensitivity testing, in order to get an approximation to a stochastic result
where the result obtained would be very similar to (or, if not, more prudent than) a
stochastically produced result
as a check on a stochastic model.
In order to be able to test the profit to variations in future experience, the model would need to
allow easily for:
changes to any of the assumptions (including supervisory reserving bases) [½]
changes to any of the features of the model policy (eg different ages, policy terms, etc).
[½]
The model will enable the projected supervisory profit to be calculated for each policy year, by
deducting the expected increase in reserves from each year’s cashflow, and adding the interest
earned on the reserves over the year. [1]
“The model will enable the projected supervisory profit to be calculated for each policy year, by
deducting the expected increase in reserves from each year’s cashflow, and adding the interest
earned on the reserves over the year. [1] “
“The reserves would include the solvency capital that the company is required to hold in respect of
this business. [½] “
“The model may need to operate stochastically in order to value any financial options or
guarantees. [½] “
“The model will project the expected cashflows arising in every future policy year, for any specified
model policy. [½] “
“In order that a premium can be obtained, the model should allow the net present value of the
future profits to be calculated, by discounting expected profits at the appropriate risk discount
rate. [½] “
“Other relevant profit measures should also be produced (eg discounted payback period, internal
rate of return). [½] “
The actuary advising a life company will require models to assist with:
product pricing
assessing return on capital
assessing capital requirements
assessing the profitability of existing business (including the present value of future
profits on the existing portfolio)
developing an appropriate investment strategy
projecting the future supervisory solvency position
any other work involving financial projections.
Define the term ‘profit criterion’ and name 3 profit criteria (3)
Single figure that tries to summarise relative effeciency of contracts with different profit signatures
NPV (net present value)
IRR (internal rate of return)
DPP (discounted payback period)
Describe the net present value criterion (2)
List 4 issues regarind the NPV criterion (4)
- NVP of profit signature is calculated by discounting at risk discount rate
- Economic theory implies NPV is best profit criterion to use
List 4 issues with NPV criterion
1. However, it’s dependent on assumptions of
RDR being appropriate for inherent risk
operating in free and effecient capital market
2. Means little by itself (e.g. can double NPV by doubling MPs’ premiums), so NPV normally expressed in relative terms such as
in proportion to initial sales costs
in proportion to total discoutned premium incomes
3. Subject to law of diminishing returns, else company could sell unlimited same policy with positive NPVs to increase profits
4. Says nothing about competitiveness: high NPV bad if can’t sell
How do we go about asessing ROC (return on capital) during a pricing exercise? (6)
- Group up net cashflows for existing/new bus, and use to assess amount of capital required to write product
regulatory basis
economic basis - Add one off development costs: to the extent that they have not already been amortised/included in expense CFs used
- Total capital requirement: given by above
can be compared with profits expected to emerge from product so as to determine epxected return on capital
What is ‘solvency’? (3)
Solvency relates to insurer’s ability to meet future outgo, both from existing bus and from future new bus may sell
Outline how an insurer should assess its capital requirements (4)
- Insurer should assess amounts and types of capital needed given
amount of liabilities
types of risks inherent in those liabilities - 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
Give 2 main bases on which the values of assets and liabilities can be determined, for the purposes of assessing solvency
Company needs to compare assets and liabilities at point in time to assess solvency, can use following bases
Supervisory values
as determined for supervisory reporting
Economic values
based on expected future experience or using a market-consistent basis
Internal rate of return
This is defined as the rate of return at which the discounted value of the cashflow is zero. It
suffers from some disadvantages in comparison with the net present value as a profitability
criterion:
it might not exist
it might not be unique
it cannot be related to other indicators such as sales cost or premium income.
Discounted payback period
This is defined as the policy duration at which the profits that have emerged so far have a
present value of zero.
It is a useful reference for companies eager to recoup their initial capital investment in as
short a time as possible. A company with limited capital might prefer to sell contracts with as short payback periods
as possible.
The need for capital
A life company needs capital:
to withstand adverse, often unexpected, conditions
to write new business, including meeting product development costs and financing
new business strain
to allow a riskier investment strategy than strict matching would dictate.
smooth surplus distributions – if the bonus declaration method allows any degree of
subjective decision by the actuary, then we might want to smooth bonuses by paying out
more than asset share when returns have fallen, and less than asset share when returns
have risen; to do this will require some capital
reduce the need for reinsurance
smooth dividend payments to shareholders
allow the company to seize any profitable business opportunities as they present
themselves (eg buying some other company).
Product redesign
Existing products need to be redesigned and repriced to be more profitable and less capital intensive. [1]
Use the model to identify the most unprofitable and the most capital intensive products.
repricing / competitiveness/ product structure/ change of distribution manage expense/comission structure
