Chapter 14 - Assumptions (1) - General considerations

Question 1

When setting assumptions it is important to

Answer 1

UFC LNPD B

• consider the USE to which the assumptions will be put
• take care of the assumptions that will have the most FINANCIAL significance
• achieve CONSISTENCY between various assumptions
• consider any LEGISLATIVE or regulatory requirements
• consider the NEEDS of the client
• ensure that the PARAMETERS derived from data are produced as the body of data will permit
• ensure that the DATA used to derive these assumptions are relevant to the risks (lives insured) that the policies encompass
• ensure that BASES used for periodic valuations and reserves are flexible to reflect changing risk circumstances

Question 2

General process for setting assumptions

Answer 2

• Use historical experience to estimate parameters
• Consider future conditions when making assumptions
• Determine best estimates given expected future conditions
• Adjust estimates for prudence margin based on model purpose and degree of risk associated with parameter

Question 3

What does achieving consistency mean in terms of setting assumptions

Answer 3

Consistency means that we make realistic allowance for how variables behave together, where correlations exist between them.

The bases should generally be consistent between related products

Question 4

What must the size of the margins depend on when pricing

Answer 4

• The degree of risk associated with each parameter used
• The financial significance of the risk from each parameter

Question 5

How may risk from adverse future experience be allowed for when pricing using a cashflow model?

Answer 5

• Through assessing what margins to apply to the expected values
• Through using a stochastic approach
• Through the risk element of the risk discount rate

Question 6

Where can margins be applied to to deal with risk

Answer 6

• The expected values
• Using a stochastic approach
• Assuming a higher discount rate

Question 7

What factors does the price ultimately charged, and the margins incorporated, depend on?

Answer 7

PRAMS

• PARENTAL guarantee ie. free assets
• RELEVANCE and credibility of the data
• ATTITUDE to risk
• MARKET influences ie. competition
• SELLING point of the company

Question 8

What should be considered when setting the assumptions used to determine the liabilities shown in a company’s published accounts

Answer 8

• Whether the accounts are prepared on a going concern basis or a break-up basis
• Whether the accounts are required to show a true and fair view
• Whether reserves are required to be assessed as best estimates or on another basis,

Question 9

How is profitability of a business usually measured

Answer 9

It is measured by the embedded value

Question 10

What is appraisal value

Answer 10

It is the value of the business as a whole, both existing business and future business

Question 11

What is embedded value

Answer 11

It is the PV of future shareholder profits in respect of the existing business of a company, including the release of shareholder-owned net assets

Question 12

How is embedded value calculated

Answer 12

-It is the sum of
– The shareholder-owned share of net assets, where net assets are the excess of assets held over those required to meet liabilities
–The PV of future shareholder profits arising in existing business

• Need to include a risk margin to allow for the unpredictability of profit emergence for health and care insurance business

Question 13

Examples of situations in which an EV is calculated

Answer 13

• To establish a value of the business, possibly for internal management accounts or information
• To include in published financial statements
• To assess the major part of an appraisal value for sale or purchase
• To analyse the value of future surpluses for reinsurance EV financing
• To assess growth in EV for the payment of bonuses to staff or salespeople

Question 14

What are the demographic assumptions a health and care insurer has to set

Answer 14

• PMI claim incidence rates
• CI claim incidence rates
• LTCI claim inception rates and any further transition probabilities
• Mortality rates
• Lapse rates

Question 15

What are the financial assumptions that a health and care insurer has to set
and other assumptions

Answer 15

BITE C

• Benefit amount and benefit inflation
• Investment return
• Tax
• Expenses and expense inflation
• Commission and clawback
• New business volume and mix
• Reserving and capital requirements
• Risk discount rate
• Profit criteria

Question 16

What happens if the company does not use consistent basis between related products

Answer 16

The company will end up selling similar products, at the same time, with which one must be more expensive than the other

Question 17

What is experience rating
and
In what type of business’s is experience rating most likely to be used?

Answer 17

It is when the premiums depend wholly or partially on the past experience of the insured

• It is most likely to be used in group business. Since the past experience of the group will help determine the premium going forward.
• For individual business, NCD may be used for PMI

Question 18

What is book rated business

Answer 18

It is when past experience of the insured is not taken into account

Question 19

Why is internal management accounts produced

Answer 19

To get a view of

CRIMPERS

• Claims and exposure
• Reinsurance performance
• Investment performance
• Movement analyses ( new policies, lapses)
• Profitability
• Expenses
• Reinsurance performance
• Solvency

Question 20

What are the two parts of embedded value

Answer 20

• The PV of future shareholder profits
• Shareholders share of net assets

Question 21

What is embedded value financing

Answer 21

It is when the reinsurer makes a loan to the insurer which is repaid by the release of future profits.

If the future profits do not emerge as expected, then the reinsurer will not be repaid