Chapter 14 Assumptions General considerations Flashcards
General considerations when setting assumptions
- When setting assumptions it is important to:
- consider the use to which the assumption will be put
- achieve consistency between the assumptions
- consider any legislative or regulatory constraints
- consider needs of clients
- ensure that the parameters are produced accurately from the data
- ensure data that the data used to derive assumptions are relevant to insured lives
- ensure that bases used are flexible to reflect changing risk circumstances
Deriving assumptions for pricing purposes
-The starting point is a best estimate bases for assumptions, however, margins will be necessary to guard against adverse future experience.
- Where a cashflow model is used, risk from adverse future experience may be allowed for:
- through assessing what margins to apply
- through using a stochastic approach
- through the risk element of the risk discount rate
- The margins incorporated & the price charged depend on
- company’s nature of market
- company’s USP (unique selling proposition)
- company’s attitude to risk
- credibility, accuracy, relevance of data
- size of company’s free assets or parental guarantee
Deriving assumptions for reserving purposes
- The starting point is a best estimate basis for the assumptions.
- principles involved in deriving these assumptions will be equivalent to those used in pricing.
- basis derived here will be similar to the pricing basis.
- it is necessary include margins to reduce chances of reserves being insufficient.
- For some purposes include statutory & published accounts margins may be incorporated.
- Consideration whether accounts are on going-concern basis or break-up basis
- Whether true and fair-view
- where there is any legislation or guidance on the basis or assumptions to use.
- for internal management purposes - margins may not be needed.
Deriving assumptions for determining profitability
- the basis is likely to be fairly realistic, although it will depend on the specific purpose.
- principles are same as those of cashflow model.
- however allowances for risk may be different.
- Embedded value is the present value of shareholder profits in respect of existing business of a company, including the release of shareholder-owned net asses.
- Appraisal value is the sum of of embedded value and goodwill and is often used when valuing a long-term insurance company for merger or acquisition.
Example of situations embedded value is calculated
- to establish a value of the business, for internal purposes
- to include in financial statements
- to assess the major part of an appraisal value for sale or purchase
- to analyse future surpluses for RI embedded value financing
- to assess growth in EV for the payment of bonuses to staff or salespeople
Calculation of embedded value
- Can be calculated as the sum of :
1. The shareholder-owned share of net assets
2. The PV of future shareholder profits arising on existing business. - The calculation may differ by types of business:
- Conventional without profits: PV of future premiums + investment income - claims - expenses + release of supervisory reserves.
- Unit-linked business: PV of future charges - expenses - benefits in excess of unit fund + investment income earned on and the release of any non-unit reserves.
Calculation of Appraisal value
-The starting point to value a company for M&A is the embedded value calc.
-Important element is goodwill
Assumptions
-If an appraisal is being prepared as a sale value it is likely to be based on realistic assumptions without margins.
-The determination of bonuses for staff requires a realistic basis.
-EV calcs need to include appropriate allowance for risk margins to allow for unpredictability of profit emergence for health & care insurance business.
-Discount rate used reflects the risk inherent in these cashflows.
-a stochastic or market-consistent approach may be adopted.
