Chapter 18-19: Models Flashcards
The prime objective of a model:
Enable actuary advising a LI’er to give appropriate advice so that it can be run in a sound way.
Requirements of a model:
• Valid, rigorous for purpose
* Adequately documented
o Rigorous
• Reflects risk profile of the products
• Parameters should allow for signif features of the business modelled
• Input pars should be appropriate to business modelled and take economic and business environments into consideration
• Workings should be easy to interpret and communicate.
* Result displayed clearly.
* Sensible joint behaviour of variables
• Outputs should be capable of independent verification for reasonableness
• Must not be overly complex to avoid interpretability and communicable criteria as well as being expensive to run – unless required.
• Should be capable of development and refinement
• Range of methods of implementation should be available
When creating model points for new business, consider (5)
- Most recent NB production
- Trends
- Intended marketing changes
- Planned new prod launches
- Imminent/pertinent legislative/fiscal changes
Factors affecting sales volumes and persistency of life, health and care prods: (4)
- Economic morale
- Gov provision of welfare
- Tax
- LTCI depends on political commitment
Factors influencing # MPs included: (8)
- Availability of computers
- Variability of contracts
- Complexity of contracts
- Age of company
- Stoch or det model
- Importance of investigation
- Time avail
- Sensitivity of results to more/fewer MPs
4 LI models
- Single policy profit test model
- New business model
- Existing business model
- Full model office
Dynamic model
One in which asset and liabilities are modelled to interact as they do in reality
2 Approaches to setting/calibration of parameters:
- Risk neutral/market consistent calibration
- Real world calibration
Risk discount rate
RDR = risk free rate + risk premium
Allows for:
- return required by the company
- level of statistical risk associated with the CFs
Profit criterion
Single figure that tries to summarise relative efficiency of of contracts with different profit signatures
3 Main profit criteria
- Net present value
- Internal rate of return
- Discounted payback period
Net present value
The PV of future profits discounted at the RDR.
Economic theory: Choose investment with highest NPV. Choice is optimal
Positive sign: Return exceeds RDR
Internal rate of return
The rate of return which makes the PV of CFs = 0
2 Important assumptions for NPV to work
- Assumes free and efficient market
- Assumes each investment discounted at RDR that reflects risk of that investment
3 “Problems” with NPV
- Difficult to interpret on its own (use a ratio_
- Says nothing about competition
- Subject to law of diminishing returns
3 “Problems” with IRR
- May not be unique - If profit signature has more than one sign
- Cannot be related to measures such as commission/premiums
- May not exist - If make profit from the outset
Discounted payback period:
Policy duration at which profits which have emerged so far, have a PV of 0 @ RDR.
Time it takes to recover initial investment with interest.
“Problem” with DPP
Does not account for profits after DPP.
Looking at premiums/charges ito marketability, may lead to reconsideration of: (4)
- Design of prod
- Distribution channel
- Company’s profit criterion
- Whether to proceed marketing the prod
Disadvantages of capital intensive prods: (4)
- Problems with supervisory solvency
- Weakens resilience to falls in assets
- Reduces financial strength (free assets)
- Opportunity costs – could use to write more business
Embedded value:
Value of future profit stream from the company’s EXISTING business together with value of net assets separately attributable to SHs.
2 Bases on which assets and liabilities may be valued
- Supervisory basis
- Economic basis (expected)
Dynamic solvency testing:
Project company’s revenue acc and balance sheet forward for suff period so that full effect of potential risks become apparent.
Life insurers estate
The difference between realistic value of assets less realistic value of liabilities
3 Reasons to hold capital
- Withstand adverse unexpected conditions
- Write more business
- Follow less restrictive investment strategy
- Smooth surplus dists
- Reduce need for reins
- Smooth div payments to SHs
- Allow company to seize opps as they arise
Scenario testing
Sensitivity testing where several pars changed in consistent way.
Main reasons for holding free assets?
REG CUSHION
Regulatory requirement to demonstrate solvency
Enable less reinsurance to be purchased
Guarantees can be offered
Cashflow timing management
Unexpected events cushion - ensure policyholder obligations met even in the event of adverse experience
Smooth profits: Smoothing dividend payments to shareholders and surplus distribution to policyholders
Help demonstrate financial strength and thus provide confidence to policyholders, shareholders and brokers
Investment freedom to mismatch in pursuit of higher returns
Opportunities i.e. mergers and acquisitions
New business strain financing
(See F102 June 2015 Q8 for example)
Models assist the actuary advising a LI company with?
OP PAD
Other work involving financial projections
Product pricing
Projecting the future supervisory solvency position
Assessing:
- return on capital
- profitability of existing business
- capital requirements
Developing an appropriate investment strategy
