Chapter 19 - Models Flashcards
Outline what process is followed when using models for product pricing (4)
- Choose model points, considering:
+existing business: profile of similar business, with advice from marketing dependent
+new business: profile of existing business, adjusting for expected future changes - For each model point, project cashflows, allowing for reserving + solvency capital requirements, on basis of set of assumptions
- Discount cashflows at risk discount rate RDR that allows for:
+return required by company
+level of statistical risk attaching to cashflows (so in theory, separate RDR for each component of cashflows) - Premium/charges for model point set to produce profit required by company
Define the term ‘profit criterion’ and name 3 profit criteria (3)
Single figure that tries to summarise relative efficiency of contracts with different profit signatures
- NPV (net present value)
- IRR (internal rate of return)
- DPP (discounted payback period)
List 4 issues regarding the NPV criterion (4)
- it’s dependent on assumptions of
+RDR being appropriate for inherent risk
+operating in free and efficient capital market - 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 (initial commission)
+in proportion to total discounted premium incomes (market share) - Subject to law of diminishing returns, else company could sell unlimited same policy with positive NPVs to increase profits
- Says nothing about competitiveness: high NPV bad if can’t sell
State 3 reasons why the NPV may be more reliable than the IRR (3)
- If more than one change of sign in stream of cashflows, IRR wil not usually be unique
- NPV can be related to useful indicators of policy’s worth to company, IRR can’t
- NPV always exists. IRR may not exist (e.. if policy makes profits from outset)
List 5 possible responses to premiums/charges being unmarketable.
(After premiums/charges that meet profit criterion have been determined, and marketability needs to be considered.)
- Reconsider product design e.g.
+remove risky features
+add product differentiating features - Consider distribution channel change if would cause/permit
+assumption change in model
+higher premium/charges without loss of marketability - Reduce company’s profit requirement’
- Decide not to market the product
- Re-examine assumed expenses
List the components that make up the present value of future shareholder profits from existing contracts for the following types of business:
* Conventional without profit
- Unit-linked
- With-profits
- Conventional without profits: the future premiums plus investment income less claims and expenses plus the release of reserves and required solvency capital
- Unit-linked business: the present value of future charges less expenses and guaranteed benefits in excess of the unit fund plus release of supervisory non-unit reserves and required solvency capital
- With-profit business the present value of shareholder transfers
How do we go about assessing ROC (return on capital) during a pricing exercise? (3)
- Group up net cashflows for existing/new business, 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 expected return on capital
Outline how an insurer should assess its capital requirements (2)
- 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
- Supervisory values
as determined for supervisory reporting - Economic values
based on expected future experience or using a market-consistent basis
What is static solvency testing? (2)
List 3 disadvantages of static solvency testing (3)
Determination of solvency to be made at a particular point in time, instead of solvency projected as part of regular supervisory submission
3 disadvantages of static solvency testing
- considers only existing portfolio, no new business
- assumes experience for remaining duration
- guarantees are hard to cost
Describe the process of dynamic solvency testing
- Involves testing solvency over future time periods
- Project revenue account/balance sheet far enough ahead to identify full effect of any potential risks
e.g. current solvency assess shows A>L, but projecting surplus might show it runs out in few years - Requires full model office, with realistic representation of liability portfolio by model points
- Projections bases either:
+deterministic, using expected assumptions, combined with assumptions with margins to test effect of adverse future experience
+stochastic (simulations), to assess probability of adverse circumstances concurring, taking into account existing business only, or also include expected future new business
List 5 key uses of dynamic solvency testing
- Managing solvency (on both supervisory and realistic bases), by assessing ability of company to withstand changes in environment
- Setting new business plans
- Setting investment strategy
- Setting bonus strategy
- Setting reinsurance strategy
What sensitivities exist for models
- Sensitivity to choice of model point - if a large number of model points are used, it can reduce model point error
- Sensitivity to parameters - mis-estimation of parameter values ie, actual future experience being different from the parameter assumptions
- Sensitivity testing when pricing - results from sensitivity analysis will help, in the case of a model used for pricing, to assess what margins need to be incorporated into the parameter values
- Sensitivity testing for business in force - results from sensitivity analysis will enable the actuary to quantify the effect of departures from chosen parameter when presenting the results of the model to the company
