Chapter 20 - Setting assumptions

Question 1

What are the most important things to consider when setting assumptions?

Answer 1

LUNCH

Legislative or regulatory constraints
Use (i.e. purpose) to which the assumptions will be put
Needs of the client
Consistency between the various assumptions
How financially significant the assumptions are

Credibility of results and hence the need for margins

Question 2

Why may past data not be relevant for the future?

Answer 2

BEST ARCHER

Balance of homogenous groups underlying the data may have changed

Economic situation may have changed
Social conditions may have changed
Trends over time, eg medical, demographic

Abnormal fluctuations
Random fluctuations
Changes in regulation
Heterogeneity within the group to which the assumptions will apply
Errors in data
Recording differences (e.g. in categorization of smoker)

Question 3

Assumptions affected by changes in social, economic, and fiscal conditions

Answer 3

1. Social trends, such as medical advances, affect mortality data
2. Economic conditions affect financial assumptions such as dividend yields, salary growth, inflation rates, and investment returns
3. Economic conditions, such as a recession, also affect demographic assumptions such as withdrawal rates, take up rates and claim rates
4. Fiscal changes affect dividend yields, salary growth and investment returns

Question 4

What are the main considerations when using data from standard mortality tables to set assumptions?

Answer 4

1. The data may not be relevant to the intended population
2. The data may be out of date and need adjusting for trends in mortality between the date to which the data relates and the date to which it is expected to apply

Question 5

What factors affect the need for accuracy and prudence when setting assumptions?

Answer 5

PSI FV

1. The PURPOSE of the valuation
2. The SIGNIFICANCE of each assumption to the overall result
3. Whether the INDIVIDUAL cashflows are important or whether the overall value resulting from a combination of cashflows is important
4. The FINANCIAL significance of any errors
5. Whether the VALUATION is for cash transactions (which cannot be corrected at a later date)

Question 6

List 3 ways in which margins for risk can be built into assumptions when pricing

Answer 6

1. Margin in the risk discount rate
2. Use a stochastic discount rate
3. Applying margins to the expected values

Question 7

Give 4 examples of profit criteria that could be used when pricing an insurance contract

Answer 7

1. NPV of profits
2. IRR
3. Discounted payback period
4. A ratio involving the NPV of profits such as the NPV of profits divided by distribution costs

Question 8

List features that will make an insurance contract design riskier

Answer 8

POUCH L

• Policyholder options
• Overhead costs
• Untested market
• Complex design
• High guarantees
• Lack of historical data

Question 9

conditions that could have changed that will lead to an insurance company’s past term assurance data not reflecting its likely future experience

Answer 9

DUMP T

• DISTRIBUTION channels
• UNDERWRITING practices
• MORTALITY rate changes
• PRODUCT design features
• TARGET market