Chapter 20: Setting assumptions Flashcards

1
Q

When setting assumptions it is important to consider

A
  • the use to which the assumptions will be put
  • take care over the choice of the assumptions that will have the most financial significance
  • achieve consistency between the various assumptions
  • consider any legislative or regulatory constraints
  • consider the needs of the clients
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2
Q

Demographic assumptions

A
eg mortality rates.
They relate to the size and distribution of the population.
They generally affect the:
- timing
- number
of the cashflows
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3
Q

Economic assumptions

A

eg investment returns
Relate to the level of income or outgo.
They generally affect the LEVEL of the cashflows.

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4
Q

4 Examples of where past data may form a useful starting point

A
  • determining an assumption for future investment returns.
  • past data on salary levels in a particular country/industry/company may be useful when making an assumption about future levels of salary growth.
  • History of an inflation index may be useful in determining an assumption for future benefit growth.
  • Historical data can also be helpful when choosing demographic assumptions
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5
Q

Current data and forecasts

A
  • Current yields may provide some indication of the market’s view of future levels of indices.
  • Policy statements by governments/controlling banks may be useful when making assumptions about economic factors
  • A scheme sponsor may be able to provide info on planned future salary increases
  • Assumptions may be defined in regulations or legislation
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6
Q

With what should the relevance of past data to future projections be balanced against?

A

the need for sufficient data for its analysis to be statistically credible. (There is a conflict between credibility and relevance)

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7
Q

When having past data, the actuary needs to consider how to deal with:

A
  • abnormal fluctuations
  • random fluctuations
  • potential errors in the data
  • changes in the experience with time
  • changes in the way in which the data was recorded
  • changes in the balance of any homogeneous groups underlying the data
  • heterogeneity within the group to whom the assumptions are to relate
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8
Q

4 Sources of historical data to set demographic assumptions

A
  • national statistics, published by government bodies and economists
  • industry data
  • tables compiled by actuaries
  • past information relating to the particular contract being considered
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9
Q

Fluctuations and changes over time

A
  • Changes affecting economic data
  • Price inflation
  • Use of real values
  • Other economic adjustments (taxation)
  • Demographic changes
  • One-off impacts (pandemic)
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10
Q

Changes affecting economic data

A
  • Changes in economic and fiscal policy

- General economic cycle

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11
Q

Price inflation

A
  • A useful indicator of the economic conditions that exist

- Current index values may be a better guide to future levels of inflation

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12
Q

Demographic changes

A
  • Also affected by economic changes
  • Trends are important
  • Mainly affected by medical advances
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13
Q

Data recording

A
  • Changes in statistics recorded (distort the past data and lead to inappropriate assumptions unless these changes are recognised)
  • Errors in data recorded
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14
Q

Heterogeneity

A
  • Changes in the constituents of the population (changes in the balance of homogeneous groups over time)
  • Splitting the population into homogeneous groups (it is important that the past data used is relevant to the group of individuals about whom the assumptions are to be made)
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15
Q

Considerations to be made when using standard tables

A
  • whether the data is relevant to the intended population at which the product is marketed
  • whether adjustments need to be made to the data to reflect continuation of past historical trends
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16
Q

The need for accuracy and prudence

A
  • Purpose of the valuation
  • Accuracy of assumptions (is there a need to make a judgement about each assumption or just the overall value resulting from the combination of assumptions)
  • Significance of error (consideration of the potential financial significance of errors in the assumptions helps to assess the degree of accuracy required)
17
Q

The effect of assumptions on cash transactions

A

Under- or overstatement will give one party a direct financial advantage at the expense of another. Each party have a preference for which side of ‘best estimate’ they would like to see each assumption.

18
Q

Assumptions

A

Estimates of the expected values for the parameters

19
Q

Where a cashflow model is being used to price a product, the risk to the provider from adverse future experience could be allowed for by:

A
  • Adjusting the risk elements of the risk discount rate
  • Using a stochastic discount rate
  • Applying margins to the expected values
20
Q

Profit margins

A

In pricing a product, a profit requirement will need to e incorporated

21
Q

Features that can make a contract design riskier (6)

A
  • lack of historical data
  • high guarantees
  • policyholder options
  • overhead costs
  • complexity of contract design
  • untested market
22
Q

Profit criterion

A

Single figure that summarises the relative efficiency of a contract.
E.g. NPV, IRR, discounted payback period