Chapter 21 Assumptions (4) Different purposes for setting assumptions, and complexities which arise Flashcards
Valuing liabilities: overview, calculation of liabilities
Broadly speaking, how do we value the liabilities of a health insurer? (4)
- Broadly speaking, determined as PV of
- Future benefit outgo
- plus claims expenses (including commission)
- plus taxes (if appropriate)
- less premums
Purposes for different assumption/basis
In the first chapter on setting assumptions, we considered setting assumptions for pricing.
What other exercises may we construct basis for? (4)
- Published results
- Supervisory reserves
- Internal management accounts
- Embedded values
Pricing assumptions: overview
Briefly describe the general process for setting assumptions in terms of
the starting point (2)
how we might allow for risk from advers future experience (3)
what might influence the level of margins used (6)
- 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 and the final price charged might depend on
- company’s nature of market
- company’s USP (unique selling proposition)
- company’s attitude to risk
- credibility, accuracy, relevance of data used
- size of company’s free assets
- presence of parental guarantees
Reserving assumptions: margins, impact
What impact do margins have on prudence on the calculation of liabilities? (1)
- Greater the margins assumed => more prudent the calculation of liabiltiies
Valuing liabilities: RDR, impact
What implication does increasing/decreasing the RDR have on calculation of liabilities? (3)
- Impact of changes in the RDR
- all things being equal,
- decreasng (increasing) the RDR, will increase (decrease) degree of prudence for a positive reserve
- decreasng (increasing) the RDR, will decrease (increase) degree of prudence for a negative reserve, where this is permitted
Reserving assumptions: overview, process
What is the first thing to consider when deriving a set of assumptions/basis to use for reserving/valuations? (3)
What would be the starting point when setting assumptions for reserving/valuation of health insurance contracts? (6)
First consider purpose for which reserving basis is needed eg
- publication purpose:
- supervisory reporting to demonstrate solvency or otherwise
- usually regulatory contraints on assumptions which can be used
- internal management use: likely need more realistic position
Starting point for assumptions is best estimate basis expected for future experience of lives being insured
- principles for basis will be similar to those used in pricing with a best estimate basis
-
then necessary to add margins
- => more prudent than pricing basis
- to reduce chances of reserves being insufficient
- lead to acceptably low probability of default
Reserving assumptions: important considerations
What important considerations need to be made when setting assumptions/basis for reserving/carrying out valuations (7)
Consideration needs to be given to
- whether to prepare reserves on a going-concern basis or break-up basis is used for accounts
- whether true and fair view is required
- any legislation/guidance on the basis or assumptions to use
- purpose to which reserves will be put
- eg whether reserves are for internal management purposes (in which case margins may not be needed)
- consistency of assumptions/basis, eg
- between assumptions
- from one basis to another
- betweeb assumptions used in pricing and statutory reporting
- etc…
Reserving assumptions: going-concern vs break up basis
- going concern
- assume insurer continues issuing new bussiness into future
- break-up
- assume new business cease immediately, or at some point in future e.g
- …closed fund by company, or..
- …transfer liabilities to another insurer, who will administer/procress claims until book runs down
Reserving assumptions: setting margins appropriately
Describe the various methods to assess the approapriate level of margins to include in reserving assumptions (8)
- Analytically:
- if have a good idea of probability distribution of assumptions.
- can set assumptions by reference to mean and variance.
- may have higher variance than pricing due to prudence, can take a lower percentile of distribution
- Stochastically via simulations
- Through sensitivity testing analysis
- Margins may be laid down in legislation
- As always, important to consider purpose of the exercise to which the assumptions/basis will be put
Reserving assumptions: profitability of existing business
What is the approach to be taken when setting assumptions/reserving basis to assess profitability of existing business? (3)
When setting assumptions/basis to determine profitability of existing business
- Aim for best estimate of all assumptions (similarly to pricing)
- Similar model approach as pricing as well (ie cashflow model)
- Bases will likely differ due to different allowances for different risks =>
- typically lower RDR than in pricing, because of reduced risks
Reserving assumptions: profitability of existing business, pricing vs reserving
What additional information can be considered when setting reserving assumptions/basis when assessing profitability of existing business ie when we are pricing vs reserving for inforce business? (4)
Additional information
- For existing policies, we have more demographic information so less uncertainty than in pricing
- Yields on existing assets relevant where no future investment is required
- Expense assumptions should not include initial expenses as these have been incurred already.
- Less uncertainty over volume and mix, as we have an actual snapshot of this as at the valuation date (as opposed to having to estimate the volume/mix)
Reserving assumptions: published valuations
State the factors to consider when deciding assumptions for determining the value of liabilities to show in an insurance company’s published accounts (6)
Here we speak of reporting/publishing of company results (to directors, for example)
- For country concerned, consider
- legislation
- accounting principles
- Matters to consider
- going concern or break-up basis
- required to show a true and fair value?
- best estimate basis or some other basis?
- precisely how terms used are to be interpreted
Reserving assumptions: internal management accounts
State key driver that should determine the pricniples to be followed for determining the value of liabilities for internal management accounts (1)
State the most likely aim of such a valuation. (1)
- Key driver should be discussion with insurance company about the principles to follow, based on the purpose for which the internal accounts are required
- Most likely aim is to have best estimates of the company’s financial performance, based on realistic assumptions.
Valuing liabilities: Supervisory reserves, key considerations
How might rules governing the solvency supervision process relate to rules for published accounts? (1)
Key considerations for supervisory reserves (4)
- If separate accounts required during process solvency supervision process , rules for preparation of separate accounts may/may not be same as rules for published accounts…
- Key considerations
- for example may be required to use different basis (going-concern/break-up basis)
- Should reference rules & guidance which was issued needing interpretation
- will most likely be certain assumption restrictions which are either
- specific (valuation interest rates must equal premium basis rate)
- general (do valuation as wish, subject to not lower than X basis)
- usually require prudent basis, some jurisdictions moved to market consistent approach
Consistency: valuation basis, intro
When setting a valuation basis, list different aspects of the basis where consistency would be important (4)
- Consistency with previous basis
- Assets vs liabilities
- Consistency with pricing basis
- Supervisory basis vs internal valuation/internal reporting basis