Chapter 21 : Setting Assumptions (1)

Question 1

What is the basic methodology for setting assumptions?

Answer 1

1. Historical experience and make best estimate from that experience.
2. Consider experience in future (target market, underwriting process, claims management,policy T&C’s, mortality improvement)
3. Determine BE given future condition
4. Look at credibility on experience data, include judgement etc
5. Margin to adjust for prudence

Question 2

What assumptions are needed when constructing a basis?

Answer 2

M4 PREP IE

Mortality
Morbidity
Market consistent valuation
Margins

Persistency (withdrawals)
Risk discount rate
Expenses and commission
Profit criteria

Investment return
Expense inflation

Question 3

Acted Acronym
What assumptions are required for pricing a product?

Answer 3

RIM PINT CREW

Risk discount rate
Investment return
Mortality rates

Profitability requirements
Inflation (expense and index linked)
New business (Volume & mix)
Tax rates

Commission
Reserving basis
Expenses
Withdrawals

Question 4

Mortality Assumptions setting

Answer 4

1. Sourcing Data

1.1. Own data (same product)
1.1.1.as long as there is enough volume to give relevant, credible and reliable data
1.1.2. Should not introduce heterogeneity due to trends over time

1.2 Should own data not be available
1.21 Similar class of business
1.2.2 Industry data
1.2.3 Reinsurer

2. Grouping data

age, gender, smoker status, benefit amount

3. Setting assumptions
   3.1 Adjustment to standard tables
4. Adjustments
   4.1 Internal changes
   Target marker, dbn channel, underwriting process, policy T&C

4.2 External trends
Mortality improvements, margins to ensure profitability and solvency requirements are met.

Question 5

Expense assumption setting

Answer 5

1. Data/Base
   1.1 Own past experience
   1.2 Similar product
2. Group expenses by function (initial,renewable, terminal)
3. Set the loading assumption (% premium/benefit or per policy)
4. Expense inflation
   4.1 Price and earning inflation
   4.2 Current and future rates of inflation

(gvt fixed - gvt index linked securities as inflation assumption) Consider own experience

Question 6

Commission assumption setting

Answer 6

Based on:

1. Current commission
2. Rates paid by competitors on similar products in the market

Question 7

Risk discount rate assumption

Answer 7

This is the return expected by investors

return = risk-free + risk premium

Question 8

Investment returns assumption

Answer 8

Assumption depends on
1. Significance of reserve on profitability.
2. Investment guarantees.
3. Level of reinvestment risk
4. Current and future returns on the assets in the investment mix

Question 9

What makes contract design more risky?

Answer 9

GOOD HP

1. Lack of historical data
2. High guarantees
3. P/holder options
4. Overhead costs
5. Complexity of design
6. Selling a product in an untested market