Chapter 21 - Setting assumptions (1) Flashcards

1
Q

Which risks can be reduced by appropriate investment matching

A
  • Investment risk
  • Inflation risk
  • Marketing risk
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2
Q

What is the common framework used to derive assumptions

A
  • Investigate the historical experience and make the best estimates of the parameters from that experience
  • Consider what the conditions (including the commercial and economic environment) will be like in the future period for which you are making your assumptions
  • Determine what the best estimates of your assumptions will be, given the expected future conditions
  • The extent to which you would rely on the experience data, and the extent to which you would allow for other factors, including judgement, depends on the credibility and relevance of the data, and how predictable the parameter is
  • The best estimate may need to be adjusted in order to include a margin for prudence
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3
Q

What is the main demographic assumption that is used to price a life insurance contract

A

Mortality rates

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4
Q

The expected future experience of the policyholders will depend crucially on what

A
  • The target market for the contract
  • The underwriting controls applied
  • The expected change in experience in the experience since the time of the last historical investigation to the point in time at which the assumptions will on average apply
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5
Q

What are the advantages and disadvantages of using reinsurers’ statistics

A

Advantages:
- They have access to the mortality experience of many direct writers. Sometimes theirs may be the most relevant available.

Disadvantage:
- The data relates to a large number of companies. Each of these companies have their own target market and underwriting procedures

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6
Q

What might cause the mortality experience of new policyholders to be different from that of the population analysed

A

DUST M

A change in

  • Distribution channel
  • Underwriting practice
  • Selective withdrawals
  • Target market
  • Mortality over time
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7
Q

What are the different approaches to determining future rates of mortality improvement

A

Expectation approaches - involve expert opinion and subjective judgment to specific a range of future scenarios

Extrapolation approaches - are based on projecting historical trends in mortality into the future

Explanatory approaches - attempts to model trends in mortality rates from a bio-medical perspective

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8
Q

What are the data limitations for income protection

A
  • Published insurance parameters for incidence have limited credibility
  • Worldwide statistics are plentiful, especially from the US, but may not be relevant
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9
Q

What are the other influences on claim distribution

A
  • Advancement in medical science, which will impact cures
  • Earlier diagnosis
  • Simpler and more readily available operations
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10
Q

The value assigned to the investment return parameter will be affected by:

A

GRAM

  • The extent of the investment GUARANTEE given under the contract - this will affect the types of assets in which the premiums from the contract will be invested
  • The extent of any REINVESTMENT risk and the extent to which this can be reduced by a suitable choice of assets
  • The significance of the ASSUMPTION for the profitability of the contract, which will depend on the level of reserves built up and the investment guarantees given
  • The intended investment MIX for the contract, the current return on the investments within that mix and, where appropriate, the likely future return
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11
Q

What are the two key factors that lead to the sensitivity of the investment assumption

A
  • The size of the reserves built up (The larger the reserve, the greater the proportion of total cashflow that arises from investment income)
  • The investment guarantees given ( The higher the investment guarantee given, the greater the care needed over setting the level of assumption)
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12
Q

What should the parameter value for expenses reflect

A

It should reflect the expected expenses to be incurred in processing and subsequently administering the business to be written under the product being priced

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13
Q

What marginal expenses should be allowed for when pricing

A
  • Initial acquisition
  • Initial medical underwriting
  • Initial administration
  • renewal administration
  • renewal reward to sales channel
  • Investment
  • Withdrawal / paid-up expenses
  • Claim/maturity administration
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14
Q

How to incorporate into the charging structure the expenses which do not vary by size of contract

A
  • Individual calculation of premium rates or charges
  • Policy fee addition to the premium - or deduction from regular benefit payments, for non-unit-linked contracts or charges that match the per-policy expenses for unit-linked contracts
  • Sum assured differential - For non unit-linked contracts, different premium rates are charged according to which band the benefit requested falls into. For unit-linked contracts, different charges, for example allocation rates, are applied according to which band the premium payable falls into
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15
Q

What should be considered when setting the value of the inflation parameter for expenses

A
  • Current rates of inflation, both for prices and earnings
  • Expected future rates of inflation
  • the differential between the return on government fixed-interest securities and on government index-linked securities
  • Recent actual experience of life insurance company or industry
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16
Q

What should the Persistency (withdrawals) assumption reflect

A

It should reflect the expected future experience in respect of the contracts that will be taken out

17
Q

What changes to benefits for a regular premium whole life contract might lead to increased withdrawals ( For both normal and unit linked)

A
  • An increase in discontinuance terms (especially surrender values)
  • A decrease in bonus rates ( or a decrease in expected bonus rates)

For unit-linked
- Reduced fund performance
- An increase in charges
- Removal in options and guarantees provided

18
Q

How might a change in distribution channel affect withdrawal rates

A
  • A change in the one who initiates the sale (Withdrawal rates are likely to be lower if the client initiates the sale)
  • Sales practice may be different - If the client takes out policy due to pressure, withdrawals are likely to be increased
  • Sales of policies made without proper information about clients’ needs
  • Different levels of financial sophistication of the client base can lead to different perceptions of the value of a contract
  • Different target markets may encompass different levels of affluence and economic prosperity
19
Q

How can the risk to the company from adverse future experiences be allowed for

A
  • Through the risk element of the risk discount rate
  • Through using a stochastic approach
  • Through assessing what margins to apply to the expected values
20
Q

What does the size of the margin used to reflect the risks depend on

A
  • The degree of risk associated with each parameter used
  • The financial significance of the risk from each parameter
21
Q

What is the risk discount rate

A

It is the risk-free rate plus a risk premium

22
Q

What is the main idea behind the CAPM model

A

It is a well-diversified portfolio of shares that cancels out the risks of investing in individual shares and leaves only the unavoidable risks of investing in the stock exchange

23
Q

What does the beta factor of the CAPM represent and what does it value represent

A

The beta factor can be thought of as a measure of the riskiness of the asset relative to that of the market

A value greater than 1 implies, when the market is rising, the asset’s value will increase more than the market average, and conversely, when the market is falling, that it will decrease in value more than the market average

24
Q

What are the features that can make a product design riskier

A

POUCH L

  • POLICYHOLDER options
  • OVERHEAD costs
  • UNTESTED market
  • COMPLEXITY of design
  • HIGH guarantees
  • LACK of historical data
25
Q

How can the level of statistical risk be assessed

A
  • Analytically, by considering the variances of the individual parameter values used
  • By using sensitivity analyses with deterministically assessed variations in the parameter values
  • By using stochastic models for some, or all, of the parameter values and simulation
  • By comparison with any available market data
26
Q

What happens if the company doesn’t use consistent basis with that of other products

A

The company will end up selling two fairly similar products, at the same time, of which one must be expensive relative to the other