Chapter 22 - Setting assumptions

Question 1

Besides setting assumptions for pricing.

What other exercises may we construct basis for? (4)

Answer 1

• Published results
• Supervisory reserves
• Internal management accounts
• Embedded values

Question 2

Valuing liabilities: overview

Broadly speaking, how do we value the liabilities of a life insurer? (4)

Answer 2

Broadly speaking, determined as PV of

Future benefit outgo

plus claims expenses (including commission)

plus taxes (if appropriate)

less future premiums

Question 3

Reserving basis vs pricing basis: uncertainty in assumptions

What’s a key difference between setting assumptions for pricing vs reserving in terms of information available? (1)

Answer 3

Key difference is that in force policies can provide important information for setting reserving assumptions (compared to pricing assumptions)

Question 4

Reserving basis vs pricing basis: using pricing assumptions for supervisory purposes

What is impact on With-profit products of using pricing assumptions prudent enough to also be used for reserving? (1)

Answer 4

For WP products, surplus will emerge from actual experience being better than that assumed in prudent assumptions ie. even if margins are high, surpluses from experience can be given back to PHs through bonuses

Question 5

Reserving basis vs pricing basis: using pricing assumptions for supervisory purposes

Why would prudent pricing basis strong enough for supervisory purposes be problematic for without profits business? (1)

Answer 5

Less appropriate for without-profits products as overly high margins => uncompetitive, hence usually small margins are used, meaning pricing basis cannot be used for supervisory solvency

Question 6

Valuing liabilities: Embedded value, key considerations

Define embedded value (4)

Answer 6

• Embededed value is defined as sum of:
  +shareholder-owned share of net assets
  +present value of future shareholder profits from existing business, including release of shareholder assets
• EV essentially recognises
  value of assets in excess of reserves
• and value to shareholders of future margin releases from reserves

Question 7

Embedded Value: Calculation PV of future shareholder profits

List components that make up the present value of future shareholder profits from existing contracts, for the following types of business:

conventional without-profits (3)
unit-linked (2)
with-profits (1)

Answer 7

Conventional without-profits business

• present value of future premiums plus +investment income, less
  +claims and expenses, plus
  +release of supervisory reserves

Unit-linked business

• present value of future charges
  +less expenses and benefits in excess of unit fund, plus
  +investment income earned on, and release of, any supervisory non-unit reserves and required solvency capital

With-profits business

• present value of future shareholder transfers, for example, as generated by bonus declarations

Question 8

Define appraisal value (2)

Answer 8

Appraisal value is sum of:

• embedded value (shareholder share of net assets + PV future profits from existing business)
• goodwill, which represents an estimate of the present value of future shareholder profits from future new business

Question 9

Embedded Value: Assumptions

What 2 different kinds of basis do we need for EV calculations? (2)

Answer 9

We need 2 bases for EV calculations

• Reserving basis: This is used to determine the technical reserves used.
• Projection basis: This is used to project the emergence of cashflow due to differences from the reserving basis.