Chapter 29: Modelling 2

Question 1

Timescale/budget

Answer 1

Should not be overly complex, otherwise will take up too much time to build and run or be unnecessarily expensive

Question 2

Realism

Answer 2

• Valid
• Rigorous enough for purpose
• Reflect risk profile of business, with approp inputs
o Eg discount rate should reflect level of risk associated with the business
• Parameters reflect features of business (eg term)
• Allow for all cashflows to/ from business (incl bonuses) including interactions between assets and liabilities
• May need to be stochastic
• Should allow for effect of reserving requirements
stochastic

Question 3

Checking and documentation

Answer 3

• Outputs should be verifiable
• Model should be adequately documented (incl limitations and key assumptions)
• Parameters should show sensitivity of results to key factors of business
o Eg renewal rates and new business volumes

Question 4

Communication

Answer 4

Model should produce results that can be communicated to the management/ shareholders/ regulator

Question 5

Future use

Answer 5

• Should be possible to reuse the model for similar purposes
• The model should be capable of development and refinement – nothing complex can be successfully designed and built in a single attempt. Also regulatory reqs may change in the future

Question 6

Objectives

Answer 6

• Determined objectives as this will affect prices charged

o Higher price if key objective is profitability rather than gaining market share

Question 7

Understanding product features

Answer 7

• Claims fixed or real?
o If real, do they depend on price, earnings, medical or court inflation?
• Understand t&c’s of product
o Excesses/ exclusions
o Consider how soon will claim be paid and if there is likely to be lengthy claims control process
• Consider whether expected sales volumes are realistic given level of comp
• Consider whether any options will be offered
• Understand target market

Question 8

Gather data

Answer 8

• Needed to estimate claim freq/sev
• If new product, no data directily relating to product will exist
o Need to use other sources (TRAINER)
• Check data is correct and relevant, adjusting if necessary
o Eg if more stringent UW standards apply then a lower price may be appropriate
• Be aware of any limitation in data used (out of date/ obsolete)

Question 9

Analyse data

Answer 9

• Split into major risk groups (eg gender/location)
• Too few groups = data not suff. Homogeneous
• Too many groups = number of data points in each will be too small to give credible results
• Analyse data over suitable period
• To estimate claim freq, number of incidents and exposed to risk need to be calculated
• Judgement must be applied to results if quantity/quality of data is poor

Question 10

Assumptions for pricing

Answer 10

• Needed in order to build cashflow model
• Cost of benefits (claim freq/sev)
o Sev may depend on relevant inflation measure
• Margins
o Allow for expenses (potentially list)
o Suitable profit and contingency margins should be included
• Discount rate – depends on level of risk involved in product and company’s risk appetite
• Other factors
o Competitor reaction
o Reserving requirements/ cost of capital
o Taxation
o Reinsurance premiums

Question 11

Monitoring

Answer 11

Once the product has been launched it will be important to monitor experience (sales volume, claim rates, claim amounts) and adjust premiums accordingly.