Chapter 31: Setting assumptions Flashcards
5 Key factors affecting the choice of assumptions
- the use to which the model will be put
- the FINANCIAL SIGNIFICANCE of the assumptions
- CONSISTENCY between assumptions
- legislative and REGULATORY requirements
- CLIENT NEEDS
When having past data, the actuary needs to consider how to deal with:
- abnormal fluctuations
- random fluctuations
- potential errors in the data
- changes in the experience with time
- changes in the way in which the data was recorded
- changes in the balance of any homogeneous groups underlying the data
- heterogeneity within the group to whom the assumptions are to relate
Features that can make a contract design riskier (6)
- lack of historical data
- high guarantees
- policyholder options
- overhead costs
- complexity of design
- untested market
Profit criterion
Single figure that summarises the relative efficiency of a contract.
E.g. NPV, IRR, discounted payback period
Demographic assumptions
eg mortality rates. They relate to the size and distribution of the population. They generally affect the: - timing - number of the cashflows
Economic assumptions
eg investment returns
Relate to the level of income or outgo.
They generally affect the LEVEL of the cashflows.
4 Examples of where past data may form a useful starting point
- determining an assumption for future investment returns.
- past data on salary levels in a particular country/industry/company may be useful when making an assumption about future levels of salary growth.
- History of an inflation index may be useful in determining an assumption for future benefit growth.
- Historical data can also be helpful when choosing demographic assumptions
Where a cashflow model is being used to price a product, the risk to the provider from adverse future experience could be allowed for by (3)
- adjusting the risk element of the risk discount rate
- using a stochastic discount rate
- applying margins to the expected values
3 Common methods of quantifying profitability
- net present value
- internal rate of return
- discounted payback period
Demographic factors (assumptions) needed for a pension scheme model
- rates of retirement in good health
- rates of ill-health retirement
- rates of withdrawal
- new entrant rates
- rate of mortality before and after retirement
- proportion married
- average age of spouses
- spouses’ mortality
- salary scale (ie promotional increases)
Economic factors (assumptions) needed for a pension scheme model
- investment returns
- discount rate (for valuing liabilities)
- earnings inflation
- price inflation
- pension increases
- expenses
Where there is little past data available, mortality assumptions could be set using (3)
- data from a similar contract
- industry data
- reinsurers’ data
5 conditions that could have changed that will lead to an insurance company’s past term assurance data not reflecting its likely future experience.
- underwriting practices
- the distribution channels used
- the target market
- product design features
- underlying mortality rates
4 Sources of historical data
- national statistics, published by government bodies and economists
- industry data
- tables compiled by actuaries
- past information relating to the particular contract being considered
4 Sources of Current Data and forecasts
- Policy statements by GOVERNMENTS OR BANKS may be useful when making assumptions about economic factors.
- There are many EXPERTS who provide alternative sources of estimates of future economic variables, most notably price inflation.
- A SCHEME SPONSOR may be able to provide information on planned future salary increases or likely future rates of withdrawal.
- The relationship between current yields for fixed-interest and index-linked bonds may provide some indication of the market’s view of future levels of the INFLATION INDEX to which bonds are related.
- In some instances, assumptions may be defined in REGULATIONS AND LEGISLATION