Chapter 6: Financial Planning Flashcards
Prime objective in modelling
To enable an actuary to give a general insurer appropriate advice so that it can be managed in a sound financial manner.
A model should ideally meet 9 requirements
- The model being used must be valid, rigorous enough for its purpose and adequately documented.
- Adequately reflects the risk profile of the financial products, schemes, contracts or transactions being modelled.
- Parameters must allow for all those features of the business being modelled that could significantly affect the advice being given.
- The inputs to the parameter values should be appropriate to the business being modelled.
- Workings should be easy to appreciate and communicate.
- Communicable and capable of independent verification.
- Not be overly complex so that results become difficult to interpret and communicate or the model becomes too long or expensive to run.
- Capable of development and refinement.
- A range of methods of implementation should be available to facilitate testing, parameterisation and focus of results.
15 Reasons why an insurer uses financial models
PREMIUM CALCULATION:
- to arrive at a risk premium per policy
- to select RATING FACTORS
- to DETERMINE PREMIUMS using experience-rating procedures
- to estimate the effect of changing the level of cover by changing the levels of deductibles
- to estimate the effect of changes in the terms and conditions of the policy wording
SOLVENCY
- to assess and project the level of solvency
- to ALLOCATE CAPITAL to different classes or categories of business
REINSURANCE
- to assess the benefits and costs of reinsurance
- to assist in the design of a suitable REINSURANCE programme
CLAIMS
- to estimate the likely VARIABILITY of claims experience
- to IDENTIFY TRENDS in claims at an early stage, for example, decline in the performance of certain contracts
- to RESERVE FOR UNCERTAINTY, for example, to estimate the possible effect of industrial diseases on the reserve run-off
BUSINESS PLANNING
- to VALUE PORTFOLIOS for purchase/sale
- to OPTIMISE INVESTMENT strategy and asset performance
- to ASSIST SENIOR MANAGEMENT in strategic decision-making and developing business strategy.
The aim of a general insurer’s financial plan
To set out courses of company action, subdivided and explained to a level of detail consistent with its purposes, which support or meet the company’s short-term targets and longer-term strategic vision.
Any financial plan must have (4)
- one or more goals
- a strategy to be followed to achieve those goals
- a set of targets that will enable the success or failure of the strategy to be measured
- a financial projection(s)
4 key benchmarks upon which a general insurance financial plan will focus
- expected loss ratios (gross and net of reinsurance)
- new business volumes and renewal rates
- capital implication
- the overall profitability of the company moving forward
Financial planning will often incorporate financial modelling.
Such a model will need to reflect: (2)
- the nature, size and structure of the general insurer
- the future financial position of the general insurer under different scenarios
Capitalisation horizon
the number of years of new business to be modelled
Modelling horizon
the number of future years for which the cash flows are projected
The capitalisation and modelling horizons should be based on …
The type of uncertainty under which we are modelling the liabilities.
The type of uncertainty in this context may be a year-on-year uncertainty or an uncertainty to ultimate.
How should the risk measure be determined?
The risk measure should be determined, for example, standard deviation, VaR, T-VaR and so on.
The risk measure should be applied to the variable under consideration, such as the net asset value or loss ratio.
Model usually splits future claims into 3 types:
ATTRITIONAL CLAIMS
usually based on a loss ratio model (high frequency, low severity)
LARGE CLAIMS
usually based on either separate claims frequency and severity models or an aggregate loss model
CATASTROPHE CLAIMS
based on a catastrophe model, where available, or based on claims frequency and severity models.
Each of the business claims would usually be split into (4)
- the development of historic notified claims (IBNER)
- Incurred But Not Reported (IBNR) claims
- claims from the period of unexpired risk on existing business
- claims from business that is written in the future
Assumptions about reinsurance will need to take into account (6)
- the reinsurance market cycle
- the financial strength of the reinsurers
any EXISTING ARRANGEMENTS:
- any changes that could be made to those arrangements
- the impact of any new products/features on the existing reinsurance arrangements
POSSIBLE NEW ARRANGEMENTS that could be put in place
4 Types of financial planning models
- deterministic
- stress and scenario
- stochastic
- Dynamic Financial Analysis (DFA)