F102 Summaries P4 Flashcards
examples of investment guarantees include
- guaranteed minimum maturity values for both unit linked and non linked endowment contracts
- guaranteed minimum surrender values for both unit linked and non linked contracts
- the ability to convert a lump sum into an annuity or vice versa on guaranteed terms.
an IC needs to be able to model the investment guarantee in order to quantify the extra liabilities that it will incur when the guarantee exceeds the EAS. Liabilities can be assessed using:
- Option pricing techniques
- stochastic simulation
Option pricing techniques iro guarantee costing
the value of the liabilities will be similar to the cost of a derivative which covers a similar guarantee or option to that which the company is offering
stochastic simulation iro guarantee costing
the extra sums likely to be needed under the guarantee can be modelled stochastically by running a simulation of investment returns thousands of times
mortality options can be valued using cashflow projections. assumptions are required for:
option take up rate
benefit chosen
mortality of those that exercise the option and those that do not
expenses relating to the option
mortality options, description
many life assurance contracts contain options whereby the policyholder can choose to extend the term or increase the level of cover at normal premium rates, without providing further evidence of health.
to the extent that the option might be exercised by someone in poor health the assurance company will bear a cost - the difference between the ordinary premium rate granted under the terms of the option and that which would have been granted had the life been underwritten.
the actuary will want to ensure that the data they use is complete and accurate, simple checks include
- data movements (reconcile data between start and end of the period)
- consistency (check that numbers are sensible) trends and averages
- unusual values, check for outliers and that unusual values do not exist
- analysis of surplus, are there any unexplained items
experience will be monitored in order to
- develop earned asset share
- to update assumptions as to future experience, thereby feeding back into the control cycle
- to monitor any adverse trends in experience so as to take corrective actions
- to provide management information
experience investigations would include
mortality
persistency
expenses
reinsurance brief definition
reinsurance involves a direct writing company ceding business to another life insurance company, the reinsurer. the reinsurer will have no contact with the policyholders
coinsurance - original terms
original premiums and benefits are shared proportionately. reinsurance commission is significant and determines the price of the reinsurance
coinsurance - level risk premium
reinsurer sets a level premium rate. insurer prices the contracts taking the reinsurance premiums into account.
all types
risk premium
reinsurer sets premium rates. risk premiums change from year to year. may or may not be guaranteed for policy duration. reinsurance benefits based on share of full sum assured or sum at risk.
excess of loss - non proportional reinsurance types
catastrophe reinsurance
stop loss reinsurance
catastrophe reinsurance
shares in the total claims above threshold from multiple claims from a single event.
annually renewable
covers non independent risks - group life insurance.
may be multiple lines for group business.
stop loss reinsurance
covers excess of all aggregate claims in a year over a threshold, up to a maximum.
financial reinsurance
finre can help the cedant to relieve part of its new business financing requirements. it can be structured as a loan, receiving either a lump sum or reinsurance commissions with repayments incorporated into the reinsurance premium or paid out of future profits.
facultative and obligatory reinsurance
reinsurance is usually codified by treaty. facultative means freedom of action, obligatory means removal of this freedom.
determining a market consistent valuation
to determine a market consistent value of liabilities, future unknown parameter values and cashflows are set so as to be consistent with market values, where a corresponding market exists. market values are also used for assets, if market prices exist.
investment returns in the determination of market consistent valuation
future investment returns are based on a risk free rate of return, irrespective of the type of asset actually held, and the discount rates are also based on risk free rates.
risk free rates may be based on government bond yields or on swap rates. it may be appropriate to make a deduction to allow for credit risk.
illiquidity premium in market consistent valuations
under certain conditions, it may be possible to take credit for the illiquidity premium available on corporate bonds and thereby discount liabilities at a higher yield than the risk free rate.
why would it be difficult to obtain market consistent assumptions for some elements of the basis? which elements?
it may be difficult to obtain a market consistent assumption for some elements of the basis, e.g. mortality, persistency or expenses, as there may not be a sufficiently deep and liquid market in which to trade or hedge such risks.
it is then likely that a risk margin would be added to the best estimate of the liabilities. this risk margin would reflect the compensation required by the market in return for taking on those uncertain aspects of the liability cashflows.
what can you do where market consistent assumptions are difficult to obtain?
it is then likely that a risk margin would be added to the best estimate of the liabilities. this risk margin would reflect the compensation required by the market in return for taking on those uncertain aspects of the liability cashflows.
this can be done by adding a margin to each assumption or by using the cost of capital approach.
solvency capital requirements by supervisory authorities
insurance supervisory authorities normally require that lic’s establish a certain amount of solvency capital. this is to protect policyholders from a company reserving too little for their liabilities, and from the harmful effects of asset volatility. supervisory reserving needs to be considered in conjunction with the solvency capital requirements and vice versa.
the relationship between reserves and solvency capital requirements
the relationship between reserves and solvency capital requirements varies between different countries and regulatory jurisdictions. normally 1 of 2 cases:
- strong reserving with a small solvency requirement
- weak reserving with a large solvency requirement.
where weak reserving means a basis close to the best estimate basis
in what ways can the level of scr be specified
the level of solvency capital required under regulation may be specified as a formula, or it may be based on a risk measure such as value at risk - VaR
the var can be calculated by subjecting the supervisory balance sheet to stress tests on each of the identified risk factors, at the defined confidence level and over the defined period.
how would the var for the scr be calculated
the var can be calculated by subjecting the supervisory balance sheet to stress tests on each of the identified risk factors, at the defined confidence level and over the defined period.
the aggregate capital requirement combines the separate stress tests to reflect any diversification benefits that exists between the various risks. this may be done through the use of correlation matrices or by copulas.
passive valuation approach
a passive valuation approach is relatively insensitive to changes in market conditions and has a valuations basis which is updated relatively infrequently.
active valuation approach
an active valuation approach is based more closely on market conditions withe the assumptions being updated on a frequent basis.
active vs passive valuation approach
passive approaches tend to be easier to implement, involve less subjectivity and result in relatively stable profit emergence.
active approaches are more informative in terms of understanding the impact of market conditions.
reasons for reinsuring
- reduce parameter and claim payout fluctuations risk
- financing new business strain - use financial reinsurance and/or quota share
- obtaining technical assistance
- benefiting from regulatory or tax arbitrage opportunities
- reducing costs
what should be considered before reinsuring
- cost of reinsurance
- counterparty risks- increase number of reinsurers and/or use deposit back
- legal risks
- type of reinsurance
- amount of reinsurance - choosing retention limits
why should the cost of reinsurance be considered?
reinsurance costs money. the lic should examine other ways of reducing claims fluctuations such as using a mortality fluctuation reserve and avoiding capital problems on new business, and compare their costs to arrive at the most efficient solution.
optimal strategy in including reinsurance and risk management
the company will seek to adopt an optimal strategy on the basis of achieving the desired level with minimum cost - which is equivalent to achieving the maximum returns for the required level of risk. a stochastic model office, including assumptions that allow the mean mortality rate as well as random mortality fluctuations to be modeled stochastically, would be used.
the results would also be sensitive to the assumed distribution of sums assured in the model points.
how do reinsurance arrangements reduce the impact of adverse claims experience?
claims fluctuations will lead to volatile profits , making it harder to smooth profit distributions, and can lead to losses that could potentially threaten solvency, especially for small companies.
how do adverse claims rise re mortality
adverse claim costs can arise if the company has priced its contracts using mortality assumptions that are too low. any original terms or risk premium method can reduce the exposure to this risk. some quota share and /or reducing retention reinsurance would be expected here as there would be more control over the proportion of the risk shared.
how to determine the retention limit
a simulation approach might be adopted. this would involve the following steps:
- decide upon some criteria for claim volatility beyond which the company cannot go. the aim may be to keep the probability of insolvency below a specified level.
- combine a stochastic model for expected claims rates together with a model of the business, to project forward claims, assets and liabilities.
- use a simulation method to determine a retention level such that the company stays solvent for e.g. 995 times out of 1000 runs. the model will need to be run lots of times at differing retention levels.
- sensitivity analysis may also be carried out, varying the mortality distribution
other factors to consider when setting the retention limit
- the company could check to see if protection might be provided more cheaply using a mortality fluctuation reserve.
- any proposed arrangements would need to be practical and simple
- the cost of the reinsurance available would affect the retention level decided on
- take into account the expected volume and mix of business expected over the duration of the proposed reinsurance treaty.
- the result should be checked for reasonability against the market norm.
personal accident insurance measure of exposure
the measure of exposure is usually the person-year or member/employee year. the rating factors used are usually very simple, e.g. occupation, but not age or gender
personal accident characteristics of costs and frequency
the incidence of an event is usually very clear and claim costs are known, although they are sometimes subject to dispute. claim frequency tends to be reasonably stable
