Forecasting and Modeling

Question 1

Uses of health insurance financial models (6)

Answer 1

1. Pricing - financial and sales models are used to determine premiums
2. Reserve calcs and reserve basis eval - some reserves (such as GPR) are calc by forecasting models
3. Monitoring of results - to validate assumptions, to warn of deviations from expected values, and for resource planning
4. Solvency testing - may indicate need for GPR
5. Financial forecasting - corporations forecast results for various reasons
6. Actuarial appraisals - these are studies of the value of a block of business, typically used when transferring ownership

Question 2

Essential characteristics of a good model (5)

Answer 2

1. Reliable accuracy - model must be good at predicting the future. It must also be robust.
2. Suitability for use - model should produce the results it’s designed fro without adding unnecessary complications
3. Appropriate precision - this relates to how many decimal places should be kept in the values
4. Sensibility - model should reflect a logical construction of what is being modeled. It should be theoretically sound
5. Effectively communicated - this includes communicating everything necessary to understand and use the model’s sresults

Question 3

Steps in building a forecast model (7)

Answer 3

1. Choose the basic structure of the model - tools include spreadsheets, database models, and sequential programs. Model types include asset share models, rsv models and agent based models.
2. Choose info to be carried - info needed will depend on purpose of the model
3. Choose assumptions and building a prototype model - starting values and assumptions built into model. Prototype cell is defined and then projected to end of forecast period.
4. Extending the prototype - model extended to other cells representing the diff subsets of modeled business
5. Validating the model
6. Document the model - allows model to be evaluated by other professionals and makes it easier to make modifications
7. Design output and communicate results

Question 4

Methods for validating forecast models (4)

Answer 4

1. Starting values compared directly to the actual values for that year.
2. Year to year changes in model are compared to actual past historical results
3. Model results are checked for reasonableness by people familiar with the business
4. Stress testing - analyze how the model results behave when underlying assumption are changed (includes sensitivity testing)

Question 5

Assumptions needed for forecasting (6)

Answer 5

1. Lapse - vary by product, duration, company
2. Mortality - highest first year and then decreases
3. Claim cost - use actual experience if possible. Trend assumptions needed.
4. Expense assumptions - usually expressed on a per unit basis
5. Model office assumptions - defined the proportion of the block of business represented by each model cell

Question 6

Basic modeling approaches (2)

Answer 6

1. Deterministic - model output is determined by parameter values and initial conditions. Need sensitivity testing and scenario testing on assumptions.
2. Stochastic - model output determined by probability distribution. Can be parametric (known distrib) or Monte Carlo simulations (create stochastic results). Provides info on distribution of results along with expected value.

Question 7

Types of Model Structures (6)

Answer 7

1. Asset share type - most common, use spreadsheets, calculated on per policy or per unit of coverage basis
2. Reserve development - claim lag model, tabular reserve
3. Agent-based models (micro-simulation models) - used to predict behavior of agents
4. Deterministic vs. Stochastic - more effort required for stochastic
5. Cell definition - number of cells required depends on type and purpose of model
6. Durational characteristics - measuring and managing durational impacts on claim cost

Question 8

Profit Assumptions (2)

Answer 8

1. Retrospective model, profit = revenue - expense
2. Prospective model - premium level for each cell based on a target profit or other sources (ex. prior rate levels) and then profit is calcualted

Question 9

Profit Measures (3)

Answer 9

1. Profit as % of annual premium (PV of profit as % of PV of premiums
2. Return on Investment (ROI) -solve for interest rate where PV of profits = 0. This is stat basis.
3. Return on Equity (ROE) - include investment capital in ROI calc. This is GAAP basis.