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CA1 > Part 7 > Flashcards

Part 7 Flashcards

1
Q

Definition of a model

A

Cut-down, simplified version of reality that captures the essential feature of a problem and aids understanding

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2
Q
  • 3 approaches to modelling
  • considerations to chose approach
A
  • Purchase commercial modelling product
  • Reuse exisiting model (possibly after modification)
  • Develop new model
  • Level of accuracy required
  • In-house expertise available
  • Number of times the model is to be used
  • Desired flexibility of the model
  • Cost of each option
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3
Q

Explain “valid” in terms of a model

A

“valid” means that we should e.g. not use a stochastic investment model which has been developed for projecting assets proceeds over periods of 30 or more years, if we are only interested in cashflows over the next 5 years

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4
Q

Definition of a “rigorous” model

A

A model that produces realistic (and hence useful) results under a wide range of circumstances and conditions

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5
Q

Dynamic model

A

Allows for interaction between the parameters and variables affecting the cash flows

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6
Q

Cash flows to consider when modelling a final salary occupational pension scheme

A

Inflows:

  • Contributions made by the employer and possibly members
  • Investment income on assets
  • Capital gains on any asset redeemed
  • Transfer values into the scheme

Outflows:

  • Pension payments
  • Transfer values out of the scheme
  • Any othe benefit payment (e.g. death benefit)
  • Administration expenses
  • Tax if applicable
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7
Q

Developing a deterministic model

A
  • Specify the purpose of the investigation
  • Collect, group and modify data
  • Choose the form of the model (identify parameters and variables)
  • Ascribe values to the parameters
  • Construct a model based on the expected cash flows
  • Check that the goodness of fit is acceptable (e.g. running a past year and comparing the model with the actual results)
  • Fit a new model if the first choice did not fit well
  • Run the model using estimates of the values of variables in the future
  • Run the model several times to assess sensitivity of the results to different parameter values
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8
Q

Developing a stochastic model

A
  • Specify the purpose of the investigation
  • Collect, group and modify data
  • Choose a suitable density function for each of the variables to be modelled stochastically
  • Specify correlation between variables
  • Construct a model based on the expected cash flows
  • Check that the goodness of fit is acceptable (e.g. running a past year and comparing the model with the actual results)
  • Fit a new model if the first choice did not fit well
  • Run the model many times, each time using a random sample from the chosen density function(s)
  • Produce a summary of the results that shows the distribution of the modelled results after many simulations have been run
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9
Q

Definition of “model point”

A

Representative single policy in a group. This policy can be used to represent the whole of the underlying business

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10
Q

What important characteristigs would you expect the model point to capture when modelling a without-profit term assurance product

A
  • Term of the policy
  • Sum assured, payable on death
  • Basis of policy (single life, joint life, last survivor)
  • Age of life/lives covered
  • Gender of life/lives covered
  • Smoker status of life/lives
  • Health status of life/lives
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11
Q

3 factors that influence the number of model points used

A
  • Heterogeneity of the class
  • Sensitivity of the results to different choices of model points
  • Purpose of the exercise
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12
Q

Risk discount rate for model points could allow for

A
  • the return required by the company
  • the level of statistical risk
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13
Q

Assessing the level of statistical risk

A
  • Analytically (consider variances of the individual parameters)
  • Sensitivity analysis
  • Stochastic models
  • Comparison with available market data
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14
Q

Decrements of a benefit scheme

A
  • Death before retirement
  • Death after retirement
  • Withdrawal from active service
  • Transfer out
  • Ill-health retirement
  • Normal/early/late retirement
  • Other options, e.g. exchanging some pension for a cash lump sum
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15
Q

Use of models for risk management

A

Determine the amount of capital that is necessary to hold to support the risks retained by a financial institution

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16
Q

Mitigating model error

A

Checks of goodness of fit to assess the suitability of the model

17
Q

Limitations of models and mitigations

A
  • Prone to model error (results are only as as good as the underlying model)
    • Consider losts of potential models
    • Employ suitable expertise to identify the most appropriate model
  • Level and timing of cash flows is uncertain
    • Use stochastic moel
  • Risk of data error (results will depend upon the data used=
    • Ensure data is regularly updated
  • Prone to parameter error (results depend upon the suitability of the assumptions used)
    • Carry out sensitivity testing to identify the key assumptions, pay careful attention to the setting of those financial assumptions which are most important
18
Q

Two main sources of data

A
  • Publicly available data
  • Internal data
19
Q

Poor data can be due to … (2)

A
  • Poor management control of data recording or its verification process
  • Poor design of the data systems
20
Q

Good quality data could mean

A
  • Complete (i.e. no ommissions)
  • accurate
  • up-to-date
  • consistent with previous data
  • Necessary level of details
  • Audit trail
21
Q

Checks on data

A
  • Detailed audit
  • Resaonability tests:
    • Averages
    • Impossible values
    • Outliers
    • Consistency over time
    • Check asset data vs. liabilities
  • Spot checks
    • In particular on the large items
    • random
22
Q

Assertions to be examined for data

A
  • That a liability or asset exists on a given date
  • That a liability is held or an asset is owned on a given date
  • That when an event is recorded, the time of the event and the associated income or expenditure are allocated to the correct accounting period
  • That data is complete, i.e. no unrecorded liabilities, assets or events
  • That the appropriate value of an asset or liability has been recorded
23
Q

4 causes for the lack of ideal data

A
  • Data have not been captured at a sufficient detailed level
  • There may be insufficient data to provide a credible result (e.g. new product)
  • Poor systems
  • Practically difficult/impossible to get good data
24
Q

Main aim of risk classification

A
  • Obtain homogeneous data
  • Reduction of heterogeneity in the data makes the experience in each group more stable
  • Therefore enables the data to be used more appropriately for projection purposes
25
Q

Common economic assumptions

A
  • Investment returns (e.g. bond yields, equity returns)
  • Discount rate (for valuing liabilities)
  • Earnings inflation
  • Price inflation
  • Pension increases
  • Expenses
26
Q

Demographic assumptions for pension scheme

A
  • Rates of retirement in good health (early, normal late)
  • Rates of ill-health retirement
  • Rates of withdrawal (for reasons other than retirement or death)
  • New entrant rates
  • Rates of mortality before and after retirement
  • Proportion married
  • Average age of spouses
  • Spouses’ mortality
  • Salary scale
27
Q

Historical data may be obtained from … (4)

A
  • National statistics (published by government bodies and economists)
  • Indistry data
  • Tables compiled by actuaries
  • Past information relating to the particular contract being considered
28
Q

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

A
  • Adjusting the risk element of the risk discount rate
  • Using a stochastic discount rate
  • Applying margins to the expected values
29
Q

Features that increase risk in a product design

A
  • Lack of historical data
  • High guarantees
  • Policyholder options
  • Overhead costs
  • Complexity of design
  • Untested market
30
Q

Classification of expenses

A
  • Fixed vs. variable
    • Example of variable expenses: Commissions, postal costs, legal expenses
  • Direct (directly belonging to a particular class of business) vs. indirect (no direct relationship to any one class of business)
    • Example of direct expenses: Underwriting costs, contract administration claims settlement expenses
    • Example of indirect expenses: Computing, human resources, general management
31
Q

Expenses need to be allocated between …

A
  • Classes of business
  • Functions (=activity, operation)
    • Securing new business
    • Maintaining existing business (renewal and investment)
    • Terminating business (including claims)
32
Q

Types of loading for expenses in contracts (3)

A
  • Fixed amount per contract
  • Percentage of the premium charged
  • Combination of the above
33
Q

Two elements of inflation adjustment needed to detemine an appropriate expense loading for premium rating

A
  • Historic (bring expense data up-to-date)
  • Prospective (inflate the expense data to the time when the expenses are expected to be incurred)
34
Q

Calculation of premium or contribution

A

value of future premium(s) =

  • value of benefits
    • value of expenses
    • contribution to profit

value of benefits = “risk premium”

total premium = “office premium”

35
Q

Scenarios to test premium for robustness

A
  • Economic scenarios (e.g. investment returns being higher or lower than expected)
36
Q

Examples of distribution systems in the UK

A
  • Independent intermediaries who select products for their clients from all or most of those available on the market
  • Tied agents, who offer the products of one provider or a small number of providers
  • Own sales force, usually employed by a particular provider to sell its products direct to the public
  • Direct marketing, via press advertising, over the telephone, internet or mailshots
37
Q

Approaches to financing benefits

A
  • Unfunded approach
    • Pay-as-you-go (PAYG)
      • Does not tie up funds
      • Low transaction costs
  • Funded approach
    • Lump sum in advance
      • Ties up excessive funds
    • Terminal funding (payment is made whenever a benefit start to be paid)
    • Regular contributions
    • Just-in-time funding (Funds are set up as son as a risk arises in relation to the future financing of the benefits (e.g. bankruptcy or change in control))
    • Smoothed PAYG (funds that are set up to smooth the costs under a pay-as-you-go approach)

CA1 (10 decks)

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