Setting Assumptions

Question 1

Basic methodology for setting assumptions

Answer 1

1) Investigate historical experience and make best estimates of the parameters from that experience
2) Consider what the future conditions will be like in the period for which you are making assumptions
3) Determine what the best estimates of your assumptions will be, given the expected future conditions
4) the extent to which you rely on the experience data and the extent to which you allow for other factors , depends on the credibility and relevance of the data and how predictable the parameter is
5) The best estimates may need to be adjusted in order to include a margin for prudence

Question 2

List the factors/parameters for which to set assumptions.

Answer 2

MR WIMP DENTI

Margins
Risk discount rate

Withdrawal rates
Investment return
Market-consistent valuation
Profit criteria

Demographic (mortality/morbidity)
Expenses and commisson
New business mix and volume
Tax rates
Inflation

Question 3

Margin size depends on…

Answer 3

1) The purpose for which the basis is to be used
2) The degree of risk associated with each parameter used
3) The financial significance of the risk from each parameter

Question 4

List three proxies for the risk-free rate

Answer 4

1) That on short-term deposits issued by stable governments
2) That on short-term bonds issued by stable governments
3) That on long-term index-linked government bonds

Question 5

Factors that make for a risky product

Answer 5

1) Lack of historical data
2) High guarantees
3) Policyholder options
4) Overhead costs
5) Complex design
6) Untested market

Question 6

Factors used to set the investment return assumption

Answer 6

1) Significance of reserves for the contract
2) The extent of investment guarantees
3) The importance of reinvestment
4) Intended asset mix for contract
5) Impact of taxation

Question 7

Methods used to determine mortality trends

Answer 7

1) Expectation approaches
2) Extrapolation approaches
3) Explanatory approaches

Question 8

Expectation approaches

Answer 8

Involve expert opinion and subjective judgement to specify a range of future scenarios

Pro - implicitly includes all relevant knowledge
Con - can be subject to bias

Question 9

Extrapolation approaches

Answer 9

Involve projecting historical trends into the future and may also require subjective judgement

Question 10

Explanatory approaches

Answer 10

Attempt to model trends on mortality from a bio-medical perspective and requires understanding of the processes that cause death

Question 11

List three ways to incorporate into the charging structure the expenses which are invariant by size of contract

Answer 11

1) Individual calculation of premium rates and charges
2) Policy fee addition to premium or deduction to regular benefit payments or charges that match per policy expenses
3) Sum assured differential

Question 12

List the most common expenses for life insurance contracts

Answer 12

Initial:
- initial commission
- initial underwriting costs
- initial administration costs

Renewal:
- renewal commissions
- renewal administration

Ongoing:
- investment costs
- overheads

Termination:
- withdrawal/paid-up expenses
- claim payment expenses

Question 13

Calculation of shareholder profits for conventional without-profits business

Answer 13

PV of

Future premiums
+ investment income
- claims
- expenses
+ release of supervisory reserves

Question 14

Calculation of shareholder profits for with-profits business

Answer 14

PV of

Future shareholder transfers

Question 15

Calculation of shareholder profits for unit-linked business

Answer 15

PV of

Future charges
+ surrender penalities
- expenses
- benefits in excess of unit fund
+ investment return on non-unit fund
+ release of non-unit fund

Question 16

What is the difference between a best estimate valuation and an embedded value?

Answer 16

For a best estimate valuation the present liability is calculated for each policy using realistic assumptions (L). The sum over all policies is compared with the total asset value (A) to give a measure of realistic solvency. This gives a measure of BENEFIT SECURITY for policyholders.

An embedded value calculation will consider the cashflows across the portfolios in each time period (rather than the PV of CFs for each policy). The focus of an EV calculation is SHAREHOLDER PROFIT .

Question 17

Reasons for calculating reserves

Answer 17

TIC TIC PEVILS

Transfer of book of business
Independent assessment of reasonability of reserves
Commutation negotiation

Tax liability calculation
Internal management accounts for decision-making
Case estimates for RBNS reserves

Profit distribution rate analysis and setting
Estimating claims costs from recent periods as part of rating process
Value company for sale or acquisition
Information on business performance by area
Liability determination for insurer’s balance sheet
Supervisory solvency calculation

Question 18

The basis for a valuation should reflect…

Answer 18

1) Expected future experience
2) Margins to ensure adequacy of reserves
3) Legislation/regulation (particularly for published reserves)
4) The need for consistency

Question 19

Legislative constraints around reserves

Answer 19

1) Whether a going-concern or break-up basis is to be used
2) Whether the accounts should be true and fair
3) Whether assumptions should be best estimate or prudent
4) Whether reserves may be discounted or not