Setting Assumptions Flashcards
Basic methodology for setting assumptions
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
List the factors/parameters for which to set assumptions.
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
Margin size depends on…
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
List three proxies for the risk-free rate
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
Factors that make for a risky product
1) Lack of historical data
2) High guarantees
3) Policyholder options
4) Overhead costs
5) Complex design
6) Untested market
Factors used to set the investment return assumption
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
Methods used to determine mortality trends
1) Expectation approaches
2) Extrapolation approaches
3) Explanatory approaches
Expectation approaches
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
Extrapolation approaches
Involve projecting historical trends into the future and may also require subjective judgement
Explanatory approaches
Attempt to model trends on mortality from a bio-medical perspective and requires understanding of the processes that cause death
List three ways to incorporate into the charging structure the expenses which are invariant by size of contract
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
List the most common expenses for life insurance contracts
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
Calculation of shareholder profits for conventional without-profits business
PV of
Future premiums
+ investment income
- claims
- expenses
+ release of supervisory reserves
Calculation of shareholder profits for with-profits business
PV of
Future shareholder transfers
Calculation of shareholder profits for unit-linked business
PV of
Future charges
+ surrender penalities
- expenses
- benefits in excess of unit fund
+ investment return on non-unit fund
+ release of non-unit fund
What is the difference between a best estimate valuation and an embedded value?
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 .
Reasons for calculating reserves
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
The basis for a valuation should reflect…
1) Expected future experience
2) Margins to ensure adequacy of reserves
3) Legislation/regulation (particularly for published reserves)
4) The need for consistency
Legislative constraints around reserves
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
