T_F102 Modelling Options and Guarantees

Question 1

Model Overview

Answer 1

• Use of model points (differentiate between existing and NB)
• Model all material features
• Chose appropriate inputs
• Independent reasonability check of results
• Communication of results
• Avoid over complexity
• Ability to make subsequent changes/updates

Question 2

Life Insurance Models

Answer 2

Single policy profit tests/New Business Models/Existing Business Models/Full Model Office

• Allow for all cash-flows (incl discretionary)
• Allow for reserving and solvency margin requirements
• Allow for interactions (dynamic model)
• Allow for guarantees and options
• Decide between stochastic or deterministic approach
• Consider projection frequency and time period
• Formula vs. Cash-flow approach
• Traditional vs. Financial Economic approach

Question 3

Model Sensitivities

Answer 3

Model results depend on the choice of model points and on values assigned to input parameters

Test for impact of model point error
Sensitivity & Scenario analysis on parameter inputs
Consider correlations as well

Used to assess parameter margins needed in pricing
Used to assess effect of departure from assumptions in return on capital and profitability models of existing business

Alternative ways of allowing for risk exist

Question 4

Models - Investment Guarantees

Answer 4

e.g.Guaranteed Minimum Maturity Values/Guaranteed Surrender Values/Guaranteed annuity rates

Policyholder protected but cost for Company
Company risk = backing assets < guarantee
Conflict of maximising returns vs. meeting guarantees

If not investing to match guarantee, then the cost of guarantee has to be allowed for in pricing basis and reserves

Methods used:
Option-pricing techniques
Stochastic simulation of investment returns

Question 5

Mortality Options

Answer 5

e.g.no underwriting for further cover, interchange product types
Various possible conditions on when to exercise exists to reduce anti-selection
Cost = Premium rate that should have been charged less Premium rate that is charged

Cost affected by factors such as term, frequency, etc.

To value an option, need the following:
probability that the option is exercised and
expected mortality of the lives who choose to exercise

Methods used:
North American Method
Conventional Method