20. Setting assumptions

Question 1

Factors affecting choice of assumptions

Answer 1

• Purpose
• Consistency between different assumptions
• Care on assumptions that will have most financial impact.
• Legislation + Regulation
• Clients’ needs

Question 2

Types of assumptions

Answer 2

• Demographic assumptions- size and distribution of population
• Economic assumptions- income and outgo

Question 3

Information

Answer 3

• Historical data

* Current + forecasts

Question 4

Use of past data for economic assumptions

Answer 4

• Future investment returns
• Future levels of salary growth
• Future growth of benefit linked to inflation

Question 5

Extent of usefulness of information

Answer 5

• Relevance + credibility of past data
• Fluctuations over time
• Data recording
• Heterogeneity
• Standard tables

Question 6

Considerations for past data

Answer 6

• Abnormal fluctuations
• Changes in experience over time
• Random fluctuations
• Changes in methods to record data
• Data errors
• Changes in mix of homogeneous groups within data
• Changes in mix of homogeneous groups to which assumptions apply

Question 7

Fluctuations and changes over time

Answer 7

• Economic + fiscal changes
• Price inflation
• Use of real values
• Demographic changes
• Other economic adjustments
• One-off impacts

Question 8

Data recording

Answer 8

• Changes in recorded stats

* Data errors

Question 9

Heterogeneity

Answer 9

• Changes in constituents of population

* Split into homogeneous groups

Question 10

Other factors to consider

Answer 10

• Accuracy + prudence
• Effect of assumptions on cash transactions
• Implicit assumptions

Question 11

Accuracy + prudence

Answer 11

• Purpose
• Accuracy of assumptions
• Significance of errors

Question 12

Factors affecting pricing

Answer 12

• Margins
• Risk discount rate
• Profit criterion

Question 13

Allowing for adverse future experience in cash flow models

Answer 13

• Adjust the risk element of risk discount rate
• Use a stochastic risk discount rate
• Apply margins to expected values

Question 14

Discount rate may be a sum of

Answer 14

Either:

• Risk free rate
• Shareholders’ required risk of return

+
*Risk premium

Question 15

Factors increasing risk

Answer 15

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

Question 16

Measuring profitability

Answer 16

• NPV
• IRR
• DPP

Question 17

Considerations when using standard tables

Answer 17

• Relevance of data to intended population

* Adjustments to reflect continuing past trends

Question 18

Other sources of data

Answer 18

• National statistics
• Industry data
• Actuarial tables
• Past information about contract

Question 19

Conditions that could have changed thus not reflecting likely future experience of term assurance

Answer 19

• Underwriting practices
• Distribution channels
• Target market
• Product design
• Mortality rates

Question 20

Setting mortality assumptions with little past data

Answer 20

• Data from similar contract
• Industry data
• Reinsurer’s data

Question 21

Demographic factors for pension scheme

Answer 21

• Good health retirement rates
• Ill-health retirement rates
• New entrant rates
• Withdrawal rates
• Mortality rates
• Proportion married
• Average age of spouses
• Spouses mortality
• Salary scale

Question 22

Economic factors for pension funds

Answer 22

• Investment returns
• Discount rate
• Earnings inflation
• Price inflation
• Pension increases
• Expenses

Question 23

Use of past data for demographic assumptions

Answer 23

• Past mortality used to make assumptions on survival of pension fund members/
• Used to find extent to which benefits will be payable
• Project mortality improvements
• Can be used when finding the probability of leaving employment, retiring etc

Question 24

Examples of current data

Answer 24

• Statements by government or controlling banks
• Industry forecasts
• Views of directors
• Relationship between current yields on fixed-i and index-linked bonds»>future expected inflation.