1
Q
What are important considerations when setting assumptions?
A
ASS: you can use your ass for multiple things from twerking to sitting but you need to choose what makes you the most money. In order to be consistent I shake my ass for 2 hours every day. Anything more than 3 hours in illegal but you need to consider the needs of the customer - if he needs 10 more minutes it’s fine as long as he is a data analyst. But it’s important that the data analyses is in line with policy conditions. The base of table used for me to twerk on is very flexible and can change according to how risky the data analyst looks.
- Consider the use to which the assumptions will be put
- Take particular care over the choice of the assumptions that will have the most financial significance
- Achieve consistency between the various assumptions
- Consider any legislative or regulatory constraints
- Consider the needs of the client
- Ensure that the parameters derived from the data are produced as accurately as the body of data will permit
- Ensure that the data used to derive these assumptions are relevant to the risks that the policies encompass
- Ensure that bases used for periodic valuations and reserves are flexible to reflect changing risk circumstances
2
Q
How do you evaluate statistical risk associated with your assumptions?
A
- in some situations analytically, by considering the variances of the individual parameter values used
- by using sensitivity analysis with deterministically assessed variations in the parameter values
- by using stochastic models for some, or all, of the parameter values
- Attention must be given to assumptions which the profitability/reserve/price displays most sensitivity
3
Q
Is the investment assumption important for health and care contracts?
A
Health and care policyholders usually do not expect poor investment returns to influence the premium reviews under reviewable contracts, unless maybe if the policies are unit-linked.
4
Q
What assumptions are needed for health insurance products?
A
*Demographic: claim incidence, duration of care, claim amounts, morbidity and mortality rates, lapse and withdrawal rates
*Financial: expenses and expense inflation, benefit and benefit inflation, commission and commission clawback, investment return, tax
* Business specific: business volumes, business mix, risk discount rates, profit criteria, reserving and capital requirements
5
Q
Deriving assumptions for pricing purposes
A
- Assumptions are the best estimates for future experience; however it may be necessary to include a margin in the basis to allow for the risk of adverse experience.
- Why might we need margins?
- Volume of relevant statistics is not as credible as life insurance
- Claim outcomes are often more subjective and more influenced by factors outside of the control of the insurer
6
Q
Deriving assumptions for reserving purposes
A
- Assumptions are the best estimates for future experience; however it may be necessary to include a margin in the basis to allow for the risk of adverse experience.
-Margins need to be applied so the prob that the resulting reserves will prove to be inadequate is below an acceptably low figure (depends on reason for valuing contracts & legislation)
-Purpose of valuation is important: published, solvency or internal management account
7
Q
How is EV calculated?
A
- EV = shareholder-owned share of net assets + PV of future shareholder profits arising on existing business
- The shareholder-owned share of net assets
- Net assets are defined as the excess of assets held over those required to meet liabilities.
- These assets may be valued at market value or may be discounted to reflect “lock-in” e.g. if they are required to be retained within the fund to cover SCR
- The PV of future shareholder profits arising on existing business
- Process is similar to performing a profit test
- Expected future CFs are projected and used to estimate the expected shareholder profit - then discounted back using an appropriate discount rate
- Tax is allowed for as appropriate.
8
Q
Purpose of reserve calculation influence on basis.
A
- For published accounts
- Assumptions should be consistent with the legislation and accounting principles governing the preparation of those accounts in the territory concerned e.g.:
- Whether accounts need to be prepared on a going concern / break-up basis
- Whether accounts are required to show a true and fair view
- Whether reserves are required to be assessed as best estimates or on some other basis & how the terms used are to be interpreted
- Assumptions should be consistent with the legislation and accounting principles governing the preparation of those accounts in the territory concerned e.g.:
- For solvency accounts
- The rules may or may not be the same as for the published accounts
- May be required to be prepared on a going concern or a break-up basis (or a run-off basis)
- Will be some constraints on the assumption decisions. The constraints might be:
- Specific e.g. valuation interest rate = pricing interest rate
- More general e.g. do valuation as you wish, subject to the final result not being lower than it would have under a prescribed regulatory basis
- Two main approaches for setting assumptions for supervisory reserves:
- Assumptions that include a margin for prudence e.g. low valuation interest rate
- Best estimate assumptions with a separate allowance for risk e.g. a risk margin or minimum SCR
- For internal management accounts
- General way to determine the best estimate liabilities
- Assumptions derived based on the actuary’s best estimate of future realistic experience, without the incorporation of prudential margins.
- The cashflow method could project future income and outgo, and the PV of any shortfall would be the reserves to be held now. All experiences will be allowed for explicitly.
- Used when management wishes to have a best estimate of the company’s financial performance (e.g. when the insurer is sold, or directors wish to reward key staff for their specific contributions to the overall growth of the company).
- Internal management accounts → usually based on realistic assumptions. Can be used to look at profitability, solvency, claims and exposure, expenses, and reinsurance performance.
- General way to determine the best estimate liabilities
9
Q
When will EV be calculated?
A
- To establish the value of the business (internal management accounts or info)
- To include in published financial statements
- To assess the major part of an appraisal value for sale or purchase (sum of embedded value and goodwill) potentiall for merger and aquisition purposes
- To analyse the value of future surpluses for reinsurance embedded value financing
- To assess growth in EV for the payment of bonuses to staff or salespeople
- *Embedded value financing - a type of financial reinsurance under which a reinsurer advances a loan (often expressed as commission) to an insurer, in return for a stream of future surpluses that will emerge from business in force, reflecting any prudence in the valuation basis.
10
Q
What assumptions are required under EV calculation?
A
- Model points representative of portfolio being transferred
- Lapse rates
- Investment rates
- Renewal rates
- Risk discount rate (allow for required return by company, level of statistical risk attaching to cashflows)
- Claim incidence rates
- Duration of care
- Provision of state benefits
- Change in persistency post acquisition
- Rates of exercising product options
11
Q
On what basis is EV calculated?
A
- Need 2 bases: reserving basis (to calculate the net assets) & a projection basis (to project experience into the future)
- Reserves always calculated using the supervisory reserving basis.
- Projection basis depends on purpose as seen below
- The basis used to calculate EV heavily depends on purpose of calculation
- For internal management accounts → best estimate basis
- For published accounts → best estimate basis
- For appraisal value for sale → realistic assumptions without margin
- For appraisal value for purchase → cautious assumptions and margins included
- For bonuses for staff and sales people → realistic or prudent basis (don’t pay bonuses for potentially unprofitable business)
12
Q
How is risk allowed for in EV calculation?
A
- EV calcs need to include an appropriate risk margin to allow for the unpredictability for health and care insurance business.
- The discount rate traditionally reflects the risk inherent in the amounts (incr. discount rate → incr. prudence)
- A stochastic or market-consistent approach (use risk-free rate) may be adopted.
13
Q
What does premium price and risk depend on?
A
- The competitive nature of the market
- The company’s USP (unique selling proposition)
- The company’s attitude towards risk / risk appetite
- The credibility, accuracy, relevance and “up-to-date-ness” of the data
- The size of the company’s free assets or parental guarantee
14
Q
How is risk allowed for in premium calculation?
A
- Through assessing what margins to apply to the expected values
- All margins incorporated in the assumptions for each individual parameter and the risk discount rate would then be the risk-free rate
- Through using a stochastic approach
- Modelling will play a big part in assessing the margins, as the actuary will employ stochastic processes to view the likely outcomes of variable with differing distributions
- Through the risk element of the risk discount rate
- May be priced assuming best estimates for individual parameters, and included margins for risk assuming a higher risk discount rate
15
Q
How is risk discount rate assumption determined?
A
- Investors will demand an expected rate of return equal to the risk-free rate plus a risk premium (to compensate for the risks of default, commercial failure and so on).
- There are 2 key aspects of the risk discount rate: *list
- The return required by the company
- Often assessed using CAPM, the “project” being the pricing of a new product
- The level of statistical risk attaching to the cashflows under the particular contract
- Product-specific risk
- The return required by the company
16
Q
How is return required by company assessed using CAPM?
A
- Idea behind CAPM: a well-diversified portfolio of shares cancels out the risks of investing in individual shares and leaves only the unavoidable risks of investing in the stock exchange.
- A suitable proxy for the risk-free assets can be chosen (short-term deposits issued by a stable government) and the average risk premium that the diversified portfolio of shares has yielded over the risk-free rate, over a period of time, is estimated.
- Q: how risky a particular company’s shares are compared with the diversified portfolio. The result of CAPM is that the proper risk premium for any particular share is in proportion to its beta.
- Look at notes for CAPM formula
- The beta factor can be thought of as a measure of the riskiness of an asset relative to that of the market.
- This process identifies the systematic risk of the asset (the risk that cannot be eliminated by diversification or making the same investment many times over).
17
Q
How can you allow for product specific risk
A
- e.g. A change in the mix of business toward new and innovative contracts would change the market’s evaluation of the company’s riskiness.
- The higher the risk, the higher the risk discount rate we should use.
- Features that can make a product design riskier, viewed as an investment:
- Lack of historical data
- High guarantees
- Policyholder options
- Overhead costs
- Complexity of design
- Untested market
- The level of statistical risk could be assessed using one of the following methods:
- In some situations analytically, by considering the variances of the individual parameter values used (if we can estimate distributions)
- By using sensitivity analysis, with deterministically assessed variations in the parameter values
- By using stochastic models, for all, of the parameter values and simulation
- By comparison with any available market data
18
Q
What is market consistent approach of determining risk discount rate?
A
- Alternative approach - perform a market-consistent valuation of the cashflows.
- Use risk-free interest rates for the discount rates, which are generally modelled as being term dependent.
- Some form of margin will then be included in respect of other parameters used in the pricing, such as morbidity and expenses, to allow for the inherent risks in their estimation.
- The risk margin would reflect the compensation required by the market in return for taking on those uncertain aspects of the liability cashflows.
- Can be a useful tool in ensuring reasonability of traditional approaches and for ensuring that any risk margin is justified.
