Chapter 14 - assumptions

Question 1

General considerations when setting assumptions

Answer 1

FUN FARC

• consider the use to which the assumptions will be put (U)
• take care over choice of assumptions that will have the most financial significance (F)
• achieve consistency between various assumptions (C)
• consider any legislation or regulatory constraint (L)
• consider the needs of the client (N)
• ensure parameters derived from the data are as accurate as possible (A)
• ensure that data used to derive the assumptions are relevant to the risks that the policy encompasses (R)
• ensure that bases used for periodic review and reserves are flexible to reflect changing circumstances (F)

Question 2

General process for setting assumptions

Answer 2

1. investigate historical experience and make best estimates of the parameters from that experience
2. consider what the conditions will be like in the future period for which you are making the assumptions
3. determine what the best estimates of your assumptions will be given the expected future conditions
4. the best estimates may need to be adjusted in order to include a margin for prudence

Question 3

Book rating

Answer 3

The past experience of the insured is not taken into account when determining the premium

Question 4

How can adverse experience be allowed for in a cashflow model

Answer 4

• assessing what margins to apply to the expected value
• stochastic approach
• risk discount rate

Question 5

What does price depend on?

Answer 5

• the competitive nature of the market
• the company’s unique selling proposition
• risk appetite
• credibility, accuracy and up-to-dateness of the data
• size of free assets or parental guarantee

Question 6

What should be considered when preparing published accounts?

Answer 6

• going concern basis or break up basis
• whether accounts are required to show a true and fair value
• whether reserves are required to be assessed as best estimate or some other basis

Question 7

EV

Answer 7

the present value of future shareholders profits in respect of existing business, including the release of shareholder-owned net assets

Question 8

Appraisal value

Answer 8

• the value of the business as a whole, both the existing business and the future new business
• if being prepared as a sale value, then likely to be based on realistic assumptions
• a purchase value may be based on cautious assumptions

Question 9

Calculation of EV

Answer 9

Has two parts

• shareholder’s share of net assets (excess of assets held over those required to meet liabilities)
• present value of future shareholder profits

For conventional with profits
- the PV of future premiums plus investment income less claims and expenses plus release of supervisory reserve

For without profit:
- release of margins within supervisory reserves relative to the assumptions used in the EV calculation