Chapter 14 Assumptions General considerations

Question 1

General considerations when setting assumptions

Answer 1

• When setting assumptions it is important to:
• consider the use to which the assumption will be put
• achieve consistency between the assumptions
• consider any legislative or regulatory constraints
• consider needs of clients
• ensure that the parameters are produced accurately from the data
• ensure data that the data used to derive assumptions are relevant to insured lives
• ensure that bases used are flexible to reflect changing risk circumstances

Question 2

Deriving assumptions for pricing purposes

Answer 2

-The starting point is a best estimate bases for assumptions, however, margins will be necessary to guard against adverse future experience.

• Where a cashflow model is used, risk from adverse future experience may be allowed for:
  
  • through assessing what margins to apply
  • through using a stochastic approach
  • through the risk element of the risk discount rate
• The margins incorporated & the price charged depend on
  
  • company’s nature of market
  • company’s USP (unique selling proposition)
  • company’s attitude to risk
  • credibility, accuracy, relevance of data
  • size of company’s free assets or parental guarantee

Question 3

Deriving assumptions for reserving purposes

Answer 3

• The starting point is a best estimate basis for the assumptions.
• principles involved in deriving these assumptions will be equivalent to those used in pricing.
• basis derived here will be similar to the pricing basis.
• it is necessary include margins to reduce chances of reserves being insufficient.
• Whether true and fair-view
• where there is any legislation or guidance on the basis or assumptions to use.
• for internal management purposes - margins may not be needed.

Question 4

Deriving assumptions for determining profitability

Answer 4

• the basis is likely to be fairly realistic, although it will depend on the specific purpose.
• principles are same as those of cashflow model.
• however allowances for risk may be different.
• Embedded value is the present value of shareholder profits in respect of existing business of a company, including the release of shareholder-owned net asses.
• Appraisal value is the sum of of embedded value and goodwill and is often used when valuing a long-term insurance company for merger or acquisition.

Question 5

Example of situations embedded value is calculated

Answer 5

• to establish a value of the business, for internal purposes
• to include in financial statements
• to assess the major part of an appraisal value for sale or purchase
• to analyse future surpluses for RI embedded value financing
• to assess growth in EV for the payment of bonuses to staff or salespeople

Question 6

Calculation of embedded value

Answer 6

• Can be calculated as the sum of :
  1. The shareholder-owned share of net assets
  2. The PV of future shareholder profits arising on existing business.
• The calculation may differ by types of business:
• Conventional without profits: PV of future premiums + investment income - claims - expenses + release of supervisory reserves.
• Unit-linked business: PV of future charges - expenses - benefits in excess of unit fund + investment income earned on and the release of any non-unit reserves.

Question 7

Calculation of Appraisal value

Answer 7

-The starting point to value a company for M&A is the embedded value calc.
-Important element is goodwill
Assumptions
-If an appraisal is being prepared as a sale value it is likely to be based on realistic assumptions without margins.
-The determination of bonuses for staff requires a realistic basis.
-EV calcs need to include appropriate allowance for risk margins to allow for unpredictability of profit emergence for health & care insurance business.
-Discount rate used reflects the risk inherent in these cashflows.
-a stochastic or market-consistent approach may be adopted.
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Question 8

Margins in pricing assumptions based on…

Answer 8

• Competition in market
• Company’s USP
• Company’s risk to attitude
• Data’s CRAQ
• Free assets/parental guarantee

Question 9

Bases on which accounts can be made on

Answer 9

• going-concern basis
• break-up basis
• run-off basis

Question 10

Purposes of valuation

Answer 10

• Reporting company results (published accounts)

- Supervisory (solvency account)