Chapter 18 & 19 - Models

Question 1

Requirements of a good model: (9)

Answer 1

1. Model must be valid, rigorous and adequately documented
2. Model points must represent the business accurately
3. Model must incorporate all the material features of the business
4. The parameter values must be set appropriately
5. Different variables should behave realistically relative to each other
6. The workings of the model must be easy to explain and understand
7. Results should be clearly displayed, verifiable, and communicable to intended recipients
8. Model should not be overly complex
9. Model should be capable of subsequent development and refinement

Question 2

What is a model point?

Answer 2

It is a data record that is fed itno the computer as an input for the modelling program. It will represent either a policy or group of policies, containing data on the most important characteristics of the policy

Question 3

Factors influencing the number of model points chosen? (8)

Answer 3

1. Availability and power of computers
2. Variability of contracts sold
3. Complexity of contracts in force
4. Age of the company
5. Whether the model is stochastic or deterministic
6. Importance of investigation
7. Time available
8. Sensitivity of the results to using more or fewer model points

Question 4

4 types of models used by LI:

Answer 4

1. Single policy profit test model
2. New business model
3. Existing business model
4. Full model office (sum of 2&3)

Question 5

Desirable features of a stochastic model as compared with a deterministic model: (3)

Answer 5

1. Method allows a probability distribution to be assigned one or more of the unknown future parameters
2. Positive liability can be calculated where a deterministic approach might otherwise produce a zero liability, eg, where CF includes a minimum guaranteed benefit
3. Future paramaters may be assumed to vary together as a dynamic set, which is particularly useful for modelling with-profit business

Question 6

Circumstances when deterministic approach may be appropriate: (2)

Answer 6

1. Actuary is satisfied that similar results could be obtained as if a full stochastic projection was used, eg possible ourcomes form a symmetric distributionand information is only required on the expectation, or if a specific scenario is being tested within a simple cashflow model
2. A quick, independent test is required to see that the results of a stochastic projection are reasonable

Question 7

The risk discount rate allows for: (2)

Answer 7

1. Return required by the company
2. Level of statistical risk attaching to the CFs under the particular contract.

Question 8

What is a profit criterion?

Answer 8

It is a single figure that tries to summarise the relative efficiency of contracts with different profit signatures

Question 9

Proft criterion that could be used: (3)

Answer 9

1. Net present value
2. Internal rate of return
3. Discounted payback period

Question 10

Net present value is more realistic than internal rate of return in some cases: (3)

Answer 10

1. If there is more than one change of sign in stream of profits in the profit signature, the IRR will not usually be unique
2. NPV can be related to usefull indicators of the policy’s worth to the company, ito sales effort or market share. Can not be done with IRR
3. If a policy makes profits from the outset then the IRR may not even exist. NPV always exist

Question 11

Disadvantages of writing capital intensive business: (5)

Answer 11

1. Could lead directly to a problem with supervisory solvency
2. Would reduce company’s apparent financial strength
3. Represents an opportunity cost, in that the company could use the same amount of capital to write more business which is less capital intensive
4. Could lead unexpectedly to a problem with supervisory solvency if the company sells much more of the business than anticipated
5. Company will be less at risk to adverse experience if it uses capital to finance a large number of non-capital intensive policies than if it uses it for a smaller number of more capital intensive policies

Question 12

What is the estate of a life company?

Answer 12

The excess of the realistic value of its assets over the realistic value of its liabilities