Chapter 13: Risk 1

Question 1

The risks attached to making assumptions may often be usefully classified as follows: (3)

Answer 1

1. Model risk - the risk that the underlying model is not adequate.
2. Parameter risk - the risk that the parameters assumed for the underlying model are incorrect.
3. Random fluctuations risk - the risk of unpredictable fluctuations arising from sample error.

Question 2

Risks faced by a life insurer: (7)

Answer 2

1. Policy data
2. Other data
3. Mortality rates
4. Claims experience for health and care products
5. Expenses
6. Investment return
7. Withdrawals

Question 3

Policy data:

Answer 3

Inadequate, inaccurate or incomplete policy data could lead to incorrect results and recommendations in actuarial investigations, including those performed for the supervisory authorities.

Question 4

Other data:

Answer 4

• Data used in the formulation of actuarial assumptions may be inadequate.
• Even where they are adequate in themselves, they may not be applicable to the purpose for which the actuary requires them.

Question 5

Mortality rates:

Answer 5

• The future parameters can never be predicted with certainty, because of, for example, new diseases and advances in medical treatment.
• However, where there are good quality and relevant data this reduces the risk of errors in parameter estimation.

Question 6

Claims experience for health and care products:

Answer 6

• For IP and LTCI the main risk relates to the mis-estimation of the transfer probabilities in the underlying multiple-state model.
• For CI products the main risk is the rates of diagnosis of the critical illnesses specified in the contract.

Question 7

Expenses:

Answer 7

• There is a risk of higher than expected expenses and expense inflation.
• Contributions to expenses from premiums and charges may be significantly mismatched with the actual expenses incurred, over time.
• Expense risk can be thought of as investment risk, persistency risk, or new business mix and volume risk depending on the cause.

Question 8

Investment return:

Answer 8

• Investment return might be modelled deterministically or stochastically.
• In either case there are model, parameter and random fluctuations risks.
• In a stochastic approach the random fluctuations are modelled explicitly.
• In a deterministic approach this risk can be explored through sensitivity testing.

Question 9

Withdrawals:

Answer 9

• The unpredictability of withdrawals makes it a risk.
• Early withdrawals usually represent a particular risk of loss, because of the failure to recoup initial expenses and asset shares can be very low or negative as a result.
• If withdrawal experience is different from expected it may invalidate assumptions about the effects of selective withdrawals on mortality experience.