Chapter 21 Assumptions (4) Different purposes for setting assumptions, and complexities which arise

Question 1

Valuing liabilities: overview, calculation of liabilities

Broadly speaking, how do we value the liabilities of a health insurer? (4)

Answer 1

• Broadly speaking, determined as PV of

1. Future benefit outgo
2. plus claims expenses (including commission)
3. plus taxes (if appropriate)
4. less premums

Question 2

Purposes for different assumption/basis

In the first chapter on setting assumptions, we considered setting assumptions for pricing.

What other exercises may we construct basis for? (4)

Answer 2

• Published results
• Supervisory reserves
• Internal management accounts
• Embedded values

Question 3

Pricing assumptions: overview

Briefly describe the general process for setting assumptions in terms of

the starting point (2)

how we might allow for risk from advers future experience (3)

what might influence the level of margins used (6)

Answer 3

• 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 and the final price charged might depend on
  
  • company’s nature of market
  • company’s USP (unique selling proposition)
  • company’s attitude to risk
  • credibility, accuracy, relevance of data used
  • size of company’s free assets
  • presence of parental guarantees

Question 4

Reserving assumptions: margins, impact

What impact do margins have on prudence on the calculation of liabilities? (1)

Answer 4

• Greater the margins assumed => more prudent the calculation of liabiltiies

Question 5

Valuing liabilities: RDR, impact

What implication does increasing/decreasing the RDR have on calculation of liabilities? (3)

Answer 5

• Impact of changes in the RDR
  
  1. all things being equal,
  2. decreasng (increasing) the RDR, will increase (decrease) degree of prudence for a positive reserve
  3. decreasng (increasing) the RDR, will decrease (increase) degree of prudence for a negative reserve, where this is permitted

Question 6

Reserving assumptions: overview, process

What is the first thing to consider when deriving a set of assumptions/basis to use for reserving/valuations? (3)

What would be the starting point when setting assumptions for reserving/valuation of health insurance contracts? (6)

Answer 6

First consider purpose for which reserving basis is needed eg

• publication purpose:
  
  • supervisory reporting to demonstrate solvency or otherwise
  • usually regulatory contraints on assumptions which can be used
• internal management use: likely need more realistic position

Starting point for assumptions is best estimate basis expected for future experience of lives being insured

• principles for basis will be similar to those used in pricing with a best estimate basis
• then necessary to add margins
  
  • => more prudent than pricing basis
  • to reduce chances of reserves being insufficient
  • lead to acceptably low probability of default

Question 7

Reserving assumptions: important considerations

What important considerations need to be made when setting assumptions/basis for reserving/carrying out valuations (7)

Answer 7

Consideration needs to be given to

• whether to prepare reserves on a going-concern basis or break-up basis is used for accounts
• whether true and fair view is required
• any legislation/guidance on the basis or assumptions to use
• purpose to which reserves will be put
  
  • eg whether reserves are for internal management purposes (in which case margins may not be needed)
• consistency of assumptions/basis, eg
  
  • between assumptions
  • from one basis to another
  • betweeb assumptions used in pricing and statutory reporting
  • etc…

Question 8

Reserving assumptions: going-concern vs break up basis

Answer 8

• going concern
  
  • assume insurer continues issuing new bussiness into future
• break-up
  
  • assume new business cease immediately, or at some point in future e.g
  • …closed fund by company, or..
  • …transfer liabilities to another insurer, who will administer/procress claims until book runs down

Question 9

Reserving assumptions: setting margins appropriately

Describe the various methods to assess the approapriate level of margins to include in reserving assumptions (8)

Answer 9

• Analytically:
  
  • if have a good idea of probability distribution of assumptions.
  • can set assumptions by reference to mean and variance.
  • may have higher variance than pricing due to prudence, can take a lower percentile of distribution
• Stochastically via simulations
• Through sensitivity testing analysis
• Margins may be laid down in legislation
• As always, important to consider purpose of the exercise to which the assumptions/basis will be put

Question 10

Reserving assumptions: profitability of existing business

What is the approach to be taken when setting assumptions/reserving basis to assess profitability of existing business? (3)

Answer 10

When setting assumptions/basis to determine profitability of existing business

• Aim for best estimate of all assumptions (similarly to pricing)
• Similar model approach as pricing as well (ie cashflow model)
• Bases will likely differ due to different allowances for different risks =>
  
  • typically lower RDR than in pricing, because of reduced risks

Question 11

Reserving assumptions: profitability of existing business, pricing vs reserving

What additional information can be considered when setting reserving assumptions/basis when assessing profitability of existing business ie when we are pricing vs reserving for inforce business? (4)

Answer 11

Additional information

• For existing policies, we have more demographic information so less uncertainty than in pricing
• Yields on existing assets relevant where no future investment is required
• Expense assumptions should not include initial expenses as these have been incurred already.
• Less uncertainty over volume and mix, as we have an actual snapshot of this as at the valuation date (as opposed to having to estimate the volume/mix)

Question 12

Reserving assumptions: published valuations

State the factors to consider when deciding assumptions for determining the value of liabilities to show in an insurance company’s published accounts (6)

Answer 12

Here we speak of reporting/publishing of company results (to directors, for example)

• For country concerned, consider
  
  1. legislation
  2. accounting principles
• Matters to consider
  
  1. going concern or break-up basis
  2. required to show a true and fair value?
  3. best estimate basis or some other basis?
  4. precisely how terms used are to be interpreted

Question 13

Reserving assumptions: internal management accounts

State key driver that should determine the pricniples to be followed for determining the value of liabilities for internal management accounts (1)

State the most likely aim of such a valuation. (1)

Answer 13

• Key driver should be discussion with insurance company about the principles to follow, based on the purpose for which the internal accounts are required
• Most likely aim is to have best estimates of the company’s financial performance, based on realistic assumptions.

Question 14

Valuing liabilities: Supervisory reserves, key considerations

How might rules governing the solvency supervision process relate to rules for published accounts? (1)

Key considerations for supervisory reserves (4)

Answer 14

• If separate accounts required during process solvency supervision process , rules for preparation of separate accounts may/may not be same as rules for published accounts…
• Key considerations
  • for example may be required to use different basis (going-concern/break-up basis)
  • Should reference rules & guidance which was issued needing interpretation
  • will most likely be certain assumption restrictions which are either
    
    • specific (valuation interest rates must equal premium basis rate)
    • general (do valuation as wish, subject to not lower than X basis)
  • usually require prudent basis, some jurisdictions moved to market consistent approach

Question 15

Consistency: valuation basis, intro

When setting a valuation basis, list different aspects of the basis where consistency would be important (4)

Answer 15

• Consistency with previous basis
• Assets vs liabilities
• Consistency with pricing basis
• Supervisory basis vs internal valuation/internal reporting basis

Question 16

Consistency: valuation basis, in depth

Discuss different aspects where consistency is important when setting a valuation basis

consistency with previous basis (7)

consistency between assets and liabilities (2)

consistency with pricing basis (3)

consistency with basis used for internal valuation/internal reporting (1)

Answer 16

Consistency with previous basis

1. starting point in selecting valuation basis is the previous valuation basis
2. deviations from previous valuation basis need justification
   
   1. appropriate to adjust for new evidence eg if gross redemption yield from gov bonds had changed
3. changing basis can have significant impact on published results
   
   1. weaker basis, justify not just to accelerate profits
   2. stronger basis, justify not just to defer profits (tax)
4. manage conflict of interest when setting reserving basis
   
   1. overreserve, delay surplus emergence, reduces returns from capital providers
   2. underreserve, accelerate profits, increase returns, but poses risk
5. educate capital providers
   
   1. to believe interests best served by solvent company
6. indentify impact of basis changes seperately in accounts

Assets vs liabilities

1. basis for valuing liabilities, consistent with basis for valuing assets
2. eg if assets valued market value, then investment return assumption of liability basis must reflect current market yields (ie expected future market yields for risk free assets) if market consistent approach is taken

Pricing basis

1. allow for cost of setting supervisory reserves in pricing model used (these reserves will have been based on some reserving basis)
2. price determined will have allowed for CoC
3. essential that pricing basis reserves consistent with actual reserving

Supervisory vs internal valuation

1. Doesn’t necessarily need to be close, but should be considered

Question 17

Consistency: embedded value basis, intro

Discuss different aspects where consistency is important when setting an EV basis (3)

Answer 17

• Consistency with previous basis
• Assets vs liabilities
• Consistency with pricing basis

Question 18

Consistency: embedded value basis, in depth

Discuss different aspects where consistency is important when setting an EV basis:

consistency with previous basis (4)

consistency between assets and liabilities (2)

consistency with pricing basis (3)

Answer 18

Previous basis

1. starting point will be basis used for previous EV calc
2. difference to prev will immediately cause some movement in EV
3. any change must be justifiable, esp if EV being used to report externally on insurer’s real worth
4. basis change appropriate if best estimate assumptions have changed

Assets vs liabilities

1. Same comments as for setting valuation basis
2. basis for valuing liabilities, consistent with basis for valuing assets

eg if assets valued market value, then investment return assumption of liability basis must reflect current market yields (ie expected future market yields for risk free assets) if market consistent approach is taken

Pricing basis

1. EV basis likely to be more best estimate than pricing basis
2. However, 2 bases should be looked at side by side.
3. Any differences will immediately lead to embedded value movements on writing new business different to those implied in pricing basis

Question 19

PMI: healthcare reserving modelling complexities, list

Briefly list some of the complexities that arise specifically in setting assumptions/basis when reserving or modelling of PMI

(6)

Answer 19

• Claim Frequency Distribution
• Claim Amount Distribution
• Impact of Sales Tax on Future Growth
• Macro-economy, style of government and market competition
• Data Limitations
• Further complications

Question 20

PMI: healthcare reserving modelling complexities, in depth

Briefly describe some of the complexities that arise specifically in setting assumptions/basis when reserving or modelling of PMI

• Claim Frequency Distribution (2)
• Claim Amount Distribution (4)
• Impact of Sales Tax on Future Growth…
• Macro-economy, style of government and market competition…
• Data Limitations (3)
• Further complications (3)

Answer 20

• Claim Frequency Distribution:
  
  • difficulty in defining a discrete claim
  • dependent on duration from inception, age, gender, etc.
• Claim Amount Distribution:
  
  • indemnity, often without ceiling => difficult to model
  • ​dependent on hospital capacity, medical advances, negotiations, inflation
  • little/no ability to control costs
  • settlement delays
• Impact of Sales Tax on Future Growth

​

• Also: macro-economy, style of government and market competition
• Data Limitations:
  
  • absence of statistics,
  • family covers where individual risk not known,
  • group arrangements where individual data can only be estimated
• Further complications: modelling also complicated by:
  
  • No Claim Discount Multi States (reduced data per ‘state’)
  • the need to recoup initial costs over several renewals,
  • modelling chain of events: GP >referrals >specialists >delays

Question 21

LTCI: healthcare reserving modelling complexities, intro

Briefly describe some of the complexities that arise specifically in setting assumptions/basis when reserving or modelling of LTCI contracts

(5)

Answer 21

• Claim Frequency Distribution:
• Claim Amount Distribution (where pre-funded)
• Volumes/demand
• Data Limitations
• Also: medical advances and care cost inflation make experience difficult to predict

Question 22

LTCI: healthcare reserving modelling complexities, in depth

Briefly describe some of the complexities that arise specifically in setting assumptions/basis when reserving or modelling of LTCI (12)

• Claim Frequency Distribution (2)
• Claim Amount Distribution (where pre-funded) (3)
• Volumes/demand (1)
• Data Limitations (1)
• Further complications (1)

Answer 22

• Claim Frequency Distribution:
  
  • little/no experience to base estimates on
  • little/no data to base estimates on
• Claim Amount Distribution (where pre-funded)
  
  • little/no control over provider costs, unless weekly/monthly benefit is capped
  • dependent on economy, inflation and capacity
  • long term efects highly variable
• Volumes/demand:
  
  • can be heavily dependent on political commitment/State benefits
• Data Limitations:
  
  • highly likely lack of credible/sufficient data/insurance stats
• Also: medical advances and care cost inflation make experience difficult to predict

Question 23

CI: healthcare reserving modelling complexities, intro

Briefly describe some of the complexities that arise specifically in setting assumptions/basis when reserving or modelling of CI

(4)

Answer 23

• Claim frequency issue
• Other claim frequency issues
• Modelling Complexity
• Data Limitations

Question 24

CI: healthcare reserving modelling complexities, in depth

Briefly describe some of the complexities that arise specifically in setting assumptions/basis when reserving or modelling of CI

• Claim frequency issue (2)
• Other claim frequency issues (3)
• Modelling Complexity (3)
• Data Limitations (2)

Answer 24

• Claim frequency issue:
  
  • major issue is potential need to estimate up to forty different distributions, plus allowances for trends…
  • …data unlikely to be adequate for this
• Other claim frequency issues:
  
  • improving diagnosis; improving treatments; greater availability of operations
  • these can all influence claim costs and need to be incorporated
  • impact differs on new and existing business
• Modelling Complexity:
  
  • disease-based vs. treatment-based claims definitions. suggested that these be modelled separately
  • guaranteed and reviewable alternatives
  • tiered benefits
• Data Limitations:
  
  • unavailability of statistics for historical incidence rates.
  • however, practically, only cancers and heart attacks will provide enough data.

Question 25

Other general issues: healthcare reserving modelling complexities

Briefly describe some complexities that arise specifically in setting assumptions/basis when reserving or modelling (and are applicable across all health care contracts) (12)

Answer 25

• Modelling Complexity:
  
  • role of genetics,
  • trends in anti-selection,
  • quality of underwriting
• Main Use of Modelling:
  
  • costing and reserving for options and guarantees,
  • model office (new business, EV, solvency, takeovers),
  • reserves (statutory, internal management),
  • pricing (profit, premium rates, charges)