C14 Models 1

Question 1

State the prime objective in building a life insurance company model

Answer 1

Prime objective of model
- Prime objective in building model is to enable actuary advising company
to give it appropriate advice …
- … so that it can be run in sound financial way.

Models will be used:
1. to assist in day-to-day work
2, to provide checks and controls on its business

Question 2

List four different types of life insurance company models (that differ in the policies that are included in the model).

Answer 2

Types of life insurance company model
1. Profit test model
2. New business model
3. Existing business model
4. Full model office

Question 3

State the basic requirements of a life insurance company model.

Answer 3

Requirements of life insurance company model
 Model should project all cashflows that may arise.
 Cost of setting up supervisory reserves and required solvency capital should be allowed for in order to calculate profit flows.
 Proper allowance must be made for guarantees and options: stochastic model will probably be needed for this.
 Allow for interactions and correlations between variables (dynamic
links).

Question 4

When might actuarial judgement may be required in the modelling process

Answer 4

Actuarial judgement may be required in the modelling process in :
- Choice of the model to be used
- Selection of inputs
- deciding on the number and the type of the underlying models points

Question 5

State three advantages of stochastic models over deterministic models.

Answer 5

Advantages of stochastic models
1. Allow probability distribution to be assigned to one or more of unknown future parameters and so provide distribution of outcomes, not just single outcome
2. Positive liability can be calculated where deterministic approach might otherwise produce zero liability, eg costing guarantees and options
3. Parameters may be assumed to vary together as dynamic set, ie interactions can be explicitly modelled. This is particularly useful for modelling with-profits business.

Question 6

State two disadvantages of stochastic models compared to deterministic models.

Answer 6

Disadvantages of stochastic models

1. Time and computing constraints
2. Possible spurious accuracy, ie results very sensitive to (deterministically chosen) assumed values of parameter(s) involved

Question 7

Give two examples of circumstances in which deterministic models might be appropriate.

Answer 7

Uses of deterministic models

1. The actuary is satisfied that similar results could be obtained as if a full stochastic projection was used, eg the possible outcomes form a symmetric distribution and 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 8

Describe two approaches to calibrating stochastic models of economic
variables.

Answer 8

Calibration of stochastic models
1. Risk neutral (or market-consistent) calibrations attempt to replicate market prices of financial instruments as closely as possible, using an adjusted (risk neutral) probability measure.
2. Real world calibrations use assumptions which reflect realistic ‘longterm’ expectations.