Chapter 20: Setting assumptions Flashcards
When setting assumptions it is important to consider
- the use to which the assumptions will be put
- take care over the choice of the assumptions that will have the most financial significance
- achieve consistency between the various assumptions
- consider any legislative or regulatory constraints
- consider the needs of the clients
Demographic assumptions
eg mortality rates. They relate to the size and distribution of the population. They generally affect the: - timing - number of the cashflows
Economic assumptions
eg investment returns
Relate to the level of income or outgo.
They generally affect the LEVEL of the cashflows.
4 Examples of where past data may form a useful starting point
- determining an assumption for future investment returns.
- past data on salary levels in a particular country/industry/company may be useful when making an assumption about future levels of salary growth.
- History of an inflation index may be useful in determining an assumption for future benefit growth.
- Historical data can also be helpful when choosing demographic assumptions
Current data and forecasts
- Current yields may provide some indication of the market’s view of future levels of indices.
- Policy statements by governments/controlling banks may be useful when making assumptions about economic factors
- A scheme sponsor may be able to provide info on planned future salary increases
- Assumptions may be defined in regulations or legislation
With what should the relevance of past data to future projections be balanced against?
the need for sufficient data for its analysis to be statistically credible. (There is a conflict between credibility and relevance)
When having past data, the actuary needs to consider how to deal with:
- abnormal fluctuations
- random fluctuations
- potential errors in the data
- changes in the experience with time
- changes in the way in which the data was recorded
- changes in the balance of any homogeneous groups underlying the data
- heterogeneity within the group to whom the assumptions are to relate
4 Sources of historical data to set demographic assumptions
- national statistics, published by government bodies and economists
- industry data
- tables compiled by actuaries
- past information relating to the particular contract being considered
Fluctuations and changes over time
- Changes affecting economic data
- Price inflation
- Use of real values
- Other economic adjustments (taxation)
- Demographic changes
- One-off impacts (pandemic)
Changes affecting economic data
- Changes in economic and fiscal policy
- General economic cycle
Price inflation
- A useful indicator of the economic conditions that exist
- Current index values may be a better guide to future levels of inflation
Demographic changes
- Also affected by economic changes
- Trends are important
- Mainly affected by medical advances
Data recording
- Changes in statistics recorded (distort the past data and lead to inappropriate assumptions unless these changes are recognised)
- Errors in data recorded
Heterogeneity
- Changes in the constituents of the population (changes in the balance of homogeneous groups over time)
- Splitting the population into homogeneous groups (it is important that the past data used is relevant to the group of individuals about whom the assumptions are to be made)
Considerations to be made when using standard tables
- whether the data is relevant to the intended population at which the product is marketed
- whether adjustments need to be made to the data to reflect continuation of past historical trends
The need for accuracy and prudence
- Purpose of the valuation
- Accuracy of assumptions (is there a need to make a judgement about each assumption or just the overall value resulting from the combination of assumptions)
- Significance of error (consideration of the potential financial significance of errors in the assumptions helps to assess the degree of accuracy required)
The effect of assumptions on cash transactions
Under- or overstatement will give one party a direct financial advantage at the expense of another. Each party have a preference for which side of ‘best estimate’ they would like to see each assumption.
Assumptions
Estimates of the expected values for the parameters
Where a cashflow model is being used to price a product, the risk to the provider from adverse future experience could be allowed for by:
- Adjusting the risk elements of the risk discount rate
- Using a stochastic discount rate
- Applying margins to the expected values
Profit margins
In pricing a product, a profit requirement will need to e incorporated
Features that can make a contract design riskier (6)
- lack of historical data
- high guarantees
- policyholder options
- overhead costs
- complexity of contract design
- untested market
Profit criterion
Single figure that summarises the relative efficiency of a contract.
E.g. NPV, IRR, discounted payback period
