# Part 7 Flashcards

1
Q

Definition of a model

A

Cut-down, simplified version of reality that captures the essential feature of a problem and aids understanding

2
Q
• 3 approaches to modelling
• considerations to chose approach
A
• Purchase commercial modelling product
• Reuse exisiting model (possibly after modification)
• Develop new model
• Level of accuracy required
• In-house expertise available
• Number of times the model is to be used
• Desired flexibility of the model
• Cost of each option
3
Q

Explain “valid” in terms of a model

A

“valid” means that we should e.g. not use a stochastic investment model which has been developed for projecting assets proceeds over periods of 30 or more years, if we are only interested in cashflows over the next 5 years

4
Q

Definition of a “rigorous” model

A

A model that produces realistic (and hence useful) results under a wide range of circumstances and conditions

5
Q

Dynamic model

A

Allows for interaction between the parameters and variables affecting the cash flows

6
Q

Cash flows to consider when modelling a final salary occupational pension scheme

A

Inflows:

• Contributions made by the employer and possibly members
• Investment income on assets
• Capital gains on any asset redeemed
• Transfer values into the scheme

Outflows:

• Pension payments
• Transfer values out of the scheme
• Any othe benefit payment (e.g. death benefit)
• Tax if applicable
7
Q

Developing a deterministic model

A
• Specify the purpose of the investigation
• Collect, group and modify data
• Choose the form of the model (identify parameters and variables)
• Ascribe values to the parameters
• Construct a model based on the expected cash flows
• Check that the goodness of fit is acceptable (e.g. running a past year and comparing the model with the actual results)
• Fit a new model if the first choice did not fit well
• Run the model using estimates of the values of variables in the future
• Run the model several times to assess sensitivity of the results to different parameter values
8
Q

Developing a stochastic model

A
• Specify the purpose of the investigation
• Collect, group and modify data
• Choose a suitable density function for each of the variables to be modelled stochastically
• Specify correlation between variables
• Construct a model based on the expected cash flows
• Check that the goodness of fit is acceptable (e.g. running a past year and comparing the model with the actual results)
• Fit a new model if the first choice did not fit well
• Run the model many times, each time using a random sample from the chosen density function(s)
• Produce a summary of the results that shows the distribution of the modelled results after many simulations have been run
9
Q

Definition of “model point”

A

Representative single policy in a group. This policy can be used to represent the whole of the underlying business

10
Q

What important characteristigs would you expect the model point to capture when modelling a without-profit term assurance product

A
• Term of the policy
• Sum assured, payable on death
• Basis of policy (single life, joint life, last survivor)
• Age of life/lives covered
• Gender of life/lives covered
• Smoker status of life/lives
• Health status of life/lives
11
Q

3 factors that influence the number of model points used

A
• Heterogeneity of the class
• Sensitivity of the results to different choices of model points
• Purpose of the exercise
12
Q

Risk discount rate for model points could allow for

A
• the return required by the company
• the level of statistical risk
13
Q

Assessing the level of statistical risk

A
• Analytically (consider variances of the individual parameters)
• Sensitivity analysis
• Stochastic models
• Comparison with available market data
14
Q

Decrements of a benefit scheme

A
• Death before retirement
• Death after retirement
• Withdrawal from active service
• Transfer out
• Ill-health retirement
• Normal/early/late retirement
• Other options, e.g. exchanging some pension for a cash lump sum
15
Q

Use of models for risk management

A

Determine the amount of capital that is necessary to hold to support the risks retained by a financial institution

16
Q

Mitigating model error

A

Checks of goodness of fit to assess the suitability of the model

17
Q

Limitations of models and mitigations

A
• Prone to model error (results are only as as good as the underlying model)
• Consider losts of potential models
• Employ suitable expertise to identify the most appropriate model
• Level and timing of cash flows is uncertain
• Use stochastic moel
• Risk of data error (results will depend upon the data used=
• Ensure data is regularly updated
• Prone to parameter error (results depend upon the suitability of the assumptions used)
• Carry out sensitivity testing to identify the key assumptions, pay careful attention to the setting of those financial assumptions which are most important
18
Q

Two main sources of data

A
• Publicly available data
• Internal data
19
Q

Poor data can be due to … (2)

A
• Poor management control of data recording or its verification process
• Poor design of the data systems
20
Q

Good quality data could mean

A
• Complete (i.e. no ommissions)
• accurate
• up-to-date
• consistent with previous data
• Necessary level of details
• Audit trail
21
Q

Checks on data

A
• Detailed audit
• Resaonability tests:
• Averages
• Impossible values
• Outliers
• Consistency over time
• Check asset data vs. liabilities
• Spot checks
• In particular on the large items
• random
22
Q

Assertions to be examined for data

A
• That a liability or asset exists on a given date
• That a liability is held or an asset is owned on a given date
• That when an event is recorded, the time of the event and the associated income or expenditure are allocated to the correct accounting period
• That data is complete, i.e. no unrecorded liabilities, assets or events
• That the appropriate value of an asset or liability has been recorded
23
Q

4 causes for the lack of ideal data

A
• Data have not been captured at a sufficient detailed level
• There may be insufficient data to provide a credible result (e.g. new product)
• Poor systems
• Practically difficult/impossible to get good data
24
Q

Main aim of risk classification

A
• Obtain homogeneous data
• Reduction of heterogeneity in the data makes the experience in each group more stable
• Therefore enables the data to be used more appropriately for projection purposes
25
Q

Common economic assumptions

A
• Investment returns (e.g. bond yields, equity returns)
• Discount rate (for valuing liabilities)
• Earnings inflation
• Price inflation
• Pension increases
• Expenses
26
Q

Demographic assumptions for pension scheme

A
• Rates of retirement in good health (early, normal late)
• Rates of ill-health retirement
• Rates of withdrawal (for reasons other than retirement or death)
• New entrant rates
• Rates of mortality before and after retirement
• Proportion married
• Average age of spouses
• Spouses’ mortality
• Salary scale
27
Q

Historical data may be obtained from … (4)

A
• Indistry data
• Tables compiled by actuaries
• Past information relating to the particular contract being considered
28
Q

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

A
• Adjusting the risk element of the risk discount rate
• Using a stochastic discount rate
• Applying margins to the expected values
29
Q

Features that increase risk in a product design

A
• Lack of historical data
• High guarantees
• Policyholder options
• Complexity of design
• Untested market
30
Q

Classification of expenses

A
• Fixed vs. variable
• Example of variable expenses: Commissions, postal costs, legal expenses
• Direct (directly belonging to a particular class of business) vs. indirect (no direct relationship to any one class of business)
• Example of direct expenses: Underwriting costs, contract administration claims settlement expenses
• Example of indirect expenses: Computing, human resources, general management
31
Q

Expenses need to be allocated between …

A
• Functions (=activity, operation)
• Maintaining existing business (renewal and investment)
32
Q

A
• Fixed amount per contract
• Percentage of the premium charged
• Combination of the above
33
Q

A
• Historic (bring expense data up-to-date)
• Prospective (inflate the expense data to the time when the expenses are expected to be incurred)
34
Q

A

• value of benefits
• value of expenses
• contribution to profit

value of benefits = “risk premium”

35
Q

Scenarios to test premium for robustness

A
• Economic scenarios (e.g. investment returns being higher or lower than expected)
36
Q

Examples of distribution systems in the UK

A
• Independent intermediaries who select products for their clients from all or most of those available on the market
• Tied agents, who offer the products of one provider or a small number of providers
• Own sales force, usually employed by a particular provider to sell its products direct to the public
• Direct marketing, via press advertising, over the telephone, internet or mailshots
37
Q

Approaches to financing benefits

A
• Unfunded approach
• Pay-as-you-go (PAYG)
• Does not tie up funds
• Low transaction costs
• Funded approach