1. 3. Deriving assumptions for reserving purposes
1.1. General principles
1.1.1. Published accounts
1.1.1.1. Consistent with accounting principles and legislative requirements of territory concerned. consider: -going concern or break up basis -true and fair view reserves are BE or other, and how the terms used are to be interpreted.
1.1.2. Solvency accounts
1.1.2.1. Maybe different if seperate solvency accounts are required. different basis Reference is to be made to rules and guidance that may have been issued. constrains. Some places moving towards supervisory regime where base reserves are calculated on best estimate or market consistent basis.
1.1.3. Expected future experience If premiums on BE, use same purpose. add margins so probability of reserves falling below certain level is acceptably low - legislative requirement
1.2. Valuing liabilities on a BE basis
1.2.1. Internal management accounts
1.2.1.1. Discussed and agreed with insurer. Aim likely to be product expected values of future experience based on realistic assumptions. look at profitiability, solvency, claims and exposure, expenses, reinsurance performance, movement analysis, investment performance, results split by source of business
1.2.2. Basis will be close to that used in new business pricing No elimination of negative reserves - unless regulations did not permit these to be held Method used if want BE of financial performance. Directors rewards, insurer to be sold, regulatory requirement, Investment strategy setting, reinsurance agreements, internal management accounts.
1.3. Statutory reserving vs pricing assumptions
1.3.1. Premium rates could be calculated using prudent assumptions - common in some places, or assumptions that reflect the expected future experience, and RDR allowing for risks. If supervisory required prudence in reserving assumptions, not appropriate to use same set for pricing and reserving.
2. 4. Deriving assumptions for determining profitability of EB
2.1. Introduction
2.1.1. Assumption principles similar to pricing purposes for cash flow model. differences will be timeframe - Pricing - want assumptions valid over next few years so don't need to reprice, EV, apply most approprate rate as of now. Discount rate lower for EV as uncertainty of sales volume and mix no longer exists.
2.2. Purpose of EV
2.2.1. Relevant to long term insurance business PV of future shareholder profits in respect of EB of company, including release of shareholder owned net assets. EV recognises assets in excess of reserves, but also, release of margins in those reserves. Ev Calculated in: -Establishing true worth of business ofr internal management accounts -include in published financial statements -assess major part of an appraisal value for sale or purchase to analyse value of future surpluses for reinsurance EV financing - Fin Re To assess growth in EV for bonus payments.
2.3. Calculation of EV
2.3.1. Shareholder owned share of net assets, where net assets, where net assets are excess of assets held over those required to meet liabilities. Assets at MV or discounted to reflect "lock in", i.e. capital invested at 4% (secure assets), but EV using 5% RDR. therefore, value 1.04/1.05 to power of years to discount capital. show lower net asset value than MV. PVFP - method similar to a profit test, EB projected to estimate expected future shareholder profit, which are discounted back. Calc may differ depending on business type: -CNP Present value of future premiums plus investment inv income less claims and expenses and release of supervisory reserves. -UL PV future charges less exenpenses and cost of benefits plus inv income and release of any non unit reserves CNP - Release of margins Reserves should be consistent in net assets, and PVFP.
2.4. Appaisal value
2.4.1. Goodwill - estimated profits expected from future business. EV plus good will is appraisal value.
2.5. Assumptions
2.5.1. EV basis key decision-need reserving basis, and projection basis. Reserves always on supervisory basis. If for internal accounts BE basis, although if published, regs may require a more prudent basis. Measure regularly so see worth and progression for share holders. Appraisal likely to be realistic basis with no margins, purchase value maybe more conservative - purchaser offer a lower price, final price depends on bargaining strength. EV financing in reinsurance, may also restrain amount of future ceding that can be factored into current commission payment. Bonus, prudent or realistic.
2.6. Allowing for risk
2.6.1. EV need to incorporate risk margin to allow for unpredictability of profit emergence for H&C business. Discount rate to reflect risk. if profit believed to be 100 in year 10, need to reflect risk of this profit occurring. Higher RDR, more prudence. Stoch or market consistent approach can be adopted. Range of outcomes, RFR, and assume investments earn RFR too. Risk margin deducted from EV to reflect on invesmtent risks, using cost of capital approach.
3. 1. General Considerations
3.1. When setting assumptions
3.1.1. Important to: *Consider use of assumptions - price, provisions *take care over choice of assumptions that are financially significant *achieve consistency between basis *consider legislative or regulatory constraints *needs of client *parameters derived from data are as accurate that the body will allow *data used are relevant to the risks the policies encompass (lives) *Basis used for period valun and resn are flexible to reflect changing risk circumstances. Credible database relevant to the risks for determining assumptions is funamental to process of valun and pricing.
3.2. Process for setting assumptions
3.2.1. Investigate historical experience, make BE of parameters - estimates appropriate in historical context *consider future conditions - commercial, economic, *Determine BE in context of expected future conditions. Reliance on historical data depends on credibility and relevance of it, and how predicable the parameter is. *May need to adjust BE to include a margin for prudence. Size depends on purpose for model, and degree of risk with param.
3.2.2. Assumptions: Demographic -IP claim inception rates and recovery -CI Claim incidence -LTCI Claim inception rates and any future transition probabilities -PMI Claim incidence rates -Mortality rates -Lapse rates -Renewal rates Financial assumptions -Benefit amount benefit inflation -Expense and expense inflation -Commission and clawback -Investment return -Taxes Other -NB vol mix -Reserving and capital requirements -RDR -Profit criteria
3.3. Consistency
3.3.1. Guiding principle in basis creation, is principle of consistency. Assumptions need to be considered in totality and not in isolation. Joint behaviour realistic - morbidity and non renewal, morbidity and claims expenses, morbidity and investment return, NB and fixed expenses, Business vol and lapse/non renewal, Lapse and investment, invesment and inflation -consistent between related products.
4. 2. Deriving assumptions for pricing purposes
4.1. Introduction
4.1.1. *Emphasis on: -book rates business(rather than experience rated) - i.e. individuals past experience - group insurance, NCD on PMI -Initial derivation of premiums for a company new to this line -Rates fine tuned as experience develops
4.2. Basis
4.2.1. BE plus margins for adverse experience
4.3. Margins Needed
4.3.1. Applying margins to expected valus
4.3.1.1. for formulaic approach, cant do stoch or via RDR. only margins. Have to use judgement
4.3.2. Using stochastic approach
4.3.2.1. Likely outcomes with differing probabilities
4.3.3. Assuming higher discount rate
4.3.3.1. Risk premium
4.3.4. Uncertainty in future outcomes, add margins to ensure that insurers promises are met - especially the case in healthcare insurance. Volume of relevant statistics not as credible as life insurance - claim outcomes much more subjective and influenced by more factors, funnel of doubt in H&C insurance than life. Margins influenced by purpose, ie. need for competitiveness. Degree of risk and financial significance key drivers.
4.4. The ultimate price for the contract
4.4.1. marketability and competitiveness also important. Underestimate incident rate, - substantial losses overestimate - risk of not selling Worse to under then over estimate morbiditiy Price charged and margins depend on: -Competitive nature of market -USP - higher, more likely to sell -Companies attitude to risk -Credibility, accuracy, relevance and up to dateness of data -size of free assets or parental guarantee