Chapter 31: Setting Assumptions

Question 1

5 Most important things to consider when setting assumptions

Answer 1

• The use to which the assumptions will be put
• The financial significance of the assumptions
• Consistency between the various assumptions
• Legislative or regulatory constraints
• The needs of the client

Question 2

4 Examples of where historical data will be a useful starting point for setting assumptions

Answer 2

• past investment data on dividend yields and total returns for setting future yield and return assumptions
• past index data for setting inflation assumptions
• past data on salary levels for setting salary growth assumptions
• past demographic data on e.g. mortality and withdrawals, for setting future rates.

Question 3

4 Examples of how current data may be useful in setting assumptions.

Answer 3

• difference between current yields on government fixed interest and index-linked bonds can be used to estimate market levels of inflation
• policy statements by governments and banks can help in setting economic assumptions
• sponsors may be able to give indications of planned salary increases or withdrawal rates
• assumptions may be defined in legislation

Question 4

In analysing past data, what issues does the actuary need to deal with?

Answer 4

There may be an insufficient quantity of past data to be credible.

The quality of the data may not be perfect since it may be affected by

• trends over time,
• abnormal fluctuations,
• random fluctuations, and
• errors.

If the data is taken over a reasonable time period, there may have been changes in:

• social,
• economic, and
• fiscal conditions;
• changes in the way the data has been recorded; and
• changes in the mix of homogeneous groups underlying the data.

The mix of business to which the future assumptions apply may also be different to that underlying the past data.

Question 5

Examples of how social, economic and fiscal changes can affect data

Answer 5

Changes in ECONOMIC AND FISCAL CONDITIONS affect

• — dividend yields,
• — salary growth and
• — investment returns.

ECONOMIC CONDITIONS affect
—- inflation rates which fluctuate significantly.
ECONOMIC TRENDS, such as a recession, affect withdrawal rates.

SOCIAL TRENDS such as medical advances affect MORTALITY data.

As a result, it is common to attempt to strip out such effects from the data, before using the data to set assumptions.

Question 6

How can you get around the problem of a change in the mix of homogeneous groups underlying the data over time?

Answer 6

By using risk classification.
Split the data down into homogeneous groups.
However, the data may not be sufficiently detailed to enable this, or if it is, the amount in each individual cell may be too small to be credible.

Question 7

What 4 factors affect the need for accuracy when setting assumptions?

Answer 7

• the purpose of the valuation
• the significance of each assumption to the overall result
• whether the individual cashflows are important or whether the overall value of the cashflows is important
• the financial significance of any errors

Question 8

6 features that can increase the risks in the design of an insurance product.

Answer 8

• lack of historical data
• high guarantees
• policyholder options
• overhead costs
• complexity of design
• untested market

Question 9

When pricing a life insurance contract allowance will need to be made for:

Answer 9

• reinsurance costs
• risk & profit margins
• risk discount rate
• profit criterion

Question 10

Examples of profit criteria

Answer 10

• Net present value
• Internal rate of return
• Discounted payback period
• Ratio involving a net present value, such as NPV/Distribution costs