Doubts from Chapter 15

[Kamal Sardana]

Q:1= Dilemma of Discount rate v/s Risk Discount rate
(A) What is the difference between 'discount rate' and 'risk discount rate'? Which one will be used in which case related to modelling perspective? In my view if we are talking about Profits, then use RDR else discount rate or interest rate?
(B) Am i correct if i say that if i want to be prudent then i will use lower valuation interest rate while doing pricing and will use higher RDR while assessing profitability of a contract? or if i say it in terms of risk that if the product is more uncertain then i will use lower interest rate for Pricing and higher RDR (due to higher risk premium) for assessing profits (i.e. via NPV,IRR,DPP)

 

[Lindsay Smitherman]

See this previous discussion thread, which should address most of what you are asking here:
https://www.acted.co.uk/forums/inde...count-rate-vs-discount-rate.15693/#post-59671

Pricing a contract is assessing the profitability of a contract: the insurer prices by changing the premium rates or charges until it gets the level of profit that it wants. Therefore a higher discount rate is prudent: it gives a lower profit outcome.

We tend to use the phrase 'discount rate' as a general reference to whatever rate is being used for discounting, and 'risk discount rate' specifically when the discount rate has had a risk margin added onto it (eg to reflect the shareholders' required rate of return allowing for risk). A 'risk discount rate' would be used for valuing future profits for either pricing or EV calculation purposes under a traditional basis.