chapter 5

In chapter 5, section 1 the basis, it talks about 'the assumptions being more cautious than the best estimates'
what does cautious mean here?

Thank You.
P.S.: The statement that I have mentioned above is in the 2nd paragraph of the attached page.

 

I think it means, we take assumption on prudent basis. Like - what is given in the next paragraph is, the insurance company assume a smaller rate of interest than expected, to be prudent. If the company expects rate of interest to be 8% pa ,even then it will take less than 8% say, 6% for calculating reserves to decrease the chances of ruin.

 

1. did you mean, that the individual assumptions in the basis are cautious about not causing a ruin?
2. what is the context of prudent basis in your reply?

Thank You

 

Okay, let me explain a bit more.

Basically, the premium collected by the insurer may not be sufficient to cover the future claims. So, the insurer needs to set aside some extra money as reserve to pay for the claims. And it also invest the premium incomes received earlier. So, if the insurer expects that the rate of return on premiums is 8% then he will keep the reserve accordingly. But now, suppose the rate comes out to be 7% say, then the insurer may fall short of money to pay the future claims since there is a lot of uncertainty. So, there is a chances of loss the insurer may face.

Now, if he make assumptions on the prudent basis, he may assume the rate to be 6%. It means he will have to keep more money as reserve than earlier because the premiums are earning less return now. So, if the rate turns out to be more or less than 8%, the insurer is safe. The rate may be slighty lower than 8%, but that's fine as the insurer is assuming 6%. And if it turns out to be higher than expected then insurer will make a profit.

This is what I understood by the meaning of this cautious assumption.

 

Thank you for your reply.
Your explanation seems reasonable, but it still doesn't answer my question.

 

Your questions were:

1. did you mean, that the individual assumptions in the basis are cautious about not causing a ruin?
2. what is the context of prudent basis in your reply?

Answer to 1: a cautious assumption is one that takes a pessimistic view of the future outcome, that is one that would lead the company to make lower profits or higher losses.
Answer to 2: Bharti has given a very clear example of this in the context of setting reserves.

Robert

 

Thank you