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Expense inflation projection

Discussion in 'SP2' started by MindFull, Jul 2, 2020.

  1. MindFull

    MindFull Ton up Member

    Hello,

    In Chapter 30, it says that expense inflation would be projected to the midpoint of the premium paying period. Is this because we expect half the policies to be off the books by then and if that is so, why (since we project lapses/deaths)?

    Thanks
     
    MindFull, Jul 2, 2020
    #1
  2. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hello

    No, that's not quite right. We're assuming that the contracts remain in force until the end, so that on average the expenses will occur half way through the policy.

    Best wishes

    Mark
     
    Mark Willder, Jul 2, 2020
    #2
  3. MindFull

    MindFull Ton up Member

    Hi Mark,
    Thanks for the reply. However I'm a little confused based on my experience. If you are pricing a 5 year term and doing a projection for say 3 years of NB, then the last set of policies should end 8 years from now. So for the expense assumption, you would inflate your NB expense assumption for 4 years even with 3 years of NB? Also, would you inflate your renewal expense to the same point or until the end of the last policy?

    Thanks again.
     
    MindFull, Jul 2, 2020
    #3
  4. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hi

    I'm not sure whether I'm looking at the same part of the notes, but at the end of the solution to 1.2 it says:

    "These expenses should be inflated to the midpoint of the period for which premium rates are expected to be in force."

    So this would allow for the term of the policy as I suggested, but also the length of time that the premium rates were in force as you suggested. Either way, we're ignoring lapses and deaths for simplicity (although in practice you could allow for these).

    Taking your example, the initial expenses occur at the start of the contract. The contracts are to be sold for 3 years. So the average inflation is 1.5 years.

    The renewal expenses occur on average half way through the term. As the term is 5 years then on average that is 2.5 years from the start of the contract. But on average these policies are sold in 1.5 years time. So we would apply the inflation to 2.5+1.5 = 4 years as you suggest.

    Best wishes

    Mark
     
    Mark Willder, Jul 2, 2020
    #4
  5. MindFull

    MindFull Ton up Member

    Hi Mark,

    Thanks for the detailed reply. Please forgive my inability to properly apply the uniform distribution to expenses being incurred. Just to close off, if we were doing the pricing process using a projection period of 1 year and the same 5 year term, NB exp should be projected to 6 months, and the renewal for 2.5? I think my confusion comes from "period for which premium rates are expected to be in force" and how that would apply to expenses we know to be incurred at the start of a contract. (Further associating renewal expenses with renewal premiums)

    Thanks and sorry for the bother!
     
    MindFull, Jul 2, 2020
    #5
  6. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hi

    Yes, if we expect rates to be in force for one year, then on average new business is sold in 6 months time and we inflate initial expenses for 0.5 years.

    If it is a 5 year contract, then on average renewal expenses occur after 2.5 years. But the contract is sold on average after 0.5 years. So we inflate renewal expenses for 3 years.

    Best wishes

    Mark
     
    Mark Willder, Jul 6, 2020
    #6
  7. MindFull

    MindFull Ton up Member

    Thanks Mark, I understand the distinction now.
     
    MindFull, Jul 6, 2020
    #7

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