General ST1 Q's

[SV001]

Hi there. My questions are as follows:

1. Ch 20 page 4 and 5 - please explain the difference between determining margins analytically versus stochastically.
2. Ch 16 - group pricing. I understand the concept of burning cost as well as the formula for experience rating premiums. But how do these 2 concepts link with each other. For example in the experience rating formula the non-bookpremium is related to past experience (does this mean that past experience is adjusted to allow for expected changes in future for the group in particular) hence this non-bookpremium is basically the same as the burning cost calculation.
3. Ch 21 p24 (Reserving) - please explain the first sentence of the third last paragraph which starts with: "For without profits business,..."
4. When we calculate premiums/do profit testing, we have to allow for reserves. Do we allow for the statutory reserves including solvency margin even though the actual basis for premium or profit testing is best estimate or realistic?

Thanks!
Valerie

 

[Steve McIntosh]

1. For each assumption, under the analytical approach you consider its probability distribution (and e.g. its mean and variance) to work out what one(prudent) value the assumption should have. You then stick these (prudent) assumptions in the model to calculate the required reserve. In this case the model is only run once – although, in practice, you are likely to do sensitivity testing

With stochastic modelling, you run the model many times, where the parameter values for each stochastic assumption is generated from random values from its probability distribution. So you end up with thousands of values for the reserve. You then chose the reserve value that you feel is appropriate, e.g. that which should be adequate in say 97.5% of cases.

2. Yes, exactly. The past experience of the group should be adjusted for expected future changes, inflation, etc. This is the “burning cost” as defined in the glossary – although “burning cost” sometimes has the alternative meaning of (unadjusted) historic cost of claims.

Group pricing is now covered in Chapter 17 of the 2009 Notes.

3. The sentence of Core Reading you refer to reads:
“For without profits business, embedded value is effectively the release of any margins within the solvency reserves relative to the assumptions used within the embedded value calculation.”

I think this is still referring to the present value of future shareholder profits on the existing business (PVFP) part of the EV calculation. If the assumptions used to calculate the supervisory reserves (including the interest rate assumption) were exactly the same as those used to calculate the future cashflows in the EV calculation, then the profit emerging in each year would be zero. (Net cashflow plus investment income on reserves would equal the release of reserves in each year.)

Therefore, the extent to which the two bases are different will be reflected in the PVFP calculation. For example, in the (more realistic) EV calculation, estimated future cashflows and estimate future interest are likely to be higher than in the (more prudent) reserving basis, which will produce positive future profits.

4. Oh yes. This is because the reserves (and the solvency margin) that we will actually need to hold are those that are calculated on the statutory basis. By doing this in the profit test calculation, we are effectively allowing for the amount of capital that is tied up in the reserves and solvency margins on the contract throughout its lifetime.

Our basis for projecting cashflows is therefore likely to be different from that used to calculate the reserves.

Hope this helps. All the best.