Setting assumptions for mortality

[QueryST]

Q1 if we use own experience data for same type of contract or similar product ,then why we need adjustment for target market or underwriting standards ?
Q2 How EAS vary wrt change in interest rate? There is a question Q6(IV) September 2011 ...investment effect on assetshare ,need to understand wrt to that ?

 

[bystander]

I will address 1). If you are setting a pricing basis, you want assumptions relevant to future experience you will get on the tranche of business written on these standards/terms etc. So the product experience to date is relevant but you may see some changes. You may have a different target market in mind eg life assurance aimed at different occupations or geography, which can have an impact on mortality experience you will get. Likewise, if you have stricter underwriting but on the same target market, you might anticipate better experience because you are screening out more of the worse risks. There can also be other differences eg in social attitudes but that tends not to affect parameters like mortality much but could mean other assumption adjustments rather than pure past experience. You should always consider the need to change even if your conclusion is there is no impact hence need to adjust.

 

[Mark Willder]

Q2 How EAS vary wrt change in interest rate? There is a question Q6(IV) September 2011 ...investment effect on assetshare ,need to understand wrt to that ?

Asset share is the accumulated value of the premiums less claims and expenses. So if assets fall in value then the asset share will fall in value.

If the company invests in bonds, then a rise in interest rates will cause the price of the bonds to fall. This will be reflected by a fall in the asset share.

Best wishes

Mark

 

[QueryST]

But we accumulate assetshare with backed assets interest rate...then if bond interest rises then assetshare should rise..at time of exit we should take credit of bonds value

 

[Mark Willder]

But we accumulate assetshare with backed assets interest rate...then if bond interest rises then assetshare should rise..at time of exit we should take credit of bonds value

No, I'm afraid this is not true. An example might help.

We buy a two year bond for 100 that yields 4% (coupons paid annually for simplicity). At the end of the first year we will have 104 as long as interest rates remain at 4%.

However, if interest rates rise to 10% then the bond will be worth 104/1.1 = 94.55. So we now have a bond worth 94.55 and a coupon worth 4, so in total we have assets of 98.55. Our earned rate of return has therefore been minus 1.45% and our asset share will have fallen.

Best wishes

Mark

 

[QueryST]

I got badly confused here_
1) why 104 in 2nd year above is used to calculate earned rate at the end of 2nd year ?..I know it may be very basic but it's not striking me now.
2) As per this 1st year assetshare will accumlate with 4% and 2nd year with -1.45% and for next year it will depend on rate of interest of purchased bond again at that time?

 

[Mark Willder]

I got badly confused here_
1) why 104 in 2nd year above is used to calculate earned rate at the end of 2nd year ?..I know it may be very basic but it's not striking me now.
2) As per this 1st year assetshare will accumlate with 4% and 2nd year with -1.45% and for next year it will depend on rate of interest of purchased bond again at that time?

To work out the rate of return in the first year, we need to know the assets we have at time 1. At time 1, the future payments will be redemption proceeds of 100 and a coupon of 4 (both paid at time 2).

At time zero we have assets of 100 (we can check this, we have coupons of 4 paid at the end of first and second years and redemption proceeds of 100 paid at end of second year, so discounting at the current yields of 4% gives us 4/1.04 + 104/ 1.04^2 = 100).

At time 1 our bond is now only worth 94.55 and we have the coupon of 4. So the return we have earned on our assets in the first year is 98.55/100 - 1 = -1.45% (so in the first year we accumulate the asset share at -1.45% and not the 4% that you suggest).

At time 2 our bond is redeemed at 100 and we have a coupon of 4, giving a total of 104. The value of the bond at time 1 was 94.55. So the return in the second year is 104/94.55 - 1 = 9.995%.

So we accumulate the asset share at -1.45% in the first year and 9.995% in the second year.

Best wishes

Mark