ALTAM Qualitative Questions

6 ADLS

• Bedding

• Eating

• Dressing

• Transferring

• Continence

• Toileting

Markov Property

• for a policy in state 1 at time t, the probability of moving from State 1 to State 2 in any future time interval is independent of the history of the state process before time t

Assumptions of multiple state models

• probability of future events depend on present but not on past

• from small interval [t, t+h], the probability of 2+ transitions is v small

• t_p_ij is a differentiable function of t

why an insurer uses waiting periods in long term health products

• short term payments involve relatively high expenses

  • once illness has gone past waiting period, it is likely to be more significant and less costly relative to benefits

• pH will have other sources of income for short term sickness (i.e sick pay)

• offers pH a choice

  • for the same premium they will receive higher benefits for long term sickness in return for giving up benefits for shorter periods

why structured settles often use annuity format rather than lump sum

• better replicate loss to injured party (IP)

  • lost wages, medical and other expenses, offset inflation

• relieve IP from investment/interest risk (or burden of managing funds)

• reduce dissipation risk

  • risk of running out of funds from squandering/overspending

change that would improve accuracy of Euler approximation

• use smaller h for greater accuracy

define the term elimination period in the context of a disability income insurance product

time between beginning of a period of disability/sickness and the start of the disability income payments (basically a lag)

state with reasons whether (x) and (y) have independent future lifetimes under this model

• if force of mortality for each is different depending on whether the other is alive or dead —> DEPENDENT

• for a 4 state (alive alive, alive dead, dead alive, dead dead) model, usually if mu01=mu23 and mu02=mu13 then —> INDEPENDENT

3 reasosn why couples have dependent future lifetimes

• common shock

  • both lives may die at the same time (accident)

  • common lifestyle

    • i.e healthy (exercising) or unhealthy habits (smoking)

  • broken heart syndrome

    • mortality may increase temporarily after the death of one’s partner

describe two ways that dependency is incorporated in a specific model

• common shock

  • simultaneous deaths represented by transitions from state 0 to state 3 or 4

• broken heart syndrome

  • mortality of surviving life is higher than individual mortality when both are alive

why employers sponsor pensions for their employees

• compete for new employees

• retain employees in productive years

• facilitate turnover of employees at older ages

• tax-efficient remuneration (total compensation)

• tool in negotiations with unions

• fulfill the responsibility to provide for long-serving employees

• improve the morale of employees

define adverse selection

• pH makes decision based on asymmetric information about risk

  • info known to pH but known to insurer

• pH who represent higher risk tend to buy more insurance

Defined Contribution Plan

• specifies how much an employer will contribute

  • usually as % of salary

• Contributions are accumulated in an account which is available to employees when they leave company

• set to meet a target benefit level

• actual retirement may be below or above target, depending on investment experience

normal cost using PUC < normal cost using TUC

explain why this will be true for all employees near retirement

• for both approaches, contribution rate tends to increase as # of service years increases (as we get closer to retirement)

• TUC doesn’t project future salary increases (valuation date) or future service credit, while PUC is based on salary with projected future salary increases

  • TUC contributions start smaller than PUC

  • rise more steeply

  • ending at considerably more than PUC

• TUC contributions in any given year must reflect full increase in salary and additional year of service which were not reflected in the accrued benefit at EOY of service

• PUC contribution only reflects the additional year of service

  • does not need to reflect salary increase

  • already accounted for in accrued liability at BOY

DC vs DB Plan

contribution level

• specify level (usually as % of salary) —> set to meet a target benefit level

• salary near retirement (final salary plans or through employment)

when fund underperforms

• no additional contribution required

  • employee will receive less in retirement benefit

• additional contribution required to bring fund up to level that is sufficient to pay specified level of benefit

  • employee will receive the specified level of benefit

when fund overperforms

• contribution level remains the same

  • employee will receive more in retirement benefit

• employer may reduce contributions into fund

  • employee will receive specified level of benefit

• investment risk assumed by employee

• investment risk assumed by employer

how are profit tests applied in practice

• set premiums

• set reserves

• measure profitability

• stress test profitability

• determine distributable surplus

explain why lapse supported policies are risky to the insurance company

• policies where profits incrase as lapse rate increases

• lapse rates are much less predictable than mortality rates

• contract that is only profitable if people lapse is very vulnerable tot he risk that policyholders lapse at much lower than the expected rates

“as the NPV and profit margin meet insurer’s requirements, the product is ready for market ” —> critique this claim

• not ideal to have negative emerging profit in later years of contract

  • requires insurer to acquire additional cash from elsewhere

without incorporating reserves, why might net cash flows in later years be negative?

• level P is more sufficient to pay expected death claims and expenses of early years

• with increasing probability of death, P is not sufficient

profit signature vs profit vector

• policy is in force at the start of the year

• assume policy is in force at time 0 (at issue)

motivation for zeroized reserves

• no reserves —> negative surplus emerges in later years of contract

  • unacceptable under risk management

• holding reserves —> positive emerging surplus in early years

  • using capital to support liabilities is expensive

• insurer does not want to hold more reserves than necessary

  • avoid negative surpluses in later contract years

• use profit test to determine minimum reserve that would be required at each year end to eliminate negative surpluses in any year, after initial outgo

why holding less capital increases NPV

• interest rate is typically less than discount rate

• discount rate indicates return required on equity invested

• within profit test, assets are earing at lower rate but higher discount means capital required for contract needs to earn higher

• if less capital is required, the cost of capital is lower, allowing more profit in form of NPV

motivation for UL

• create insurance policies that can compete with the flexibility and upside potential of mutual fund-type investments

  • insurers have devised a range of new style, variable contracts, with greater flexibility, greater transparency and with profit sharing integrated in the policy design

• flexibility in premiums and benefits

  • increased emphasis on investment returns compared w traditional insurance

Type A vs Type B UL

• level total DB

  • as AV increases, ADB decreases

• level ADB

DB = AV + ADB

why the corridor fact requirement exists for UL insurance

• UL is regulated as an insurance product

  • CF ensures the insurance benefit is significant through contract term

identify a common secondary guarantee and briefly describe it

• no-lapse guarantee

  • with this benefit, once a specified # of P have been paid in full —> DB cover remains in replace even if no further P is paid and even if the AV is insufficient to support CoI in any future year

  • guarantee could apply if expense and mortality charges increase sufficiently to exceed monthly P

  • pH AV would support balance until exhausted — nlg comes into effect

what is a lapse-supported policy?

• insurance contract where P is set with expectatino that certain % of pH lapse

main purpose of insurer including surrender charge in UL policy

• allow insurer to recover upfront expenses, such as commissions and underwriting costs, if policy is surrendered early

“higher P will increase profit and so the required profit margin can be changed by just adjusting P” —> critique this claim

• premium paid is an input assumption, not policy parameter (unless insurer changes minimum P)

• changing minimum P would likely significantly reduce marketability of policy

explain the difference between GMIB and GMWB

• once pH annuitizes fund under GMIB, they no longer have access to fund

• GMWB allows pH to access funds at anytime, as long as something is left

• at pH death, GMIB does not provide residual payment (unless annuity has a fixed term of payment)

• GMWB pays remaining funds in account (to policyholder’s estate) upon death

one advantage/disadvantage of GMWB vs GMIB (perspective of pH)

• advantage

  • can withdraw whatever with GMWB as long as funds available

  • GMIB —> fixed annuitization

• disadvantage

  • minimum payment is lower under GMWB than GMIB (w/same fund value at start of annuity)

major risk an insurer faces when selling GMDB

• costly to insurer if assets in pH fund perform poorer than expected

one advantage and disadvantage for the insurer of purchasing put options to hedge guarantee costs

• advantage

  • hedging guarantee limits downside risk

• disadvantage

  • cost of options is substantial

describe one advantage and one disadvantage of hedging the guarantee (compared w holding reserves)

• major risk of GMMB is that pH fund returns are low enough to be less than single P paid

  • cannot be diversified away by the insurer selling a large number of identical policies

• put option eliminates all risks associated w GMMB

  • more expensive than holding reserves

reset option advantages

• encourage pH not to surrender policy even when guarantee is far out of money

• discourage costly lapse and re-entry risk

• useful for marketing

reset option disadvantages

• keep outdated/old contracts on books

• time concentration risk

  • many pH may reset at same time which means maturity dates will be around same time

• liquidity risk

  • create spike in guarantee cost of portfolio at specific time

effect of common shock on Actuarial Liability for pension plan

• reduces expected period of payment of spousal benefits

effect of reset option on a policy

• guarantee matches the fund value at that time

• extends maturity date to x years from the reset date

why the analysis of surplus is an important component of valuation

• indicates whether parts of the valuation basis are too conservative or too weak

• assists in assessing performance of managers

• assists in determining allocation of resources

is the reserve on a UL policy containing secondary guarantees higher, lower, or the same as the AV?

• higher

• If there is a secondary guarantee, the insurer should set aside additional reserves to cover the cost of supporting the guarantee