Valuation of Life Insurance Liabilities - Chapter 8 - CASH FLOW TESTING
Overview
- Good and Sufficient - used to be OK to just do a GP valuatin
- GP valuation used to cover following situations
- stat Valn was deficient - did not consider w/d or expenses
- experience mortality higher than stat valn standard
- reserve strengtening needed due to investment yields not supporting valn i
- Now relies on Valn Actuary concept
- CFT includes interaction between A/L under differernt int scenarios
- impact of epidemics on co's resources
- impact of mortality deterioration due to selective lapsation
Definition of CFT
- projection of cash flows in which specific timing of asset and liab cash flows is considered
- CFT generally recognizes the following factors
- interrelationship between assumptions
- competitors i & div rates
- investment yields available in marketplace in general
- company assumptions w/r to non-guar elements in different economic environments
Assumptions Needed
- Future Economic Environments
- must choose a set of future economic scenarios to test under
- Handpicked Scenarios (aka Deterministic Approach)
- 1990 SVL adn NY126
- Advantages
- teset is more comfortable w/ reviewing results since he constructed them
- scenarios tend to be easy to describe (up/down, rapidly increaseing, etc)
- Disadvantages
- disagrement over probability of a scenario
- cumbersome to generate a large # of hadnpicked scenarios
- need a lot of scenarios for statistical credibility
- tens to produce more favorable restults than expected statistically
- Log-Normal Model
- basic assumptions
- ln(i(t+1)/i(t)) is Normal RV
- mean (mu) = 0 and std dev (sigma) is measure of volatility to be expected
- used to generate future s/t and l/t in rate
- usually 90 day and 10 yr
- other rates through interpolation or functional relationships
- Transitional Probability Approach
- define universe of yield curves
- probability matrix - probabilities of one yield curve following another
- start w/ current yield curve and run monte carlos to generate future yield curves
- Competitor Rate or Market Rate Assumption
- important since many CFT funtional relationships key off relationship between credited int rates , mkt int rates and lapse rates
- mkt rate assumptions often bases as function of current int rates and a moving avg of an int rate
- Nonguaranteed Elements Practices
- Typical CFT strategies include
- credit earned rate less investment margin
- credit some function of market rate
- hybrid approach
- Lapse Rates
- little experience w/r to interaction between lapse rates and credited rates on life and annuities
- lapse assumption based on common sense argument - as other options become more attractive, more likely to surrender policy
- things to consider
- presence and level of SC
- mktg techniques and loyalty of field force
- prominence of i in mktg and maint of policy
- duration from issue
- type of products sold - SPDAs more int rate lapse sensitive than trad life
- Reinvestment Strategies
- actuary and investemetn officer work together to understand/define how positive cash flows invested in future
- ex. % of pos cash flows into each type of security or a blance of each type w/in total portfolio
- need to define what mkt conditions might change this strategy
- negative cash flows
- sell assets
- negative assets (borrowing between lines)
- borrowing @ s/t rate
Case Study
Copyright © 2004 Steve Welander.
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