7.1 Introduction
The following flow chart identifies the key steps that would typically be followed when setting the assumptions. The assumptions can be split into economic and non-economic items. There are also standard assumptions and non standard assumptions. The non standard assumptions tend to be in the form of manual adjustments.
7.2 Assumptions setting flow chart
Step1: Carry out experience investigation
Step 2: Analyse and interpret the results of the experience investigation
Step 3: Propose assumptions taking into account the results of the experience investigation
Step 4: Assess the impact of the proposed assumptions
Step 5: Get approval and sign off of the assumptions e.g. by the board/auditors
Step1: Carry out experience investigation – For standard non-economic items such as mortality and persistency, this involves investigation of the company experience in the recent past, assuming there is sufficient data to get credible results. For economic items, this may involve looking at the movement in the value of relevant indices. The experience investigation for non-standard items e.g. endowment
mis-and the results may be compared with prior year values. A check may be made to see if there are trends. An attempt may be made to explain any unusual experience.
Step 3: Propose assumptions taking into account the results of the experience investigation – based on an analysis of the experience and interpretation of the results of the experience, a best estimate basis will be proposed. It is important that all areas of actuarial agree the best estimate assumptions to ensure consistency across the company when these results are used for different purposes.
Propose assumptions for each reporting purpose, e.g. regulatory reporting, pricing, internal management reporting – this will include the consideration of a margin or adjustment to the best estimate assumptions agreed above.
Step 4: Assess the impact of the proposed assumptions – Calculations are done to assess the impact of changing the assumptions. This may involve running a copy of the production model and making assumptions changes in a way similar to what would actually happen in production. The impact of changing each assumption in turn will be calculated.
Document the assumptions and the relevant experience investigations – The experience investigation and assumptions will be documented in line with the company standards and guidance.
Step 5: Get approval and sign off the assumptions – The assumptions will be brought for approval, typically by the company board. The approval should be sought and should be obtained before the assumptions are used.
Risks and controls that need to be considered when setting the assumptions are considered in Section 7.3 below.
7.3 Risk & Controls
Step 1: Carry out experience investigation
Risks Risk factors Preventative Controls Detective Controls
1.1 Inconsistent methodology across groups • Complexity of the business • Document methodology (M) • Regular external reviews of methodology (M)
Step 2: Analyse and interpret the results of the experience investigation
Risks Risk factors Preventative Controls Detective Controls
2.1 Results not correctly analysed / wrong interpretation of the results
• Complexity of the assumptions is affected by company structure, type of basis (deterministic or stochastic) and item of basis.
• Qualification and experience of the individual
• Degree of review and sign off
• Agree and document method and approach to use for analysing the results (H)
• There should be independent review of all the work carried out. (H)
• All work reviewed and formally signed off by senior experienced resource (H)
• Involve the marketing department in the interpretation of the results (M)
• Compare the results with the work done by other departments e.g. high volume of claims will mean claims department would have been very busy. (M)
• Compare the results of the current year with the results of previous years. (M)
• Compare the results with those of peers in the market (M).
• Provide an explanation of the results (H).
2.2 High level or too low level analysis undertaken
• Knowledge and experience of individual
• Review by a senior resource (H) 2.3 Materiality not properly taken into • Knowledge and experience of • Set materiality guidelines (M).
Step 3: Propose assumptions taking into account the results of the experience investigation
Risks Risk factors Preventative Controls Detective Controls
3.1 Assumptions do not reflect the actual experience i.e. basis not appropriate
• There is no methodical link between the results of the experience investigation and the assumption setting
• Prudence in the assumptions
• Market pressure - basis may be set to be in line with the assumptions used by other companies in the market
• Assumptions should be justified in relation to actual experience (H)
• Margins in the assumptions should be explicit (M)
• There should be a documented basis setting process linking the basis to the results of the investigation (H).
• Impact of assumptions change should be compared with the financial impact of the actual experience. (M)
3.2 Assumptions do not comply with the regulations
• Staff knowledge of the regulations.
• Extent of formal checks that the assumptions comply with the regulations.
• Degree of complexity of the assumptions and extent to which the valuation systems can cope with complex bases.
• There should be a formal check that the assumptions do comply with the regulations (H)
• Regular reviews of the systems to ensure that they can cope with the nature of assumptions required by the regulations. (H)
• Seek external review of the assumptions (M)
• Benchmark the assumptions against those used by other companies in the market (H)
3.3 Assumptions does not reflect the actual experience for sub classes of
business/products
• Assumptions is set at a very high level
• The assumptions should be set separately for each sub class of business/product where the results of the experience are credible (M).
• Analyse the results by class of business/product where there is adequate data for credible results (M).
Step 3: Propose assumptions taking into account the results of the experience investigation
Risks Risk factors Preventative Controls Detective Controls
3.4 Results of the investigation are not used for setting the assumptions
• Time constraints.
• Existence of a well defined process linking the assumptions and the results of the
investigation.
• The experience investigation should be done well in time to allow the results to be used for setting the basis (M).
• Set a timetable for the experience investigation with key dates and milestones (M)
.
Step 4: Assess the impact of the proposed assumptions
Risks Risk factors Preventative Controls Detective Controls
4.1 The estimated impacts are incorrect. • Many model used
• Data errors
• Any approximations that are used to estimate the impact of the basis change
• Complexity of the change being carried out
• Complexity of the model
• The number of changes being carried out simultaneously
• A signed off model should be used to assess the impact of the assumption change (M)
• An independent check should be made of the impact of the assumption change. This could be by way of approximate manual calculations (M).
• Any issues identified should be documented and management should be involved in making sure that the issues are resolved (H).
• The actual impact of the assumption change should be compared to, and reconciled with the estimated impacts (H).
4.2 Impacts misunderstood • Competency and skill level of the person analysing the results
• Miss-interpretation of the results
• Work should be done by an individual who is suitably qualified and has the relevant experience (M)
• The impacts should be subject to review (H).
• The actual impact of the assumption change should be compared to, and reconciled with the estimated impacts (M)
Step 5: Get approval and sign off of the assumptions e.g. board/auditors
Risks Risk factors Preventative Controls Detective Controls
5.1 Assumptions are not approved • Number of models/versions in use
• Poor/inadequate documentation
• Degree of compliance with the regulations
• Extent to which assumptions are justified.
• Degree of potential market pressure or internal conflicts
• Assumptions should not be used before approval (M)
• The assumptions should be documented and presented in a manner that is readily understood by the management (M).
• The assumptions should be fully justified e.g. by reference to company experience and FSA regulations (M)
• The assumptions should be benchmarked against the basis used by other companies in the market (M)
• There should be an assumption document signed off by suitable senior management of the company (M).
5.2 Sign off – Board does not understand the results
• Complexity of the basis e.g.
stochastic more complex than deterministic
• Knowledge and experience of board members
• Provide training (M) • Review communication material to see if appropriate for the audience (M)