Speaker Name & Country :

Topic:

Kailan Shang (Canada)

Ripudaman Sethi (India)

Stochastic Approach For With-Profits

Business

Glimpse from History- With Profit Business

Participating Business originated in UK in the 18th
Century (1760s)
1980s: Investment yields high (12%-13% pa) Insurers
offered high guarantees to their policyholders.
1990s onwards: Interest Rates start falling and
guarantees start becoming onerous.
2000s : Interest rates go down further ( to 2%). Some
guarantees heavily in the money e.g. GAR
M&A and Closure of funds- Assets declined from 420
billion in 2005 to 330 billion in 2009
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What was the real Issue?

Management of Fund
Investment Strategy not in line with the
Level of Bonus Rates
Smoothing etc.

Corporate Governance
Responsibilities for treating Customers fairly
Accountabilities- Role of the Board /Appointed Actuary/Senior Management
Risk Management Identification/Quantification /Mitigation

Policyholder Communication
Actuarial Valuations- NPV + Prudent Assumptions

Valuation Excluded future Bonuses but Lower Interest Rate

Actual Payouts mapped to Asset Share
So, liability valuation method not in line with actual liabilities
Time Value of Options & Guarantees
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Lessons to be learnt from Past

Better risk management for participating business as well
Participating business needs to be adequately regulated
despite discretions with insurers.
Complexity of the business warrants appropriate
disclosures both to the regulator and PHs.
Transparency- Risk is shared with PHs who should be
updated regularly on the business.
PH behavior is a significant potential risk.
All above highlight the need for more sophisticated tools
e.g. Stochastic Modeling
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Stochastic and Dynamic Modeling

Fair valuation of the cost of guarantee (CoG): risk

neutral scenarios, illiquid market makes it difficult
to know the fair price.
Reserve and capital assessment: real world
scenarios, looking at possible outcomes.
Dynamic policyholder behavior.
Dynamic management action.
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Dynamic Policyholder Behavior

Actual investment return

New investment return
Bonus rate
Surrender penalty
Policyholder expectation management

Dynamic Bonus Strategies

Profit sharing rules

Split among cash bonus, reversionary bonus
and terminal bonus
Stability of bonus rates
Undistributed estate
Trigger of bonus rate change
Competitive position
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Application of the Model

Product Development

Product features: bonus type, minimum bonus rate guarantee

Pricing
Communication plan

Business Strategy

Bonus rate setting

Profit sharing
Policyholder behavior management
Capital allocation among business lines

Risk Management

Economic capital
Cost of guarantee
Risk adjusted measures: RAROC, MCEV
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Numerical Example- Stochastic Model

Overview
Economic Assumption
Insurance Assumption
Dividend Setting Strategy
Profit and Risk Measurement
Sample Result
Conclusion
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Overview

The illustrative EXCEL tool can be downloaded at

http://swinsolutions.com/download/WP%20Model.zip
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Economic Assumptions

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Interest Rates
Initial Government Bond Yields (India, Nov. 2015 )
Bond Yield Volatility: 1.76% (Historical Vol. May
1998 ~ Nov. 2015)
Yield Curve Extension: Cubic-Spline and NelsonSiegel

Stochastic Scenarios: one-factor Hull-White

model
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Yield Curve Extension

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Credit Spread/Equity Return/Real Estate

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Correlation

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Asset Allocation

Rebalanced annually with a target duration of 10 years

Sample:

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Insurance Assumptions

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Mortality/Lapse
Mortality: Indian Assured Lives Mortality table (2006-2008) for male and

female (2-year age set back).

Lapse: Base + Dynamic

, ,
=

, 0 ,

DLt: Dynamic lapse during period t in terms of

percentage.
rn: New money rate in terms of percentage.
rp: Portfolio rate which is the realized
investment return in terms of percentage.
BLt: Base lapse rate during period t.
a: scale factor.
b: sensitivity factor.
c: deductible.
d: maximum dynamic lapse rate.

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Others

Expense/Commission/CSV/Reserving
Asset Share
1
= 1 + 1 + 1 +
Where

0.5

ASt: Asset share at time t.

+ 1

Pt: Premium income at time t.

Et: Expense and commission at time t.
DBt: Death benefit during period t.
SBt: Surrender benefit during period t.
SurvBt: Survival benefit during period t.
qt: Mortality rate during period t.
wt: Lapse rate during period t.
it: Realized investment return during period t.

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Cost of Guarantee

Contractual Minimum (0%) ?

Lowest Illustration Rate (4%) ?
Soft Guarantee (Somewhere between 0% and
4%) ?
3% used in this example to partially lower cost
of guarantee, avoid mass lapses in extreme
situation and stay competitive.

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Risk Based Capital

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Dynamic Dividend Setting Strategy

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Principles

90/10 Profit Sharing (91/9 at initial

considering expense overrun)
Reversionary bonus rate is dynamically
projected so that the ending surplus is zero
Maximum 25% annual change from previous
year
3% soft guarantee rate
Terminal bonus adjusted proportionally
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Bonus Scale v.s. Realized Return

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Profit and Risk Measurement

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Measures

1.

FrCoC: frictional cost of capital. It reflects the taxation and investment costs on the assets backing
required capital.

2.

CRNHR: cost of residual nonhedgeable risks. It includes the impact of nonhedgeable, nonfinancial risks
and nonhedgeable financial risks and should be presented as an equivalent average cost of capital
charge.
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Deterministic vs. Stochastic

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Risk Based Capital

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Thank you!

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Disclaimer
The opinions expressed and conclusions reached by the presenter are their own and
do not represent any official position or opinion of their employees. The employers
disclaim responsibility for any private publication or statement by any of its
employees.
Kailan Shang FSA, CFA, PRM, SCJP, Managing Director of Swin Solutions, can be
contacted at kailan.shang@swinsolutions.com.
Swin Solutions is a strategy consulting firm located in Ontario, Canada focusing on
business intelligence, risk management and predictive modeling. Visit us @
http://www.swinsolutions.com
Ripudaman Sethi, AVP of DHFL Pramerica, can be contacted at
ripudaman.sethi@dhflpramerica.com.
DHFL Pramerica Life Insurance Company Limited is one of the fastest growing life
insurance companies in India headquartered in Gurgaon, India. We provide a wide
range of life insurance solutions for individuals as well as groups taking care of our
customers various financial protection needs such as securing their childs future,
retirement planning, savings and wealth creation.

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