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PRACTITIONERS’ FORUM SESSION 29 JIM BRIDGEMAN UNIVERSITY OF CONNECTICUT APPROVAL CODE LAH209140129 SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 1 STOCHASTIC INTEREST SCENARIOS • WHY DO IT? • HOW? • WHATEVER DOES IT MEAN? SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 2 THE COMPANY • $3 BILLION RESERVES • $1.5 BILLION PREMIUM • VERY RAPIDLY GROWING SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 3 THE ENVIRONMENT • US DOM / ONLY TAIWAN BUSINESS • TAIWAN RESERVES OK FOR STATE • OPINION STILL REQUIRED SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 4 PRODUCTS • TRADITIONAL LIFE INSURANCE • HIGH CASH VALUE FORMS • 25% PREM IN HIGH MARGIN RIDERS SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 5 INVESTMENTS • NO CURRENCY MISMATCHING • FEW LONG DURATIONS AVAILABLE • CDs, FLOATING RATE MORTGAGES, SOME MEDIUM TERM BONDS SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 6 DURATION MISMATCH • NOT VERY COMPLICATED • BEGAN TO FAIL SOME DOWN SCENs • WHAT’S “MODERATELY ADVERSE” ? SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 7 THINK FIRST • PROBLEMS: POP-DOWN & DECLINE • OK: DOWN-UP • SO “DOWN FOREVER” IS THE ISSUE SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 8 CLEARLY • “FOREVER” MORE THAN MODERATE • DOWN-UP LESS THAN ADVERSE • DETERMINISTIC SENSITIVITY TESTS IN BETWEEN SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 9 NOT SO CLEAR • WHERE TO DRAW THE LINE? – WOULD STOCHASTIC INTEREST RATES HELP? • ONLY AS GOOD AS ASSUMPTIONS – WHAT WOULD MAKE YOU BELIEVE? – WHAT DO THEY MEAN? – MOST DON’T EVEN LOOK REAL OR EVEN LIKE HISTORICAL SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 10 BASIC APPROACH • 2-FACTOR PROPRIETARY MODEL • DRIVEN BY Q/Q VAR AND MEAN REV • JUDGE RESULTING INT RATES: – DISTRIBUTIONS: at points in time – SCENARIOS: across time SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 11 STUDENTS TRIED Q/Q TOO STABLE RATES TOO TIGHT FOR TOO LONG SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 12 ACTUARY TRIED TOO FEW EXTREMAL SCENARIOS TOO MANY ZIG-ZAGS SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 13 FINALLY USED SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 14 REVERSION TARGET JUMPS RANDOMLY • GAMMA JUMPING TIMES • LOGNORMAL LANDING PLACES • ISSUE: WHAT’S THE RIGHT MEAN? SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 15 PARAMETER FITTING THE MEAN REVERTING LOGNORMAL 1ST • Q/Q VOLATILITY & MEAN REV – JOINTLY FIT (TRIAL & ERROR) • TO HISTORICAL Q/Q & STABILIZED RATES WITHIN A 5 YR HORIZON SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 16 PARAMETER FITTING TARGET JUMP TO RECREATE HISTORICAL INTEREST RATE DISTRIBUTION • GAMMA MEAN 20 MODE 10 - trial&error • MEAN LANDING - to fit recent history • LANDING VARIANCE - to fit long history SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 17 THE RESULT • STILL ONLY A STRESS TEST – NOT A FORECAST MODEL • BUT LOOKS MORE LIKE THE WORLD • (FAT TAILS) BUT REASONABLE VAR • Subsequently amended to: “Broad Shoulders” • BETTER THAN 90TH PERCENTILE OK SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 18 THIS YEAR’S ISSUE • WHAT PERCENTILE DEFINES “MODERATELY ADVERSE”? SEPT 14, 2001 VALUATION ACTUARY SYMPOSIUM 19