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Canadian Institute of Actuaries. L’Institut canadien des actuaires. 2007 Annual Meeting ● Assemblée annuelle 2007 Vancouver. Update on various CLIFR topics Group Education Note Segregated Fund Valuation Issues Calibration of Interest Rate Models. 2007 Annual Meeting

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2007 annual meeting assembl e annuelle 2007 vancouver

Canadian

Institute

of

Actuaries

L’Institut canadien

des

actuaires

2007 Annual Meeting ●Assemblée annuelle 2007

Vancouver


Pd39 clifr ii

Update on various CLIFR topics

Group Education Note

Segregated Fund Valuation Issues

Calibration of Interest Rate Models

2007 Annual Meeting

Assemblée annuelle 2007

PD39 – CLIFR II


Valuation of group life and health policy liabilities

PD39 - CLIFR II

2007 Annual Meeting

Assemblée annuelle 2007

Valuation of Group Life and Health Policy Liabilities


Current status of group education note

Revising the May 2000 Research paper on Group insurance valuation considerations

Plan to release as an Education Note

Fall 2007

Working Group has been reviewing over 2006-2007

Similar content to original Research paper

Updated to reflect current Standards

Updated to reflect current Group practices

Some additional sections added, to provide guidance on CALM, impact of 3855

2007 Annual Meeting

Assemblée annuelle 2007

Current Status of Group Education Note


Scope

Provides guidance to actuaries valuing group life and health policy liabilities

Includes supplemental information to the Standards of Practice

Application

employee, association and creditor groups

Benefits typically covered:

short & long-term disability, medical & dental, term life (including group conversion benefits), other

Various financial arrangements

Refund Accounting,Hold Harmless, ASO, Other

2007 Annual Meeting

Assemblée annuelle 2007

Scope


Financial arrangements

Basic Premium policy liabilities

plans are typically yearly renewable term with no guarantee of renewability

Fully Pooled

Prospectively Rated

Refund Accounting for larger groups

ERR and deficit recovery

Claims Fluctuation Reserves to stabilize premiums

Policyholder valuation basis vs Insurer’s CGAAP valuation basis

Retrospective Premium Arrangements

Administrative Services Only

Split Funded Arrangements

Combinaton of insured plus ASO beyond specified maximum

Hold Harmless Agreements

2007 Annual Meeting

Assemblée annuelle 2007

Financial Arrangements


Challenges under calm

Variety of Benefits and Financial Arrangements policy liabilities

Customization in contracts

TPAs – record keeping and administrative practices vs valuation data requirements

Refund Accounting for large groups

Difference between statement and policyholder valuation bases

Lack of reliable experience data

Materiality considerations

Per group

By line of business

By company

2007 Annual Meeting

Assemblée annuelle 2007

Challenges under CALM


Cica 3855

Degree of mismatch (long term assets supporting short term liabilities)

Surplus implications

ERR at market (e.g., maintain BV of ERR and adjust for difference of excess of MV over BV)

2007 Annual Meeting

Assemblée annuelle 2007

CICA 3855


Term of the liability

SOP 2320.03 liabilities)

the term of the liability should take account of any renewal, or adjustment equivalent to renewal after the balance sheet date if

the insurers discretion at that renewal is contractually constrained, and

if the policy liabilities are larger as a result of taking account of that renewal.

Differentiate between term of active lives and term of claim liabilities

Active Lives

Next “rate adjustment date” or rate guarantee period (e.g., LTD benefits)

Actuary would be cautious if extending period reduces policy liabilities and would select longer term if such action increases policy liabilities.

Claim Liabilities

Extend to end of claim-paying period

2007 Annual Meeting

Assemblée annuelle 2007

Term of the Liability


Ltd considerations

Termination Rates : SOP liabilities) 2350.14 to 2350.18

1987 Basic GLTD table

Muirhead Table

1985 CIDA for individually underwritten business (e.g., association or creditor plans)

CDT64 table is outdated and may not be appropriate without significant modification.

Benefit Offsets: e.g., CPP, QPP, SSDI and workers’ compensation

Appropriate for the projected benefits to reflect offsets.

COLA Provisions: e.g., % of CPI

the assumptions for future CPI increases would be consistent with the valuation interest rate scenario

2007 Annual Meeting

Assemblée annuelle 2007

LTD considerations


Ltd considerations1

Other considerations which complicate valuation: liabilities)

Pending/Resisted/Suspended Claims

Recurrence of Disability (may be part of IBNR liability)

Claims Terminated But Not Reported

Rehabilitation/Partial Disability:

Exercise caution in assuming that the most recent net benefit is representative of longer term net benefit payments

Unusual Financial Arrangements:

e.g., ASO for a period of time (e.g., two years) after disability, and insured thereafter.

Given the complexity, the actuary may find it useful to validate overall reasonableness of the resulting liabilities by performing adequacy testing

Note provides an example in Appendix 3.

2007 Annual Meeting

Assemblée annuelle 2007

LTD considerations


Waiver of premium considerations

Liability cash flows include liabilities)

projected death benefits on disabled lives, related expenses and conversion costs to individual life insurance policies

Modifications needed to 1970 Kreiger table

typically involves substantially reducing the mortality rates and increasing the recovery rates (at least for durations 1 to 10 )

Small insurers issues: consider using LTD valuation assumptions

Actuary would exercise caution in applying LTD tables since the insurer’s definitions of disability, and therefore termination experience, may potentially be significantly different for waiver and LTD

2007 Annual Meeting

Assemblée annuelle 2007

Waiver of Premium considerations


Liabilities for unreported claims

Liability for Claims Due and Unpaid liabilities)

represents an exact recognition for a known amount owing but not paid

Coordinate with liability for reported claims

Incurred But Not Reported (IBNR) Claim Liabilities

Arise from lags in:

reporting of claims to the insurer,

recording by the insurer of claims which have been reported (e.g., delay recording of disability claims incurred until the end of the elimination period), and

claims that will be appealed or litigated in the future.

Note describes various factors that can affect claim lags. Eg:

level of claim processing backlog,

changes in benefits or exposure,

etc

2007 Annual Meeting

Assemblée annuelle 2007

Liabilities for unreported claims


Common ibnr methodologies

Factor Method liabilities)

for benefits where there is a short lag or run-off period (e.g., group term life insurance)

Factors based on past experience as % premiums, paid claims, liability, other

Loss Ratio Method

(AVG EP + AVG Reporting Lag) × Loss Ratio × Premiums inforce.

If the information is available, valuation could be done on seriatim basis considering for each group its own elimination period, premiums paid or loss ratios.

Suitable for cases where the recording of LTD claims is delayed until after the elimination period.

Lag or Development method:

Development of paid claims by period of incurral and payment, which is used to develop a claim run-off chart.

2007 Annual Meeting

Assemblée annuelle 2007

Common IBNR methodologies


Liability for future claims

Claims that have not been incurred as at the valuation date but will be incurred before the end of the term of the liability.

Mostly significant for long premium rate guarantees on LTD business

The longer the term of the premium rate guarantee, the more material is the exposure to risk of inadequate pricing and to interest rate risk (e.g., LTD Benefits)

Examples

Paid-Up Life

LTD:

Need to consider incidence of disability rates

Creditor Insurance

Term of the liability is to the end of the insured loan and subject to any renewal guarantees

May exhibit individual and group characteristics

2007 Annual Meeting

Assemblée annuelle 2007

Liability for Future Claims


Liability for future experience rating refunds

In theory, need a group by group projection of future refunds based on projected experience

In practice, approximations often used

relationship between reported policyholder reserves and the corresponding statutory (GAAP) reserves

policyholder reserves > GAAP reserves  excess margin may generally be expected to be refunded to policyholder

policyholder reserves < GAAP reserves  future deficits can be expected to arise. May be partially recoverable if group has hold harmless, CFR, or other risk sharing

Interest adjustment to the ERR may be required if interest credited on policyholder reserves does not equal the policyholder valuation interest rate.

May need additional provision if actuary has concerns about the adequacy of risk charges

2007 Annual Meeting

Assemblée annuelle 2007

Liability for Future Experience Rating Refunds


Treatment of deficit recoveries

Deficit represents negative policyholder experience balance net of any funds the insurer has a contractual right to offset.

Section 2130.29 - the actuary would test the appropriateness and recoverability of the receivable amount

Note outlines specific considerations in determining the amount of deficit deemed recoverable

In practice, recoverable deficits only reflected to extent of collateral (Hold Harmless, CFR, etc).

2007 Annual Meeting

Assemblée annuelle 2007

Treatment of Deficit Recoveries


Asset considerations

Consider both invested and non-invested assets (e.g., outstanding premiums or recoverable deficits)

The actuary would consider the likely timing and expected payout of recoverable deficits before considering this within the CALM testing.

Actuary may need to further allocate the assets by benefit type to understand any ALM issues that may arise. (e.g., LT assets supporting IBNRs may create additional volatility under 3855)

2007 Annual Meeting

Assemblée annuelle 2007

Asset Considerations


Other considerations

Provisions for ASO contracts outstanding premiums or recoverable deficits)

Stop Loss

DAC

Reinsurance

International Issues

Tax Issues

2007 Annual Meeting

Assemblée annuelle 2007

Other Considerations


Considerations in the valuation of segregated fund products

PD39 - CLIFR II outstanding premiums or recoverable deficits)

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products1

Sub-Committee of CLIFR formed late in 2005 outstanding premiums or recoverable deficits)

Mandate

Review areas where additional guidance could be provided to ensure compliance with standards and to narrow the range of practice

Expected Completion – Fall 2007

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products2

Contents of note outstanding premiums or recoverable deficits)

Methodology – Bifurcated versus Whole Contract

Term of the Liability

Hedging

DAC Recoverability Testing

Level of Aggregation

Discounting and C3 PfAD

Policyholder Behaviour

Provision for Adverse Deviation

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products3

Methodology – Bifurcated vs. Whole Contract outstanding premiums or recoverable deficits)

Bifurcated

Revenue is allocated between recoverability testing of the DAC and the liability for the guarantee

Allocation does not change from period to period

Policy liability for the guarantee is calculated separately using revenue based on thisallocation

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products4

Methodology – Bifurcated vs. Whole Contract outstanding premiums or recoverable deficits)

Bifurcated

Allocation of revenue to the guarantee would generally be related to the additional charge priced into the product for the guarantee

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products5

Methodology – Bifurcated vs. Whole outstanding premiums or recoverable deficits)

Contract

- Whole Contract

Total policy liability is determined using all net cash flows available

Several Variations of method

Some don’t consider DAC separately

Could cause unamortized DAC to increase

Inconsistent with Section 2320.24 of SOP

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products6

Methodology – Bifurcated vs. Whole outstanding premiums or recoverable deficits)

Contract- Whole Contract Approach – DAC Focus

DAC is first tested to ensure recoverability using all fee income

In order to calculate the liability for the guarantees, the DAC balance is added to the stochastic result

Mathematically equivalent to backing out a PV of fee income equal to the DAC balance

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products7

Methodology – Bifurcated vs. Whole outstanding premiums or recoverable deficits)

Contract- Under both methods

If the DAC becomes unrecoverable it is written down to the extent it is recoverable

Future amortization is reduced accordingly and locked in consistent with SOP Section 2320.24

Once the DAC is written down it may not be written back up

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products8

Methodology – Considerations outstanding premiums or recoverable deficits)

Total liability under Whole Contract method will be less than or equal to that under the Bifurcated method

Whole Contract method will defer possible writing down of the DAC as long as possible as the DAC has first priority on future revenue.

Once the liability for the guarantee has become positive the liability may become more volatile under the Whole Contract method as the allocation of revenue can change period to period.

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products9

Methodology – Considerations outstanding premiums or recoverable deficits)

At this time CLIFR is not recommending one method over the other

Both methods consistent with standards

Currently the whole contract method is more commonly used

Direction of international standards appears to be toward bifurcated approach

When the direction of international standards becomes clearer we will move in that direction.

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products10

Term of the Liability outstanding premiums or recoverable deficits)

Section 2320.27

“…the term of the liability ends at the balance sheet date for….the general account portion of a deferred annuity with segregated fund liabilities but without guarantees;”

Section 2320.23

“The actuary would extend such term solely to permit recognition of cash flow to offset acquisition or similar expenses whose recovery from cash flow that would otherwise be beyond such term was contemplated by the insurer in pricing…

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products11

Term of the Liability outstanding premiums or recoverable deficits)

Add Guarantee:

2320.22 => term ends at the earlier of:

First renewal or adjustment date at or after B/S date at which there is no constraint

Renewal / adjustment date after the B/S date which maximizes policy liabilities

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products12

Term of the Liability – what to conclude outstanding premiums or recoverable deficits)

CLIFR’s view is that term of the liability

ends at the balance sheet date if the liability would otherwise be negative and

the term would be extended beyond the balance sheet date to the date which maximizes the liability

Corollary is that the liability for the guarantee is floored at zero

SOP implies the above interpretation applies only to contracts with no material constraints

Fully guaranteed contracts would have term equal to the life of the contract

CLIFR may recommend changes to the standards for the fully guaranteed contracts

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products13

Hedging outstanding premiums or recoverable deficits)

Application of zero floor can disrupt the parity between the asset and liability sides of the balance sheet

Hedge assets can start with fair value of zero but this value will go up or down with market movement

Change in fair market value of derivatives flows through investment income and would be expectedto be offset by a change in the liability

This balance can be disturbed by the zero floor onthe liability side

Result can be inconsistent with direction of market movement

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products14

Hedging outstanding premiums or recoverable deficits)

CLIFR believes it would be appropriate to consider both sides of the balance sheet in this situation

Negative liability could be acceptable subject to constraints on the amount of profit capitalized, consistent with unhedged position

Situation viewed as an unforeseen situation in the context of General Standards Section 1330.01

“ Deviation from a particular recommendation or other guidance in the standards is accepted actuarial practice for an unusual or unforeseen situation for which the standards are inappropriate.”

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products15

DAC Recoverability Testing outstanding premiums or recoverable deficits)

Should be tested at least annually

Assumptions should include margins

CTE level between CTE60 and CTE80

If full amount is not recoverable, actuary

reduces unamortized DAC to recoverable amount

reduces remaining future write-down amounts proportionately

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products16

DAC Recoverability Testing outstanding premiums or recoverable deficits)

Amortization period for DAC (length of write-down pattern)

Should be consistent with the extended term for DAC recoverability established at inception perSOP Section 2320.24

Once established it is locked in

Extended term for DAC recoverability will differ from the amortization period over time

Extended term adjusts to reflect only enough revenue to recover DAC

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products17

Level of Aggregation outstanding premiums or recoverable deficits)

SOP Section 2320.09 presents CALM as an aggregate methodology

“ The actuary would usually apply the Canadian asset liability method to policies in groups which reflect the insurer’s asset liability management practice for allocation of assets toliabilities and investment strategy.”

Section 2320.22 defines term of the liability at thepolicy level

Some judgment required

Level of aggregation is an important consideration for term of the liability / application of zero floor

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products18

Level of Aggregation outstanding premiums or recoverable deficits)

CLIFR’s view is that term of the liability can be appliedat the segment level

Would have to test on an ongoing basis for term which maximizes the liabilities

Term could change more frequently if segment contains diverse cohorts, e.g. when a block reaches maturity date

For practical purposes may want to aggregate at a cohort level where cohorts are homogeneous with respect to key risk characteristics

Finer splits into cohorts would be expected to increase total liability

Extreme case is seriatim level which would be inappropriate

More work required on this

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products19

Discounting and C3 PfAD outstanding premiums or recoverable deficits)

Using the CALM method for guarantee reserves likely impractical

Implies using stochastic or deterministic interest rate scenarios along each stochastic guarantee test path

Common approximation method is to use a discounted cash flow method

Discount rate should be related to current statement value of supporting assets as reflected in current book yield

Under 3855, if assets are designated as Held for Trading (HFT) yield would be reflective of fair value and discount rate should be variable period to period

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products20

Discounting and C3 PfAD outstanding premiums or recoverable deficits)

C3 MfAD is usually estimated as an adjustment to the Discount Rate

Theoretically should be calculated or justified by CALM testing reflecting reinvestment or disinvestment exposure of liabilities and supporting assets

In practice tested after the fact on representative cash flows

Often not a material issue because of the size of the liabilities

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products21

Policyholder Behaviour – Summary outstanding premiums or recoverable deficits)• Policyholder behaviour an important assumption for segregated funds:

Full and Partial Withdrawal

Resets

Fund transfers

Annuitizations if material

Consider interrelationships, particularly reaction to the scenario

Must combine experience data with common sense / intuition when modeling dynamic behaviour

Consider higher MfADs for these

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products22

Policyholder Behaviour – Guiding Principles outstanding premiums or recoverable deficits)

• Option exercise correlated with in- - the – moneyness

Anti-selection

Consider reasonable expectations

PH sophistication & perceived financial interest in policy

< 100% efficiency

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products23

Provision for Adverse Deviation outstanding premiums or recoverable deficits)

The term of the liability for segregated fund products has resulted in different interpretations as to the period over which the calculation extends

Distortions can result if related to general account liabilities

SOP Section 1110.39: “Provision for adverse deviations is the difference between the actual result of a calculation and the corresponding result using best estimate assumptions.”

This suggests there can be a PfAD only if there is a difference between the actual reserve and the best estimate reserve

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Considerations in the valuation of segregated fund products24

Provision for Adverse Deviation outstanding premiums or recoverable deficits)

Examples

Recoverability margin for DAC would not be a PfAD

If reserve for guarantees is floored at zero, difference between this and calculated negative reserve would not be a PfAD

These amounts could be disclosed separately as additional segregated fund margins

2007 Annual Meeting

Assemblée annuelle 2007

Considerations in the Valuation of Segregated Fund Products


Calibration of interest rate models

VAL-2: CLIFR Part II - PD outstanding premiums or recoverable deficits)

2007 Annual Meeting

Assemblée annuelle 2007

Calibration of Interest Rate Models


Clifr calibration of interest rate models working group

Agenda - Update from the Working Group outstanding premiums or recoverable deficits)

Recap Goals and Principles from Ottawa 2006

Derivation of Draft Initial Calibration Criteria

Model Testing

Immediate Next Steps - to complete for 2007 guidance

Beyond 2007

Questions

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group1

Objective outstanding premiums or recoverable deficits)

It is desirable to have a set of calibration standards that can be applied consistently to as wide a range of interest-sensitive insurance and investment products as possible, including both long and short term products.

Mandate

The working group has been formed to investigate and develop methodologies and standards for the calibration of interest rate models for determining policy liabilities to be held by life insurance companies.

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group2

General Principles outstanding premiums or recoverable deficits)

Be sufficiently robust to narrow the range of practice, but allow the actuary to apply reasonable judgement to specific circumstances;

Be applied to the set of scenarios produced, not to the model parameters or inputs;

Be applied to not only the near term, but also the steady state portions of the scenarios produced;

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group3

General Principles (continued) outstanding premiums or recoverable deficits)

Be applied to more than one point on the yield curve including a mix of short, medium, and long-term points;

Promote the development of scenario sets that measure exposure to yield curve shocks as well as long-term paths of declining as well as rising interest rates, consistent with history;

Look at average rate distributions corresponding to extended periods of time as well as rate distributions at selected points in time.

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group4

Working Group Contacts outstanding premiums or recoverable deficits)

Wally Bridel, Chair

Edward Astrachan

Michael Bean

David Campbell

Christian-Marc Panneton

Jason Wiebe

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group5

Derivation of Initial Calibration Points outstanding premiums or recoverable deficits)

Long term horizon (steady state)

Review historical experience

Capture high and lows

Not limited only to Canadian historical experience

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group6

Canadian Long rates - 1936-2007 outstanding premiums or recoverable deficits)

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group7

Canadian short rates - 1936-2007 outstanding premiums or recoverable deficits)

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group8

USA long rates - 1919-2007 outstanding premiums or recoverable deficits)

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group9

USA short rates - 1857-2007 outstanding premiums or recoverable deficits)

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group10

Draft Calibration Criteria outstanding premiums or recoverable deficits)

Long horizon

Percentile

Long rate

Left tail

2.5th

2.60%

5th

2.95%

2007 Annual Meeting

Assemblée annuelle 2007

10th

3.40%

Right tail

90th

10.00%

95th

12.00%

97.5th

13.50%

CLIFR Calibration of Interest Rate Models Working Group

Long horizon is 30-40 years. Long rate is 20 year bond.


Clifr calibration of interest rate models working group11

Draft Calibration Criteria outstanding premiums or recoverable deficits)

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group12

Model Testing outstanding premiums or recoverable deficits)

Testing different model forms (Vasicek, CIR, Brennan-Schwartz, Multiplicative Shock)

Single and multiple regimes

Unconstrained and constrained

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group13

Initial Results (preliminary) outstanding premiums or recoverable deficits)

Vasicek can be adjusted to satisfy calibration points but presents undesirable features (simple AR(1) model)

In general, single regime models can be adjusted to meet calibration criteria

Reasonably parameterized regime switching models can satisfy the calibration criteria

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group14

Initial Results (preliminary) outstanding premiums or recoverable deficits)

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group15

Initial Results (preliminary) outstanding premiums or recoverable deficits)

Fatter low rate tail models (Vasicek and CIR forms) appear to be constrained by the 10th and 97.5th percentiles

Thinner low rate tail models (Brennan-Schwartz and Multiplicative Shock forms) appear to be constrained by the 2.5th and 90th percentiles

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group16

Initial Results (preliminary) outstanding premiums or recoverable deficits)

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group17

Initial Results (preliminary) outstanding premiums or recoverable deficits)

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group18

CLIFR Goals outstanding premiums or recoverable deficits)

More in depth presentation at the AA Seminar

No changes anticipated to the 2007 Fall Letter

Develop an Educational Note in 2008

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group19

Working Group Goals for 2007 outstanding premiums or recoverable deficits)

Complete testing on long rate, long horizon

Determine calibration criteria for short and medium rates at the long horizon

May be mix of quantitative and qualitative criteria

May be derived from model testing

Any other criteria necessary for the long horizon

Sustained highs and lows

Yield curve shape (positive, inverted, flat, humped)

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group20

Beyond 2007 outstanding premiums or recoverable deficits)

Prioritize next steps

USD at long horizon, or

Shorter horizons

Other.…

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


Clifr calibration of interest rate models working group21

Questions? outstanding premiums or recoverable deficits)

2007 Annual Meeting

Assemblée annuelle 2007

CLIFR Calibration of Interest Rate Models Working Group


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