Actuarial Concept Series — #7

Actuarial Models

Limitation of the deterministic model to test the suitability of asset distribution for insurers

As deterministic model is based on a single set of assumptions, It fails to take into account the variability of asset returns & the correlated variability of the liability values.

This is a problem because it is difficult to test whether the nature of the assets (i.e. ‘fixed’ or ‘real’) is suitable to match the liabilities. We therefore really need to run a deterministic model a number of times considering different scenarios (e.g. low inflation/high growth, high inflation/low growth) in order to investigate how the surplus might vary under different possible outcomes.

Scenario testing is highly subjective. Suppose there is much variability in the parameters. In that case, insolvency may have a non-negligible probability even where a deterministic approach suggests that there is a significant excess of assets over liabilities. Even scenario testing may not identify this problem.

In this case, Stochastic model is a better option.
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