PRACTITIONERS

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PRACTITIONERS FORUMSESSION 29

• JIM BRIDGEMAN
• UNIVERSITY OF CONNECTICUT
• APPROVAL CODE LAH209140129

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STOCHASTICINTEREST SCENARIOS

• WHY DO IT?
• HOW?
• WHATEVER DOES IT MEAN?

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THE COMPANY

• 3 BILLION RESERVES
• 1.5 BILLION PREMIUM
• VERY RAPIDLY GROWING

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THE ENVIRONMENT

• US DOM / ONLY TAIWAN BUSINESS
• TAIWAN RESERVES OK FOR STATE
• OPINION STILL REQUIRED

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PRODUCTS

• TRADITIONAL LIFE INSURANCE
• HIGH CASH VALUE FORMS
• 25 PREM IN HIGH MARGIN RIDERS

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INVESTMENTS

• NO CURRENCY MISMATCHING
• FEW LONG DURATIONS AVAILABLE
• CDs, FLOATING RATE MORTGAGES, SOME MEDIUM TERM
  BONDS

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DURATION MISMATCH

• NOT VERY COMPLICATED
• BEGAN TO FAIL SOME DOWN SCENs
• WHATS MODERATELY ADVERSE ?

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THINK FIRST

• PROBLEMS POP-DOWN DECLINE
• OK DOWN-UP
• SO DOWN FOREVER IS THE ISSUE

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CLEARLY

• FOREVER MORE THAN MODERATE
• DOWN-UP LESS THAN ADVERSE
• DETERMINISTIC SENSITIVITY TESTS IN BETWEEN

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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 DONT EVEN LOOK REAL OR EVEN LIKE HISTORICAL

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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

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STUDENTS TRIEDQ/Q TOO STABLERATES TOO TIGHT FOR
TOO LONG
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ACTUARY TRIEDTOO FEW EXTREMAL SCENARIOSTOO
MANY ZIG-ZAGS
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FINALLY USED
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REVERSION TARGET JUMPS RANDOMLY

• GAMMA JUMPING TIMES
• LOGNORMAL LANDING PLACES
• ISSUE WHATS THE RIGHT MEAN?

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PARAMETER FITTINGTHE MEAN REVERTING LOGNORMAL 1ST

• Q/Q VOLATILITY MEAN REV
• JOINTLY FIT (TRIAL ERROR)
• TO HISTORICAL Q/Q STABILIZED RATES WITHIN A 5
  YR HORIZON

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PARAMETER FITTINGTARGET JUMP TO RECREATE
HISTORICAL INTEREST RATE DISTRIBUTION

• GAMMA MEAN 20 MODE 10 - trialerror
• MEAN LANDING - to fit recent history
• LANDING VARIANCE - to fit long history

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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

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THIS YEARS ISSUE

• WHAT PERCENTILE DEFINES MODERATELY ADVERSE?