Mis-estimation risk: measurement and impact

Abstract

AbstractWhen deriving a demographic basis from experience data it is useful to know (i) what uncertainty surrounds that basis, and (ii) the financial impact of that uncertainty. Under the Solvency II regime in the EU, insurers must hold capital against a number of risks. One of these is mis-estimation risk, i.e. the uncertainty over the current rates of mortality and other biometric risks experienced by a portfolio. We propose a general method for assessing mis-estimation risk, and by way of illustration we look at how mis-estimation risk can be assessed for a portfolio of pensions in payment from a UK pension scheme. We find that the impact of mis-estimation risk varies according to the risk factors included in a model, and that the inclusion of some necessary risk factors increases the financial impact of mis-estimation risk. In particular, the inclusion of risk factors which improve the model’s fit and financial applicability can lead to an increase in the mis-estimation risk. We also find that a full-portfolio valuation is preferable to using model points when assessing mis-estimation risk.