Summary

In this chapter we introduce emerging costs, or cash flow analysis for traditional life insurance contracts. This is often called profit testing when applied to life insurance.

Traditional actuarial analysis focuses on determining the EPV of a cash flow series, usually under a constant interest rate assumption. This emphasis on the EPV was important in an era of manual computation, but with powerful computers available we can do better. Using cash flow projections to model risk offers much more flexibility than the EPV approach and provides actuaries with a better understanding of the liabilities under their management and the relationship between the liabilities and the corresponding assets.

We introduce profit testing in two stages. First we consider only those cash flows generated by the policy, then we introduce reserves to complete the cash flow analysis.

We define several measures of the profitability of a contract: internal rate of return, expected present value of future profit (net present value), profit margin and discounted payback period. We show how cash flow analysis can be used to set premiums to meet a given measure of profit.

We restrict our attention in this chapter to deterministic profit tests, and introduce stochastic profit tests in Chapter 12.