Casualty Actuarial Society (CAS) Practice Exam

How does inaccurate projection of business income impact PML calculations?

1. It makes the PML calculation more rigorous

2. It can lead to an overestimation of the PML

3. It introduces uncertainty due to potential fluctuations

4. It has no impact on the calculations

The correct answer is: It introduces uncertainty due to potential fluctuations

Inaccurate projection of business income directly impacts the calculation of Probable Maximum Loss (PML) by introducing uncertainty related to potential fluctuations in actual income. When projections are inaccurate, the estimates used in determining the PML could be either overly optimistic or pessimistic, leading to miscalculations in the anticipated maximum loss. This uncertainty can affect how stakeholders perceive risk and could lead to inadequate or excessive capital reserves being held. Accurate income projections are crucial for effective loss modeling; hence, inaccuracies can obscure the true risk profile of the business. While it is true that inaccurate income projections could also potentially lead to overestimating or underestimating the PML, the broader impact is more about the uncertainty introduced – affecting risk management decisions rather than simply altering the numerical outcome of the PML calculation. Therefore, recognizing the introduction of uncertainty is pivotal in understanding the overall implications of accuracy in projections for business income.