How do You Setup Indicators in Your Prophet Model?

In my previous post, I have discussed areas that you may consider in setting up input variables. Before I proceed my discussion on core variables, I would think that it is good for use to take a look on indicators - as indicators play an important role in setting core variables with various formulas (known as "variable definitions" in a Prophet model). 

The funny thing about indicators is: it DOES NOT carry any formulas that you need to use in calculating a variable! Basically, they are just some texts that you can combine using different logical operators (AND, OR, NOT), such as "ORD_PAR AND SING_PREM" for a single premium ordinary participating product. 

How do Indicators Work?

We can define multiple formulas, or variable definitions, for a variable. There are many ways we can setup a variable definition, which the common ones are:

• Formula
• Constant
• Global
• Parameter
• Extended formula
• t-dependent extended formula

Variable definitions setup in a variable are not necessary come from the same type, e.g. the most common mixture of variable definitions are formula and constant. Let's take fund management charge ("FMC") variable as an example, which is applicable to investment-linked products.

• Say FMC variable is as a mandatory variable required for all products.
• For an investment-linked product, we need to define formulas that calculates FMC from unit funds. Normally, the respective variable definition is setup as Formula type. 
• For an ordinary participating product, we can right away set the variable to 0. In this case, we can use Constant type of variable definition.

In case the FMC variable is not a mandatory variable, we can totally exclude this variable from the ordinary participating product - FMC is not applicable to this product anyway. The question is: how do we setup the variable definitions, so that Prophet selects the correct action as per our condition?

Yes, that's right, by using a combination of indicators, together with logical operators to define indicator expression. To cater for the calculations required for the FMC variable, we shall have INVST_LINK (investment-linked) created in the library. 

• For variable definition used by investment-linked products, we should insert INVST_LINK in the indicator expression.
• Although another product in our context is an ordinary participating product, FMC variable should be set to 0 for all non investment-linked products. Hence, we should insert NOT INVST_LINK in the indicator expression.

If the FMC variable is not a mandatory variable, what are the indicators we should use? The answer is simple, we don't need to setup the second variable definition at all. If Prophet cannot find any variable that meet the indicators selected by a product, the variable will not be called in.

How do We Setup Indicators?

Again, there is no single correct answer on how we should setup indicators. Based on my explanations above, we can easily see that indicators allow a variable to be defined in a different way. We should then drill down what make a variable having different variable definitions.

Some common types of indicators that you may consider setting up in your library are:

• General: Such as ALWAYS. Please remember that ALWAYS is a lone wolf - it doesn't make sense to use ALWAYS with other indicators.
• Product type: Such as ordinary participating, ordinary non-participating, investment-linked.
• Benefit type: Such as death benefit, TPD benefit and CI benefit.
• Reserving method: Such as gross premium valuation method ("GPV") method, sterling reserve method.

"Must not be selected if" under Selection Criteria group

When we create a indicator, we have to consider the possible conflict that may arise from other indicators. For example, when we select INVST_LINK for a product, we should not select ORD_PAR (ordinary participating) for the same product - a product cannot be investment-linked and ordinary participating product at the same time! Hence, it is important to include adequate conditions for indicators, under "Must not be selected if" section. By using INVST_LINK as an example, we should insert "ORD_PAR OR ORD_NONPAR" in "Must not be selected if" section, under Selection Criteria group (assuming the company only has three product types). 

By having this condition, when you select INVST_LINK, ORD_PAR and ORD_NONPAR will be automatically disabled. Hence, you will not have any chance to make a mistake in selecting 2 or more of these indicators.