A301 P1

Question 1

Retention

Answer 1

In the context of reinsurance, a company’s retention is the amount of any particular risk that it wishes to retain for itself.

It will then reinsure the excess over that retention.

Question 2

Retail price inflation

Answer 2

The measurement of price changes at the retail (consumer) level.

Question 3

Return on capital employed

Answer 3

Profit before interest and tax divided by capital employed, expressed as a percentage.

An indicator of a company’s efficiency in generating profits from its asset base.

Question 4

Risk-based capital

Answer 4

The assessment of the CAPITAL REQUIREMENT for a provider

by considering the risk profile of the business written and of any other operations.

Question 5

Risk discount rate

Answer 5

A rate at which future uncertain cashflows might be discounted.

It typically arises when carrying out a discounted cashflow assessment of value of a project.

It represents the

• risk-free rate of return that the providers of capital demand
• plus an amount to allow for the risk that the profits may not emerge as expected from the project.

Question 6

Risk factor

Answer 6

A factor that is expected, possibly with the support of statistical evidence, to have an influence on the intensity of risk in an insurance contract.

Question 7

Risk premium

Answer 7

The amount of premium required to cover claims expected for a risk. It may alternatively be expressed as a rate per unit of exposure.

The additional return required over the risk-free return to reflect the riskiness of future cashflows.

Question 8

Running yield

Answer 8

The annual income on an investment divided by its current market value.

Important examples are the flat yield on gilts, the gross dividend yield on equities and the rental yield on property.

Question 9

Run-off basis.

Answer 9

A valuation basis that assumes an insurer will cease to write new business,
and continue in operation purely to pay claims for previously written policies.

Typically expenses and reinsurance arrangements change after an insurer ceases to write new business.

Question 10

Offer price

Answer 10

The price at which a market maker offers to SELL a security.

The price at which the manager of a unitised financial product is prepared to sell units to an investor.

Question 11

Operational risk

Answer 11

The risk of loss due to fraud or mismanagement within an organisation.

Question 12

Option

Answer 12

the right to buy or sell an asset

Question 13

Option (life insurance)

Answer 13

a health option is where the life insurance company gives a policyholder the right to increase or extend the death - or sickness - cover under a life insurance contract at some future time or times without further evidence of health.

Question 14

Option premium

Answer 14

The price paid for an option. received by the writer

Question 15

Option writer

Answer 15

The seller of an option

Question 16

Pay-as-you-go

Answer 16

An arrangement under which benefits are paid out of revenue and no funding is made for future liabilities.

Question 17

Payback period

Answer 17

The time period it takes for an investment to generate sufficient incremental cash to recover its initial incremental capital outlay in full.

Question 18

Preference share

Answer 18

A particular class of share which generally ranks ahead of ordinary shares.

Preference shareholders are normally entitled to a
- specified rate of dividend
and, unlike ordinary shareholders, are
- not entitled to residual profits.

Although part of a company’s share capital, from an investment perspective preference shares are much more like fixed-interest bonds.

Question 19

Prime property

Answer 19

Property that is most attractive to investors is called prime.
Prime property would score highly on the following factors:
- location
- age and condition
- quality of tenant
- the number of comparable properties available to determine the rent at rent review and for valuation purposes.
- lease structure
- size

Question 20

profit commission

Answer 20

Commission paid by a reinsurer to a cedant under a proportional reinsurance treaty that is dependent upon the profitability of the total business ceded during each accounting period.

Also used in other arrangements, such as commission contingent on claims experience.

Question 21

Profit test

Answer 21

A technique involving consideration of the cashflows arising under a contract to assess the expected profitability of that contract.

It can be used to determine the premium or the level of charges under a contract.

Question 22

Proprietary insurer

Answer 22

An insurance company owned by shareholders.

Question 23

Privatisation

Answer 23

The sale of state assets or businesses, often to reduce government debt.

Question 24

Put option

Answer 24

The right, but not the obligation, to sell a specified asset at a specified price at specified times.

Question 25

Rating basis

Answer 25

The collection of assumptions used to associate the risk premium with the characteristics of the risk being insured.

Question 26

Rating factor

Answer 26

A factor used to determine the premium rate for a policy, which is measurable in an objective way and relates to the likelihood and/or severity of the risk.

It must, therefore, be a risk factor or a proxy for a risk factor or risk factors.

Question 27

Real yield

Answer 27

The yield on an investment after inflation has been allowed for.

Often approximated as the difference between the nominal yield and the rate of inflation over the corresponding period.

Question 28

Nil claim

Answer 28

A claim that results in no payment by the insurer:

• The claim is found not to be valid
• the amount of the loss turns out to be no greater than the excess
• The policyholder has reported a claim in order to comply with the conditions of the policy but has elected to meet the cost in order to preserve any entitlement to no-claim discount.

Question 29

No-claim discount

Answer 29

A form of experience rating in which policyholders are allowed a discount from the basic premium according to a scale that depends upon the number of years since the most recent claim.

Question 30

Nominal value

Answer 30

Refers to an amount of stock. It is the amount specified on the stock certificate.

Dealings in debt securities are carried out in amounts of nominal

Question 31

Redemption

Answer 31

The return to an investor of the capital value of a debenture or other debt security.

Redemption may take place on a fixed date or on one of a series of specified dates.
The bond may include an option for the borrower to choose the date or for the lender to choose.
The capital amount repaid may be fixed or linked to an index.

Question 32

Redemption yield

Answer 32

The gross redemption yield, or yield to maturity, is the RATE OF RETURN
at which the discounted value of all payments of interest and capital
is equal to the dirty price of a debt security.

The net redemption yield allows for taxation of the amounts received by the investors.

Question 33

Reinsurance

Answer 33

An arrangement whereby one party (the reinsurer),
in consideration for a premium,
agrees to INDEMNIFY ANOTHER PARTY (the cedant)
against part or all of the LIABILITY assumed by the cedant under one or more insurance policies,
or under one or more reinsurance contracts.

Question 34

Reinsurer

Answer 34

An insurer providing reinsurance cover.

Some reinsurers do no write any direct or primary insurance business.

Question 35

Requirement for capital

Answer 35

On a per contract basis, the requirement for capital is the amount of finance a company needs in order to be able to write that contract, ie the new business strain.

This can be extended to the whole company where its requirement for capital is the finance it needs in order to be able to carry out its new business plans.

Question 36

Hurdle rate

Answer 36

A target or minimum rate of return used in capital project assessment

Question 37

Immunisation

Answer 37

Ensuring that the discounted mean term of assets equals that of the liabilities and that the spread of the assets is greater than the spread of the liabilities.

This means that a uniform change in interest rates will cause the reinvestment rate and capital value on assets to move in opposite directions so that a fund does not make a loss.

Question 38

Principle of Indemnity

Answer 38

The principle whereby the insured is restored to the SAME FINANCIAL POSITION after a loss as before the loss.

This is typical of most types of insurance.

This contracts with the new-for-old basis of settlement, often used in home contents insurance, under which the insured is entitled to the full replacement value of the property without any deduction for depreciation or wear and tear.

Question 39

Index-linked gilt

Answer 39

A bond issued by the British Government for which the interest payments and the final redemption proceeds are linked to movements in the RPI.

Question 40

Index-linked security

Answer 40

A security whose redemption value and/or coupon payments are adjusted to reflect inflation.

Question 41

Index tracking

Answer 41

An index tracking fund (index fund) is an investment fund with the objective of tracking a particular index.

The fund manager can either hold all the stocks in the index in the appropriate proportions or use some mathematical model to choose a smaller sample of stocks which will perform as closely as possible to the index.

Question 42

Inflation risk premium

Answer 42

The difference between the yield on a fixed income bond and the sum of the guaranteed real yield and the expected inflation rate on a similar index-linked bond.

It is required as compensation for the uncertainty in the real return on the bond by investors with index-linked liabilities.

Under the inflation risk premium theory the yield curve will tend to slope upwards because investors need a higher yield to compensate them for holding longer-dated stocks which are more vulnerable to inflation risk than shorter dated stocks.

Question 43

Insured scheme

Answer 43

A benefit scheme where the sole long-term investment medium is an insurance policy (other than a managed fund policy)

Question 44

Internal rate of return

Answer 44

The discount rate at which the Net Present Value of a series of cashflows is zero.

Question 45

Investment trust

Answer 45

Investment trusts are public companies whose function is to manage shares and investments.

They have a capital structure in the same way as other public companies and can raise both loan and equity capital.

Most have quoted shares allowing small investors to gain exposure to the portfolio held by the investment trust.

Question 46

Lapse

Answer 46

A life insurance contract lapses if the policyholder ceases to pay premiums (ie withdraws), without the company making a payment - surrender value - to him or her.

Question 47

Leasehold

Answer 47

A lease is an agreement which allows one of the parties (the leaseholder) the use of a specified portion of a building owned (or sometimes itself leased) by the other party for a specified period in return for some payment (the rent)

Question 48

Liquidity preference.

Answer 48

The liquidity preference theory is based on the generally accepted belief that investors prefer liquid assets to illiquid ones.

Investors require a greater return to encourage them to commit funds for a longer period.
Long-dated stocks are less liquid than short-dated stocks, so yields should be higher for long-dated stocks.

Question 49

Long

Answer 49

A long position in an asset means having an economic exposure to the asset.

In futures and forward dealing, the long party is the one who has contracted to take delivery of the asset in the future.

Question 50

Long-tailed business

Answer 50

Types of insurance in which a substantial proportion (by number or amount) of claims take several years to be notified and/or settled from the date of exposure and/or occurrence.

Question 51

Loss

Answer 51

1. The financial loss suffered by a policyholder, as distinct from the amount of any insurance claim that may be payable in respect of that financial loss.
2. The amount of the insurance claim, as in the expression “loss reserve” which means the same as the reserve (or provision) for outstanding claims.
3. In relation to accounts, the opposite of profit. In this case, the word needs to be appropriately qualified, eg underwriting loss or operating loss.

Question 52

Managed fund

Answer 52

1. An investment contract by means of which an insurance company offers participation in one or more pooled funds.
2. An arrangement where the assets are invested on similar lines to unit trusts by an external investment manager.

Question 53

Market capitalisation

Answer 53

The total value at market prices of the securities at issue for a company, or a stock market, or a sector of a stock market.

Question 54

Market risk

Answer 54

the risk relating to changes in the value of a portfolio due to movements in the market value of the assets held.

Question 55

Market value of assets

Answer 55

Represents what they are worth in the open market, given a willing buyer and a willing seller.

Question 56

Matching

Answer 56

Arranging assets and liabilities so that the cashflows generated by the assets can be expected to meet the liability payouts, either because the assets generate income of the right amount at the right time or because the market values of the assets are linked to the market values of the liabilities appropriately.

Question 57

Member.

Answer 57

1. A person who has been admitted to membership of a pension scheme and is entitle to benefit under the scheme.
2. A person who is entitled to participate in the management (usually by having a vote at General Meetings) of a mutual insurance company or society.

Question 58

Mismatching reserve

Answer 58

If the assets of an insurance company are not matched to its liabilities it may be unable to meet claims as they fall due in the event of adverse future investment conditions.
It may be required to set up a mismatching reserve that it can call upon if experience so requires.

Question 59

Money purchase

Answer 59

The determination of an individual member’s benefits by reference to the contributions paid into a benefit scheme in respect of that member, usually increased by an amount based on the investment return on those contributions.

Question 60

Moral hazard

Answer 60

The action of a party who behaves differently from the way they would behave if they were fully exposed to the consequences of that action.

The party behaves inappropriately or less carefully than they would otherwise, leaving the organisation to bear some of the consequences of the action.

Moral hazard is related to information asymmetry, with the party causing the action generally having more information than the organisation that bears the consequences.

Question 61

Mutual insurer

Answer 61

A mutual insurer is owned by policyholders to whom all profits (ultimately) belong.