A301 P2

Question 1

Weighted average cost of capital

Answer 1

The aggregate return required by the providers of debt and equity capital, allowing for the effects of tax and the risks borne by the capital providers.

Question 2

Withdrawal benefit

Answer 2

A benefit payable when an employee leaves a benefit scheme.

Question 3

With-profit (participating)

Answer 3

A life insurance contract is with-profit if the policyholder is entitled to receive part of the surplus of the company.

The extent of the entitlement is usually at the discretion of the company.

Question 4

Without-profit (non-participating)

Answer 4

A life insurance contract is without-profit if the life insurance company has no discretion over the amount of benefit payable, ie the policy document will specify at outset either the amount of the benefits under the contract or how they will be calculated.

Question 5

Yield curve

Answer 5

A plot of yield against term to redemption.

Usually the yield plotted is the gross redemption yield on coupon bonds but other yields can be used.

Question 6

Zero-coupon bond

Answer 6

A bond where the sole return is the payment of the nominal value on maturity.

Question 7

Zero-coupon yield curve

Answer 7

A plot of redemption yields against term to redemption for (usually hypothetical) zero-coupon bonds.

Question 8

Swap

Answer 8

A contract between two parties under which they agree to exchange a series of payments according to a pre-arranged formula.

Question 9

Systematic risk

Answer 9

the risk of the individual share relative to the overall market which cannot be eliminated by diversification.

Question 10

Terminal funding

Answer 10

An arrangement whereby a payment to meet the value of a benefit is made only at or about the time when the benefit is due to commence.

Question 11

Treasury bill

Answer 11

A short-term government debt security.
Usually issued with a term of 91 or 182 days. No interest is paid, but the bill is issued at a discount to its redemption value.

Question 12

Trust

Answer 12

A legal concept whereby property is held by one or more persons (the trustees) for the benefit of others (the beneficiaries) for the purposes specified by the trust instrument.
The trustees may also be beneficiaries.

Question 13

Trust deed

Answer 13

A legal document, executed in the form of a deed, which establishes, regulates or amends a trust.

Question 14

Trustee

Answer 14

An individual or company appointed to carry out the purposes of a trust in accordance with the provisions of the trust instrument and general principles of trust law.

Question 15

Underwriting

Answer 15

1. The process of consideration of an insurance risk. This includes assessing whether the risk is acceptable and, if so, the appropriate premium, together with terms and conditions of the cover. It may also include assessing the risk in the context of the other risks in the portfolio.
2. The provision of some form of guarantee. In investment, underwriting is where an institution gives a guarantee to a company issuing new shares or bonds that it will buy any remaining shares or bonds that are not bought by other investors.

Question 16

Underwriting Cycle

Answer 16

The process whereby relatively high and thus profitable premium rates that often result in an increase in the supply of insurance are followed by lower and less profitable premium rates usually associated with increased competition.

These in turn may be followed by a decrease in supply as companies leave the less profitable market, reduced competition and a return to higher premium rates.

The process is complex but appears to occur in all types of insurance and reinsurance, though at different speeds and to different degrees.

Question 17

Underwriting factor

Answer 17

Any factor that is used to determine the premium, terms and conditions for a policy.

It may be a rating factor or some other risk factor that is accounted for in a subjective manner by the underwriter.

Question 18

Unitised contracts

Answer 18

After deducting an amount to cover part of the costs, each premium under a unitised contract is used to buy units at their offer price.

These units are added to the contract’s unit account. when the insured event happens the amount of the benefit is then based on the bid price value of all the units in the contract’s unit account.

Question 19

Unit trust

Answer 19

An open-ended investment vehicle whereby investors can buy units in an underlying pool of assets from the trust manager.

If there is demand for units, the managers can create more units for sale to investors. If there are redemptions (sales by investors), the managers will buy in units offered to them. Unit trusts are trusts in the legal sense.

Question 20

Unsecured loan stock

Answer 20

A form of long-term corporate debt which is not secured on any specific assets of the borrower.

Question 21

Valuation rate of interest

Answer 21

The rate at which future liabilities and assets are discounted to the valuation date.

Question 22

Vested rights

Answer 22

Benefits to which a member of a scheme is entitled whether or not they remain an active member of the scheme.

Question 23

Volatility

Answer 23

The sensitivity of the market price of an investment. A highly volatile investment is one which has a very unstable price.

For fixed-interest bonds, volatility is specifically defined as the rate of change in the dirty price (P) of the bond for a change in the gross redemption yield (y).
V = -1/p dP/dy

A.k.a. modified duration

Question 24

Waiting period

Answer 24

1. In the case of occupational pension provision, the period during which an employee does not yet meet the eligibility conditions for membership of the occupational benefits scheme.
2. In the case of sickness benefits, the period beginning at the policy inception during which the policyholder is not allowed to make a claim.

Question 25

Waiver of premium

Answer 25

This is a benefit attached to a contract under which regular premiums are payable.

In the event of sickness or disability or, sometimes, unemployment, the premium payable under the contract, including the premium of the waiver of the premium benefit, is waived.

Question 26

Self investment

Answer 26

The investment of the assets of an occupation benefits scheme in employer related investments.

Question 27

Short

Answer 27

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

In futures and forward dealing, the short party is the one who has contracted to deliver the asset in the future.

Question 28

Short-tailed business

Answer 28

Types of insurance in which most claims are usually notified and/or settled in a short period from the date of exposure and/or occurrence.

Question 29

Solvency

Answer 29

A provider is solvent if its assets are adequate to enable to meet its liabilities.

Supervisory authorities will usually have requirements, in terms of the values a provider can place on its assets and liabilities for the purpose of showing statutory solvency.

Question 30

Solvency margin

Answer 30

The solvency margin of a provider is the excess of the value of its assets over the value of its liabilities.

Question 31

Specific risk

Answer 31

The risk of holding a share which is unique to the industry or company and can be eliminated by having a suitably diversified portfolio of shares of differing types of companies.

This is sometimes also referred to as alpha, unsystematic, diversifiable or residual risk.

Question 32

Spot interest rate

Answer 32

The n-year spot interest rate is the geometrical average of the interest rates that are expected to apply over the next n years.

It is the redemption yield on an n-year zero-coupon bond.

Question 33

Surplus

Answer 33

1. Surplus is the excess of the value placed on a life insurance company’s assets over the value placed on its liabilities. A negative surplus is usually called a strain.
2. A type of proportional reinsurance where the cedant retains the risk up to its retention level and reinsures the excess.

Question 34

Surrender value

Answer 34

This is the amount paid out to a policyholder who terminates his or her contract before the contractual termination date.

Question 35

Net asset value per share

Answer 35

The book value of the shareholders’ interests in a company, usually excluding intangibles such as goodwill, divided by the number of shares in issue.

Question 36

New business strain

Answer 36

When the premium(s) paid at the start of a contract, less the initial expenses, is not sufficient to cover the reserve that the company needs to set up at that point.

Question 37

Freehold

Answer 37

The freeholder of land is the absolute owner of it in perpetuity.

Question 38

Funding objective

Answer 38

The arrangement of the incidence over time of payments with the aim of meeting the future cost of a given set of benefits.

Question 39

Futures contract.

Answer 39

Like a forward contract, this is a contract to buy (or sell) an asset on an agreed basis in the future.
However, futures contracts are STANDARDISED contracts that can be TRADED on a recognised exchange.

Question 40

Gearing

Answer 40

The ratio of debt to equity. (financial gearing)

Question 41

Gilt

Answer 41

A bond issued by the British Government that pays regular coupons.

Question 42

Going concern basis

Answer 42

The accounting basis normally required for an insurer’s published accounts, that is based on the assumption that the insurer will continue to trade as normal for the long-term future.

Question 43

Group contract

Answer 43

That is a contract that covers a group of lives, where the group is specified but not necessarily the individuals within it.

Question 44

Guarantee (investment)

Answer 44

In the context of life insurance, this refers to a promise that the company will pay a specified sum of money - or sums of money - at specified times if a specified condition is fulfilled. The condition can be an event such as the surrender or maturity of a contract.

the term can also refer to the situation where a company guarantees the rate it will use, at some future date, to convert a lump sum into an annuity or vice versa.

Question 45

Hedging

Answer 45

Action taken to protect the value of a portfolio against a change in market prices.

Hedging involves holding OFFSETTING POSITIONS in assets or portfolios the values of which are expected to respond identically to market changes.