Chapter 1

Question 1

What makes pricing insurance products different than most products?

Answer 1

The fact that the cost of the raw materials is not known at the time of determining the life insurance price.

Question 2

When is the actual profitability of a life insurance product determined?

Answer 2

cannot be determined until policy lapse or when the last policy holder(s) has died

Question 3

Who determines the setting of the mortality expectations, expenses, interest rates etc?

Answer 3

the product development actuary

Question 4

What are the two key items an organization needs to consider when determining the cost of the product?

Answer 4

1. Have the skill set to appropriately analyze the risk being considered
2. Must be Realistic about underlying cost of different offerings

Question 5

The consumption of life insurance products tends to be driven by what pull?

Answer 5

1. The price in the marketplace
2. The competition pressure is driven by the accepted belief insurance products are bought as a commodity

Question 6

Define surplus

Answer 6

The capital that is held above the expected needs of the product to ensure that all policyholder claims are met. Surplus can be assigned based on a products design.

Question 7

T/F. On a theoretical level, with all ventures, expected returns should correlate directly with the amount of underlying risk present?

Answer 7

True

Question 8

T/F. The greater the risk, the expected return should be higher in regards to a life insurance product.

Answer 8

True

Question 9

3 types of risk established by the NAIC through the RBC (risk based capital) formula.

Answer 9

1. Asset Risk
2. Underwriting/Insurance risk
3. Other risk

Question 10

Define Asset Risk

Answer 10

risk that the assets supporting the product line lose some or all of their value

Question 11

Define Underwriting/Insurance Risk

Answer 11

risk that the price for the insurance product is inadequate or underwriting standards were not maintained.

Question 12

Define Other Risk

Answer 12

All other risks (business, interest rate, political risk).

Question 13

What do you call the management of Interest Rate risk? Define it

Answer 13

This risk management process is known as asset liability management of ALM. the management of this risk has precipitated sig amount of industry work aimed at matching the liability cash flow of a product with the cash flow of the invested assets.

Question 14

What is the key risk for a Term Product?

Answer 14

Underwriting risk which would be mortality risk.

Question 15

What is the biggest cost in a life insurance product?

Answer 15

Mortality.

Question 16

Define the difficulties of preferred risk class product pricicng.

Answer 16

When there is more stringent underwriting, The expected mortality decreases on the block of policies that qualify at this tighter level criteria = more competitive prices. However fewer individuals will qualify under the more stringent underwriting requirements.

Question 17

Criteria far more stringent than historically defined standards were introduced for preferred classes. What were they?

Answer 17

Focused primarily on cardiovascular risks, requiring better blood pressure, cholesterol, chol/hdl ratios, fhx, other factors

Question 18

Proposed insureds that just miss qualifying for a company’s preferred rates will likely do 1 of 3 things. Name them.

Answer 18

1. Find a company with a slightly less restrictive preferred criteria and obtain an preferred classification from that company.
2. They will be unhappy that they did not qualify as preferred and drop out of the buying pool altogether
3. They will purchase the residual standard policy from your company

Question 19

Actuaries are trained to do what?

Answer 19

To think of the dynamics of large groups assuming homogenous risks.

Question 20

Underwriters are trained to do what?

Answer 20

To think about the absolute risk of the individual in question.

Question 21

What is the largest decrement affecting the number of policies in force?

Answer 21

The lapses that occur in a product.

Question 22

When will a lapse hurt profitability?

Answer 22

If a lapse occurs when the premium collected is greater than the mortality cost for the duration.

Question 23

When will a lapse profitability improve?

Answer 23

If a lapse occurs when the premium collected is less than the mortality cost

Question 24

T/F. Early duration lapses improve profitability while later duration lapses hurt profitability.

Answer 24

False. Early duration lapses hurt profitability while later duration lapses improve.

Question 25

Generally, how long does a policy needs to be in place in order to recover the expenses that incurred upon issue?

Answer 25

5 years.

Question 26

Name some factors in included in the expense levels built into the product.

Answer 26

• Agents compensation
• Corporate overhead
• Support of an agency system
• Advertising
• Underwriting expenses

Question 27

When ordering additional requirements in order to assess a risk, there is a balancing act to consider in view of the expenses levels and profitability.

What are the 4 factors considered?

Answer 27

1. The cost of a requirement
2. The corresponding mortality savings (i.e. protective value) that occurs due to obtaining the requirement
3. The proposed insureds adverse reaction to being subjected to a battery of requirements for the desired level of coverage
4. the time taken to issue a policy

Question 28

What products have a significant asset accumulation component?

Answer 28

Whole Life, Universal Life

Question 29

In addition to basic pricing components of a product there are other components established by regulation.

What are these items?

Answer 29

1. reserve bias
2. non-forfeiture laws
3. surplus needs
4. tax laws

Question 30

Define reserve bias

Answer 30

The purpose is to make sure enough of the premium earned in the early duration of a contract is held until the time when the group of policyholder ages and the probability of death is greater than the premium received.

Question 31

In regards to reserve bias …

Answer 31

In the US, statutory reserve standards are established by state regulation. In Canada, statutory reserves are established by federal regulation.

Question 32

Define non-forfeiture laws

Answer 32

Allows for the return of excess premiums in the form of a cash value (net of allowing the company to recover its expenses) if the policy holder chooses to lapse the policy.

This can happen if the policyholder pays too much for coverage in the early duration of the contract and not enough in later years.

Question 33

Define surplus needs

Answer 33

A safety net needs to be provided, beyond the level of reserves being held, in case experience turns out to be much worse than expected.

Question 34

Federal taxes paid by an insurance company are **income based **and are affected by what 3 main components?

Answer 34

1. corporate tax rate
2. tax reserves
3. DAC (deferred acquisition cost) tax

Question 35

What is the purpose of DAC tax?

Answer 35

a way to disallow full deductibility of acquisition expenses in the year they were incurred, but rather to force them to be recognized over a 10-year period.

Question 36

Define tax laws for insurance companies in Canada.

Answer 36

Insurance companies are subject to corporate taxes at a federal and provincial level in much the same way that US companies are. At the federal level, taxes related to the company’s income (federal income tax) and the provincial level they relate to premiums (provincial premium tax).

Question 37

In simple terms how do you price a product?

Answer 37

Schedule out a series of expected expenses and couple that with a stream of premium payments to produce a profit that meets the corporate requirements for the product. It must also be filed and approved with each state before it is made available for sale in that state.

Question 38

The interaction between the actuary and the underwriter in product development takes form through two main decision processes.

What are they?

Answer 38

1. The setting of the underwriting requirements
2. The reasonableness of the pricing expectations

Question 39

What are the two components in the underwriting requirement process?

Answer 39

1. Verifying information obtained from the proposed insured
2. Discovering information that is either new to or is being concealed by the proposed insured

Question 40

what is “protective value” in relation to pricing?

Answer 40

Refers to the relationship of mortality savings from a requirement to the cost of administering the particular requirement.

Question 41

T/F. To the extent that greater mortality cost is saved than the cost of the requirement, the requirement should be ordered.

Answer 41

True.

Question 42

Establishing a valid protective value study requires evaluation of what issues?

Answer 42

First, which requirement identified the underlying impairment. Second, the proposed insured’s behavior.

Question 43

T/F. The purpose of a protective value study should be examined in the context of the underwriting process.

Answer 43

True.

Question 44

T/F. Many companies look at their competitors when establishing underwriting requirement grids.

Answer 44

True.

Question 45

T/F. History has proven that if a company establishes underwriting requirements that are “ahead of the market”, then a proposed insured’s behavior will be modified and additional risks will be attracted.

Answer 45

True.

Question 46

What are the two most important functional areas of an insurance company?

Answer 46

The pricing actuary and underwriter

Question 47

T/F. One should establish the underwriting grid simply by looking at the competitors.

Answer 47

False. One should not establish the underwriting grid simply by look at the competitors.

Question 48

T/F. One should never establish the underwriting process without being cognizant of what is common practice in the marketplace.

Answer 48

True.

Question 49

T/F. It is unusal for the underwriting requirement grid or underwriting processes to change over time.

Answer 49

False. It is not unusual.

Question 50

What two pieces of information are important for the product development actuary?

Answer 50

Historical behavior of the UW department is already reflected in the underlying underwriting cost structure as well as mortality studies

Question 51

What is a controversial topic in the underwriting community?

Answer 51

Exceptions

Question 52

For the best underwriting class, what percentage of people can qualify?

Answer 52

As few as 10-20% can qualify.

Question 54

In regards to exceptions, an organization should fully document all exceptions that are granted and analyze the type and frequency of exceptions. This information should also be shared with who? To determine what?

Answer 54

Should be shared w/the product actuary to determine the impact on the expected mortality and what adjustments are necessary.

Question 55

T/F. An early duration claim defines a poor risk or poor decision.

Answer 55

False. An early duration does not define a poor risk or poor decision any more than one that lives defines a good risk.

Question 56

Feedback mechanism needs to consider what?

Answer 56

Risks that died and risks that lived.

Question 57

A claim beyond the contestable period can not be contested unless…

Answer 57

except for fraud

Question 58

What is the key to ensuring ongoing profitability?

Answer 58

make product decisions based on realistic assumptions and then reguarly measure the experience against the assumptions.

Question 59

Underwriting criteria generally used in the pricing of preferred policies

Answer 59

blood pressure
chol/HDL ratios
family history

Question 59

What three functions should always have a healthy respect for eachother for success of the product?

Answer 59

The underwriting, actuarial, and marketing functions.

Question 60

What are life insurance pricing components that are established by regulation?

Answer 60

reserve basis
tax law
non-forfeiture laws

Question 61

What is the relationship of mortality savings from a requirement to the cost of administering the requirement?

Answer 61

Protective value

Question 62

Protective value study should..

Answer 62

• evaluate which requirement identified the underlying impairment
• consider the PIs behavior in accepting or rejecting the offered policy
• ensure that the offered product is “at the market”

Question 63

A safety net that needs to be provided beyond the level of reserves being held in case a company’s mortality experience turns out to be much worse than expected is referred to as:

Answer 63

Risk based capital