Chapter 1 terms Flashcards
Accrual rate
The rate at which rights build up for each year of service in a defined benefit scheme.
Accrued benefits
The benefits for service up to a given point in time, whether vested rights or not. They may be calculated in relation to current earnings or projected earnings.
Acquisition costs
Costs arising from the writing of insurance contracts including: direct costs, indirect costs, such as advertising costs.
Active member
A member of a benefit scheme who is at present accruing benefits under that scheme in respect of current service.
Anti-selection
People will be more likely to take out contracts when they believe their risk is higher than the insurance company has allowed for in its premiums. This is known as anti-selection.
Arbitrage
In investment markets, the simultaneous buying and selling of two economically equivalent but differentially priced portfolios so as to make a risk-free profit.
Average earnings scheme
A pension scheme where the benefit for each year of membership is related to the pensionable earnings for that year.
Balance of cost scheme
A defined benefits scheme to which beneficiaries make a defined contribution and the main sponsor pays the remainder of the unknown cost of providing the benefits.
Bancassurance
An arrangement between a bank and an insurance company to allow the insurance company to sell its products to the bank’s clients.
Bear market
A period of time during which investors are generally unconfident and stock market prices decline. (Compare with bull market.)
Benchmark
A standard or model portfolio (e.g. investment index) against which a fund’s structure and
performance will be assessed.
Best estimate
An actuarial assumption which the actuary believes has an equal probability of under- or over- stating the future experience - median of the ditribution fo future experience
Bid (also selling) price
The price at which a market maker offers to buy a security.
Book reserve
A provision in a company’s accounts for a future benefit liability for which no funds have been set
aside.
Bulk rate
A premium rate applied uniformly per head on large benefit schemes across a membership type (independent of actual members’ ages). Also called ‘Unit rate’.
Bulk transfer
The transfer of liabilities (and usually assets), relating to a group of members, from one benefit scheme to another.
Bull market
A period of time during which investors are generally confident and stock market prices increase. (Compare with Bear market.)
Catastrophe reserve
A reserve built up over periods between catastrophes to provide some contingency against the risk of catastrophe.
Ceding company (cedant)
An insurance or reinsurance company that passes (or cedes) a risk to a reinsurer. The term ‘cedant’ may also be applied to a Lloyd’s syndicate.
Chinese walls
Regulations or practices intended to prevent conflicts of interest in integrated security or consultancy firms
Claim frequency
The number of claims in a period per unit of exposure
Coinsurance
An arrangement whereby two or more insurers enter into a single contract with the insured to cover a risk in agreed proportions at a specified premium. Each insurer is liable only for its own proportion of the total risk.
Commutation
The giving up of a part or all of a stream of future income for an immediate lump sum.
Composite insurer
An insurance company writing both life and non-life business.
Convexity
The convexity of a bond is defined as the second derivative of the log bond price with respect to the continuously compounded yield r
Credibility
A measure of the weight to be given to a statistic. This often refers to the experience for a particular risk (or risk group) compared to that derived from the overall experience of a corresponding parent or larger population.
Credit rating
A rating given to a company’s debt by a credit-rating company as an indication of the likelihood of default.
Credit risk
Credit risk is the risk of failure of third parties to meet their obligations.
Custodian
The keeper of security certificates and other assets on behalf of investors.
Debenture
A loan made to a company which is secured against the assets of the company. Debentures usually have a floating charge over the assets of the company so that debenture holders rank above other creditors should the company be wound up. Debentures with fixed charges are called mortgage debentures.
Deferred member
A member of a benefits scheme who is no longer accruing benefits but who has accrued benefits that will be payable at a future date.
Defined ambition scheme
A scheme where risks are shared between the different parties involved, such as scheme members, employers, insurers and investment businesses.
Defined benefit scheme
A benefits scheme where the scheme rules define the benefits independently of the contributions payable, and benefits are not directly related to the investments of the scheme.
Defined contribution scheme
A scheme providing benefits where the amount of an individual member’s benefits depends on the contributions paid into the scheme in respect of that member increased by the investment return earned on those contributions.
Derivative instrument
A financial instrument with a value dependent on the value of some other, underlying asset.
Discontinuance valuation
An actuarial valuation carried out to assess the position if a benefits scheme were to be discontinued.
Discounted income model
A model for valuing investment which determines a present value for the investments by discounting the expected future income from the assets
Duration
The duration of a conventional bond (also known as the effective mean term or discounted mean term) is the mean term of the payments from the stock, where each term is weighted by the present value of that payment.
Efficient frontier
An efficient portfolio is one for which it is not possible to increase the expected return without accepting more risk and not possible to reduce the risk without accepting a lower return. The efficient frontier is the line joining all efficient portfolios in risk-return space. In portfolio theory, risk is defined as variance or standard deviation of return.
Efficient market hypothesis
A hypothesis that asset prices reflect all relevant information.
Embedded value
It represents the value to shareholders of the future profit stream from a company’s existing
business together with the value of any net assets separately attributable to shareholders.
Experience rating
A system by which the premium of each individual risk depends, at least in part, on the actual claims experience of that risk
Final salary scheme
A defined benefit scheme where the benefit is calculated by reference to the final earnings of the member, and usually also based on pensionable service.
Financial gearing
The expression ‘gearing’ or ’financial gearing’ is often used to refer to the impact on the profits for a
company caused by fixed-interest borrowing. For a financially highly geared company a small change in the total profits might have a very large proportionate impact on the profits for shareholders. A company with lots of fixed interest borrowing is ‘highly geared’.
Free assets
This term is loosely used to refer to that part of a life insurance company’s assets that are not
needed to cover its liabilities. Opinion differs as to what should be included in the liabilities.
Gearing
Debt to equity ratio
Going-concern basis
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.
Hedging
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.
Hurdle rate
A target or minimum rate of return used in Capital Project assessment.
Immunisation
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.
Indemnity, principle of
The principle whereby the insured is restored to the same financial position after a loss as before the loss.
Insured scheme
A benefit scheme where the sole long-term investment medium is an insurance policy (other than a managed fund policy).
IRR
Internal rate of return
The discount rate at which the Net Present Value of a series of cash flows is zero.
Long
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 which has contracted to take delivery of the asset in the future.
Long-tailed business
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.
Lloyd’s (of London)
Lloyd’s is an insurance market that transacts mainly general insurance and reinsurance. Rather than being a company, it is a collection of underwriting pools (’syndicates’) that comprise corporations and private individuals.
Market capitalisation
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.
Matching
Arranging assets and liabilities so that the cash flows 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.
Mismatching reserve
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.
Money purchase
The determination of an individual member’s benefits by reference to contributions paid into a benefit scheme in respect of that member, usually increased by an amount based on the investment return on those contributions. Sometimes called defined contribution, or DC.
Moral hazard
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
Mutual insurer
A mutual insurer is owned by policyholders to whom all profits (ultimately) belong.
New business strain
New business strain arises when the premium(s) paid at the start of a contract, less the initial expenses including commission payments, is not sufficient to cover the reserve that the company needs to set up at that point.
Occupational scheme
A benefits scheme organised by an employer or on behalf of a group of employers to provide benefits for or in respect of one or more employees.
Offer (also buying) price
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.
Open ended investment company (OEIC)
An investment vehicle similar in corporate governance features to an investment trust but with the open ended characteristics of a unit trust.
Option
The right (but not the obligation) to buy or sell an asset at a previously agreed price.
Prime
Property that is most attractive to investors is called ‘prime’. “Prime property”
Profit commission
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.
Proprietary insurer
An insurance company owned by shareholders, as opposed to a mutual insurer.
Rating basis
The collection of assumptions used to associate the risk premium with the characteristics of the risk being insured.
Rating factor
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.
Reinsurance
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.
Requirement for capital
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, i.e. the new business strain.
Retention
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.
Risk-based capital (RBC)
The assessment of the capital requirement for a provider by considering the risk profile of the business written and of any other operations.
Risk discount rate
A risk discount rate is a rate at which future uncertain cash flows might be discounted. It typically arises when carrying out a discounted cash flow 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.
Run-off basis
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.
Self-administered scheme
An occupational benefits scheme where the assets are invested, other than wholly by payment of insurance premiums, with an in-house investment manager or an external investment manager.
Self-investment
The investment of the assets of an occupational benefits scheme in employer-related investments.
Short
A short position in an asset means having a 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
Short-tailed business
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.
Solvency
A provider is solvent if its assets are adequate to enable it 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.
Specific risk
Unsystematic or diversifiable risk
Spot interest rate
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. (See zero coupon yield curve.)
Strips
Debt securities comprise a series of coupons and (possibly) a final redemption amount. For certain such securities, each individual cashflow may be traded as an isolated zero coupon bond, called a
‘strip’.
Swap
A contract between two parties under which they agree to exchange a series of payments according to a pre-arranged formula.
The most common kind of swap is an interest rate swap, where one party with fixed interest cashflows enters a swap with another party based on a variable interest rate.
Systematic risk
The risk of the individual share relative to the overall market which cannot be eliminated by diversification.
Treasury bill
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.
Trust
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.
Underwriting
(1) The process of consideration of an insurance risk
(2) The provision of some form of guarantee - in investments 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.
Underwriting cycle
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.
Unitised contracts
After deducting an amount to cover part of its costs, each premium under a unitised contract is used to buy units at their offer price.
Vested rights
Benefits to which a member of a scheme is entitled, regardless of whether they remain an active member of the scheme.
Weighted average cost of capital
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.
Winding up
The process of terminating a benefits scheme, usually by applying the assets to the purchase of individual insurance contracts for the beneficiaries, or by transferring the assets and liabilities to another scheme.
Yield curve
A plot of yield against term to redemption. Usually the yield plotted is the gross redemption yield on coupon paying bonds but other yields can be used.
Unit-linked contracts
Unit-linked contracts are unitised contracts whose value of units is directly attributable to the underlying value of the invested assets.
With and without profits (participating) contracts
A life insurance contract is with profits if the policyholder is entitled to receive part of the surplus of the company or of a sub-fund within the company. The extent of the entitlement is usually at the discretion of the company. Without profits contracts do not have this profit participation feature.
Income drawdown
Some defined contribution arrangements allow for ‘income drawdown’. Under such an arrangement instead of buying an annuity the fund remains invested and the member withdraws an amount of the fund each year. This may be just the income earned on the fund or may also include some of the fund capital.
Proportional reinsurance
Under proportional reinsurance, the reinsurer covers an agreed proportion of each risk. This proportion may be constant for all risks covered (called quota share reinsurance) or may vary by risk covered (called surplus reinsurance). Both forms have to be administered automatically, and therefore require a treaty.
Quota Reinsurance
Under quota share reinsurance a fixed percentage of each and every risk is reinsured. Quota share is widely used by ceding providers to spread risk, write larger portfolios of risk and encourage reciprocal business.
Excess of loss reinsurance
Excess of Loss (XL) reinsurance is non-proportional cover where the cost to a ceding company of such large claims is capped with the liability above a certain level being passed to a reinsurer.
