F102 Flashcards
Define an endowment assurance.
An endowment assurance is a contract to pay a benefit on survival to a known date. The contract may also provide a significant benefit on the death of the life insured before that date. This cover is provided in exchange for either a single premium at the start of the contract or a series of regular premiums throughout the contract.
Define the asset share of a contract.
The asset share is the retrospective accumulation of past premiums, less expenses and the cost of cover, at the actual rate of return on the assets.
In the case of with-profit contracts, allowance may be made for miscellaneous profits from without-profit contracts and from surrenders and lapses, and also for the cost of guarantees and any capital support provided.
In simpler terms, the asset share is the accumulation of monies in less monies out, the accumulated cashflow in respect of a policy.
State the the components which give rise to deductions for an asset share of a contract. (P BEC TW)
commission paid and expenses incurred (net of tax, if appropriate)
the cost of providing all benefits in excess of the asset share (life cover, guarantees, options) on a smoothed, rather than current cost, basis
tax on investment income including any reserves made for future tax liabilities
transfers of profit to shareholders
the cost of capital necessary to support contracts in the early years
contributions to the undistributed surplus in the with-profits policyholder fund
The capital requirement of a contract will depend on:
The design of the contract
The frequency of payment of premium
The relationship between the pricing and supervisory reserving bases
The additional solvency capital requirements
The level of initial expenses
Define a whole life assurance.
A whole life assurance is a contract to pay a benefit on the death of the life insured whenever that might occur. A surrender value could also be available.
Define a term assurance.
A term assurance is a contract
- To pay a benefit on the death of the life insured within the term of the contract chosen at the outset
- Typically, no benefit is available at surrender
- Premiums could be paid regularly over the term (or some shorter period) or as a single premium at the outset
Define and immediate annuity.
An immediate annuity is a contract to payout regular amounts of benefit provided the life insured is alive at the time of payment. Immediate indicates that the contract starts payments immediately. The contract is usually purchased by a single premium, this premium may be the proceeds of another contract.
Define a deferred annuity.
A deferred annuity is a contract to pay out regular amounts of benefit provided the life insured is alive at the end of the deferred period when payments commence, and subsequently alive at the future times of payment.
As there is a deferred period, regular or single premiums may be payable up to the vesting date.
Define conventional without-profits.
Conventional without profits are characterised by fully guaranteed benefits and, usually, level regular premiums (depending on the product).
Define with-profits contract.
A with-profits policy is one where:
- The policyholder has a share in the surplus arising within the with-profits fund
- 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
Define unit-linked.
Unit-linked is a policy where the benefits are linked directly to the investment performance of a specified fund, and characterised by a lower level of guarantees on benefits and premiums.
Define index-linked.
Index-linked is a policy where the benefits are linked directly to a specified investment index or economic index, and are guaranteed to move in line with the performance of that index.
Define a unit fund.
A unit fund defines the policyholders basic benefit, and a company has a liability to pay this amount at the time of claim.
Define a non-unit fund.
The non-unit fund can be thought of as being the accumulated value of all charges the company has taken out of its unit-linked policies, less all actual costs it has incurred on behalf of those contracts, less any distributions of profit it has made to its providers of capital, plus any capital injections paid in (for example, in order to pay for setting up reserves). The actual costs will include actual expenses, plus any additional claim costs over and above the amounts of unit fund paid out ( e.g. the extra amounts required to make up any total guaranteed sum assured for those policyholders who die).
What is, and what is the aim of, actuarial funding?
Actuarial funding is a technique whereby life insurance companies can hold lower reserves for unit-linked contracts to which it can be applied, and thus can reduce new business strain.
Is a method which a life insurance company can use to reduce the size of the “unit reserves” it needs to hold in respect of its unit-linked business. The company effectively capitalises some or all of the unit-related charges it expects to receive from the units it has nominally allocated, with the funding being repaid from these future charges as they are received. When associated with appropriate surrender penalties it enables the company to reduce its financing requirement.
What are the purpose of reserves?
The purpose of reserves is to
- Demonstrate solvency to the supervisory authorities
- To investigate the realistic/true position of the life insurance company
o To help determine the long-term sustainability of profit distribution rates (such as bonuses) as well as current bonus declarations
o help determine the realistic profitability of the company for the information of shareholders and management
o to assist in the general financial management of a life company
With regards to negative non-unit reserves, what may regulation specify in a prudential valuation. (PANS)
The sum of the unit reserve and non-unit reserve for a policy should not be less than any guaranteed surrender value.
The future profits arising on the policy with the negative non-unit reserve need to emerge in time to repay the loan.
After taking account of the future non-unit reserves, there are no future negative cashflows for the policy (there is no future valuation strain).
In aggregate, the sum of all non-unit reserves should not be negative (from a select group of policies in the company’s business - regulation dependent).
The supervisory authority’s primary concern is to ensure that insurance companies have sufficient assets to cover their liabilities with a high degree of certainty. This could be achieved by:
Requiring insurance companies to hold reserves calculated on a prudent basis
Requiring a minimum level of solvency capital to be held
Requiring a combination of prudent reserves and solvency capital to be held
Define a market consistent methodology for a valuation.
A market consistent approach (“fair valuation”) can be taken when setting reserves, with assets also being valued at market value.
To determine the liabilities, future unknown parameter values and cashflows are set so as to be consistent with market values, where a corresponding market exists.
The purpose of solvency capital requirements is to provide an additional level of protection for policyholders. It will protect policyholder against:
- the reserves being underestimated (adverse future experience relative to the reserving basis assumptions)
- a drop in asset values (including individual asset defaults)
What is the aim of a risk-based capital approach.
The aim of a risk-based capital approach is to set aside an extra amount of capital, where the amount of capital is appropriate to the extent of the risks involved.
Define the Value at Risk approach.
An example of a risk-based solvency capital requirement approach is to use a VaR measure, normally expressed at a minimum required confidence level (eg 99.5%) over a defined period (eg one year).
So the insurer calculates the amount of capital it needs so that its assets will exceed its liabilities in one year’s time with probability of 0.995 say.
For example, a VaR of 10 million over the next year with a 99.5% confidence interval means that there is only a 0.5% expected probability of losses being greater than 10 million over the next year.
Define a passive valuation approach.
A passive valuation approach is one which uses a valuation methodology:
- Which is relatively insensitive to changes in market conditions.
- Where the valuation basis is updated relatively infrequently
What are the advantages and disadvantages of a passive valuation approach. (SSS BOF)
Advantage
- more straightforward to implement
- less subjectivity involved
- (to the extent that they are used for accounting purposes) result in relatively stable profit emergence
Disadvantage
- becoming out of date as it is relatively insensitive to changes in market conditions
- valuation basis which is updated relatively infrequently may not take into account important trends (rising expense inflation or deteriorating claims experience)
- danger that it provides a false sense of security and management fails to take appropriate actions
Define an active valuation approach.
An active valuation approach is one which uses a valuation methodology:
- Which is based closely on market conditions
- Where the valuation basis is updated frequently
What are the advantages and disadvantages of using an active valuation approach. (IG CCV)
Advantages of an active valuation approach:
- more informative
o in understanding impact of market conditions
o in the ability of the company meeting its obligations (particularly in relation to financial guarantees and options)
Disadvantages of an active valuation approach
- more complex
- more costly
- results more volatile
Define an income protection (IP) product.
An IP product is used to replace part of the income that the insured life would have earned if they become unable to work (referred to as incapacity) due to accident or illness. IP therefore pays a benefit in the form of a regular income (short- or long-term payments during periods of incapacity). IP benefits are in the form of a temporary annuity that continues until the insured recovers, dies or the annuity term ends, whichever occurs first. The regular income may be commutable to provide a lump sum, but this is not generally the case.
Policy conditions should aim to: (ICU)
Reflect the true intentions of the office
Give some cushion against adverse events over which the office has no control, for example if the office feels unable to assess the extra cost of claims that would result if war was declared, it should use policy conditions to exclude these claims
Be as far as possible, simple and unambiguous, so as to assist the sales, underwriting and claims processes.
Define a critical illness policy.
The benefit under a critical illness policy is typically a lump sum that is payable if the policyholder suffers one of the defined conditions. The product may also offer the lump sum to be paid in instalments, with any outstanding amount payable on death (if applicable). The lump sum is usually used to purchase an impaired life annuity that provides a regular income from date of a valid claim until death. The critical illness benefit is generally payable upon: the happening of a critical illness event; on reaching a defined degree of impairment; on undergoing a surgical procedure.
What are the major advantages of the revalorisation method?
It is simple to apply
The method codifies exactly how a company should declare part of its profits as a bonus to with profits policyholders, very little judgement is required, and should therefore be relatively cheap to administer, only an exception if the policyholder participates in the insurance profit
Protects policyholders from ungenerous life insurance companies
By taking assets at book value a smooth emergence of investment profit is usually achieved
What are the major disadvantages of the revalorisation method
The company has no discretion in its profit distribution
Methods tend to discourage equity investment, because of the fact that there is no deferral of profit distribution, this means all investment losses are borne by the company which would constitute insolvency risk
Versions that do not share insurance profit with policyholders goes against the principle of mutuality
To very easy to explain to policyholders with “constant premium” policies, who see very small additions to their guaranteed benefits early in the policy term
Define anti-selection.
Anti-selection occurs when people will be more likely to take out contracts when they believe that the risk which they pose is greater that the risk the insurance company has allowed for in its premiums.
Anti-selection also arises where existing policyholder have the opportunity to exercise a guarantee or an option. Those who have the most to gain from the guarantee or option will be most likely to exercise it.
What is the appraisal value of a life insurance company?
It is the sum of the embedded value of the company and the value to its shareholders of the future profits they expect to receive from future new business. The latter part of the appraisal value is often referred to as the “goodwill” value of the company.
Define embedded value.
This is part of the appraisal value of the life insurance company. It represents the value of the future profit stream from the company’s existing business together with the value of any net assets separately attributable to shareholders.
What is the purpose of the “management box” of an internal unit-linked fund, and what are the risks associated with the “management box”
Some companies create more units in their internal unit-linked fund than is strictly necessary to cover the corresponding unit liabilities. The “management box” are these additional funds. The purpose of the “management box” is to reduce the need to cancel or create units for a given day.
Risks:
- The most significant risk here is that the value of the underlying assets, so the value of the units that the company is holding for its own account decreases. For this reason, companies that use a box will normally keep it as small as practical given the degree of unit flows that arise from their policyholders.
- There is also a risk that the expenses of managing a box are higher than expected.
- There are operational risks, for example in keeping track of which units belong to policyholders and which to the company.
What is the basic equity principle of unit pricing for an internal fund?
The interests of unit-holders not involved in a unit transaction should be unaffected by that transaction.
Unit-holders should not be affected by the creation or cancellation of other units, otherwise cross-subsidies between unit-holders will arise.
The creation and cancellation of units should not give rise to a change in the net asset value per unit.
Define the appropriation price
The appropriation price is the price at which the company will create a unit. This can only be achieved if the amount of money put into the fund for each new unit appropriated is such that the net asset value per unit is the same after, as before, the appropriation.
Define expropriation price
The expropriation price is the price at which the company will cancel units. This can only be achieved if if the amount of money the company takes out of the fund for each unit expropriated is such that the net asset value per unit is the same after, as before, the expropriation.
What is the “broad equity” approach?
The “broad equity” approach specifies that the basis is only changed if there is significant cashflow movement against the existing basis (if there is a significant net cash inflow for a fund being priced on a bid basis). This approach provides broad equity between different unit-holders and reduces price volatility.
Sometimes companies use a management box to minimise changes to the basis.
State key features of the bonuses relating to the conventional with-profits policies.
- surplus arises on the policyholders fund from interest, mortality, expenses and possibly lapses, the surplus is distributed by means of regular reversionary bonuses, special reversionary bonuses and terminal bonuses.
- surplus distribution is normally determined for fairly homogeneous groups of policies by product and by duration.
- comparison is made with the smoothed asset shares at maturity to determine appropriate payouts for each group
- the method allows for smoothing of bonuses over time
- this method allows a higher proportion of equity and property investment (more for conventional than AWP)
- this method allows the actuary to apply judgmental considerations
- any perceived inequity between policyholders may be difficult to explain or justify, this method is less transparent than AWP
State key features of the bonuses relating to accumulating with-profit (AWP) policies.
- the benefit takes the form of an accumulating fund of premiums where profits are distributed by means of regular bonuses (applied as a proportion of the fund, and often on a daily basis) and terminal bonuses (added to the fund at the time of claim)
- under this method it is more common for investment surplus only to be distributed (although other sources of surplus can also be distributed).
- the accumulating benefit fund could have a unitised structure
- surplus distribution is normally determined for fairly homogeneous groups of policies by product and by duration.
- comparison is made with the smoothed asset shares at maturity to determine appropriate payouts for each group
- the method allows for smoothing of bonuses over time
- this method allows a lower proportion of equity and property investment (more for conventional than AWP)
- this method allows the actuary to apply judgmental considerations
- any perceived inequity between policyholders is easier to explain or justify, this is because the AWP is more transparent than conventional
State key features of bonuses applied on the contribution method for with-profit policies.
This method identifies the investment, mortality and expense surplus arising on individual policies.
The actual experience rates used to calculate these individual surplus contributions would be based on the experience of broadly homogeneous groups of policyholders.
The surplus could be distributed by means of:
- An addition to the guaranteed benefit
- Reduction in premium
- Cashback to policyholders
- Retention of surplus for eventual “terminal dividend” distribution on claim/maturity
The total distributable surplus each year is determined by the company, so there is some discretion for smoothing of the profit distribution over time.
The subdivision of the surplus between homogeneous groups is mostly driven by a pre-set formula, which results in profits being distributed in proportion to the groups’ contributions to that profit.
Some judgement will be necessary in allocating any unusual sources of surplus to policies (from large capital gain from property).
The ability to invest in volatile assets such as equities and property would normally depend on the relative amount of terminal dividend being used.
State key features of bonuses applied on revalorisation method for with-profit policies.
Under this method, the investment surplus on the policyholders’ fund is distributed to all with-profits policies by means of an increase in reserves.
This increase in reserves is effected by means of an increase in benefit, and there may also be an increase in premiums.
The surplus may also be calculated to include a mortality and expense contribution…although such items may be considered as a reward for the insurance risks undertaken and hence reasonably distributed entirely to the shareholders.
The method treats all policies in the same way, and is formula driven (objective).
No profit deferral occurs, hence discouraging investment in more volatile assets.
What is reinsurance?
Reinsurance is an agreement 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 reinsurance contracts.
What are the reasons for using reinsurance.
reduce volatility and uncertainty of future results
manage capital more efficiently
reducing parameter and claim payout fluctuations risk
financing new business strain - use financial reinsurance and/or quota share
obtaining technical assistance
benefiting from regulatory or tax arbitrage opportunities
reducing costs
limit the amount paid on any particular claim
limit total claims payout
increase profits, return or risk-adjusted return on capital (by reducing risk cost or increasing volumes)
separate out different risks from a product
What are considerations a company may take before choosing reinsurance.
cost of reinsurance
counterparty risks - increase number of reinsurers and/or use deposit back
legal risks
type of reinsurance
amount of reinsurance (choosing retention limits)
Experience will be monitored as part the control cycle so as to: (UTIA)
update assumptions as to future experience, thereby feeding back into the control cycle
to monitor any adverse trends in experience as as to take corrective actions
provide management information
develop earned asset shares
What is an important requirement when monitoring experience.
The most important requirement when monitoring experience is a reasonable volume of stable, consistent data for the experience investigations.
The data should be of sufficient size to allow credible analysis down to the level of broad product groups split by the relevant risk factors.
Experience investigations will typically include mortality, persistency (withdrawals) and expenses.
Why would a company want to analyse the surplus arising over a year.
to show the financial effect of divergences between the valuation assumptions and the actual experience, exposing which assumptions are the more financially significant
show the financial effect of writing new business
provide a check on the valuation data and processes, if carried out independently
identify non-recurring components of surplus, thus enabling appropriate decisions to be made about the distribution of surplus to with-profit policyholders
give management information on trends in the experience of the company
comply with regulatory requirements
an analysis of surplus is a breakdown of the surplus arising over a year into elements, surplus/loss due to differences between actual experience and valuation assumption could arise due to investment, mortality, expenses, withdrawals and new business.
Define underwriting.
Underwriting is the process of consideration of an insurance risk. This includes assessing whether the risk is acceptable and, if so, setting the appropriate premium, together with the terms of cover. It may also include assessing the risk in the context of the other risks in the portfolio.
Reasons for underwriting. (FASTER)
protect the insurer against anti-selection
identify the lives with substandard health risk
identify the special terms to offer the substandard risks
help ensure that all risks are rated fairly
help ensure that mortality experience is consistent with the pricing basis
reduce the risk from over-insurance (through financial underwriting)
Reasons for performing an analysis of surplus.
show the financial effect of divergences between the valuation assumptions and the actual experience, exposing which assumptions are more financially significant
show the financial effect of writing new business
provide a check on the valuation data and processes, if carried out independently
identify non-recurring components of surplus
give management information on trends in the experience of the company
comply with regulatory requirements
List the principles that should be considered in determining the methodology for policy alterations. (AA EE SARB FP)
Affordability
Anti-selection risk managed
Ease of explanation to policyholders
Ease of calculation, administration and documentation
Stability (over time and duration)
Alteration terms used by competitors
Method allowed by regulation and professional guidance
Boundary conditions consistent
Fairness between shareholder and policyholders and a reasonable amount of profit
Policyholder reasonable expectations
In determining how to calculate paid-up sums assured, what principles should be considered. (ALS)
Paid up sums assured should be supported by the earned asset share at the date of conversion on the basis of expected future experience.
Paid up sums assured should at later durations, be consistent with projected maturity values, allowing for premiums not received.
Paid up sums assured should be consistent with surrender values, so that the surrender values before and after the conversion are approximately equal.
In determining how to calculate surrender values, what principles should be considered. (PELDAA CCC)
Surrender values should:
- take into account policyholder’s reasonable expectations
- at early durations, not appear too low compared with premiums paid, taking into account any projections given at new business stage
- at later durations, be consistent with projected maturity values
- not exceed the earned asset share, in aggregate, over a reasonable time period
- avoid anti-selection against the insurer
- be capable of being documented clearly
- take account of surrender values offered by competitors
- not be subject to frequent change, unless dictated by financial conditions
- not be excessively complicated to calculate, taking into account the computing power available
