F102 P2

Question 1

Additional disadvantages of IRR

Answer 1

Assumes single interest rate suitable for the whole term of the project

Assumes income is invested at the IRR, which may be unrealistic

The risk profile over the lifetime of the project needs to be considered along with the cash flow profile

Timing of profits is not obvious from IRR

Question 2

with profits / participating

Answer 2

A life insurance contract is with profits 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 3

without profits / non participating

Answer 3

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

Question 4

Waiting period

Answer 4

This is a feature adopted by insurers under which benefits will not be paid for a specific period after the policyholder first takes out the insurance policy.

This waiting period may also be applied to any additional benefit from the date that the member buys the additional units of cover. It might also be called a no claim period.

Question 5

valuation

Answer 5

This is the process by which a life insurance company will place a value on its assets and/or its liabilities.

Question 6

unit reserve

Answer 6

This is part of the reserve that a life insurance company needs to set up in respect of its unitised contracts. The unit reserve represents its liability in terms of the units held under the contracts.

Question 7

Income protection insurance (IP)

Answer 7

Income protection provides cover against incapacity . The benefit is paid as an income (usually monthly) for as long as the disability exists, up to a predefined age (60/65) or retirement if earlier

Question 8

Internal unit linked fund

Answer 8

an internal unit linked fund consists of a set of clearly identifiable assets. The fund is divided into a number of equal units consisting of identical sub-sets of the funds assets and liabilities. Responsibility for unit pricing rests with the company, subject to any relevant policy conditions.

Question 9

Key person cover

Answer 9

key person products are taken out by an employer to cover key employees. They fall into 2 categories:

• those designed to provide compensation for loss of profits
• those designed to cover the key employees salary (to facilitate the temporary recruitment of a replacement).

The insurance should cover sickness, incapacity or death of the key person.

Question 10

market value reduction (mvr)

Answer 10

insurance companies normally retain the right to apply a market value reduction on surrenders or withdrawals from an accumulating with profits contract, if the value of the underlying assets is less than the fund value including all bonuses. The mvr is designed to protect policyholders who remain in the with profits fund, as its application means that the withdrawing policyholder gets a fair share of the assets. There are normally points at which no mvr will be applied (eg maturity or death after a specified time or on partial withdrawals below a certain limit)

Question 11

mathematical reserves

Answer 11

in the context of supervisory reporting, the mathematical reserves consists of the value of a company’s liabilities. The terminology may also include any explicit additional contingency reserves, e.g. a mismatching reserve. however, in some jurisdictions contingency reserves are termed “capital requirements” rather than “mathematical reserves”.

Question 12

mismatching reserve

Answer 12

if the assets of a life 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. A mismatching reserve is a reserve that has been set up as a contingency reserve that may be called upon in the even of such adverse conditions.

Question 13

Actuarial Funding

Answer 13

This is a method that 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 then being repaid from these future charges as they are received.

When appropriate surrender penalties are incorporated, it enables the company to reduce its financing requirement.

Question 14

Aggregate asset share

Answer 14

Asset share calculations can be carried out for the individual policies, for specified product lines or for the whole with profits portfolio. The latter two are sometimes referred to as aggregate asset share. This term may also be used to describe the sum of the individual asset shares.

Question 15

Anti - selection

Answer 15

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.

Anti-selection can also arise where existing policyholders have the opportunity to exercise a guarantee or an option. Those who have the most to gain for the guarantee or option will be the most likely to exercise it.

Question 16

Appraisal value

Answer 16

The appraisal value of a proprietary life insurance company is the sum 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.

Question 17

Appropriation price

Answer 17

This is the amount of money per unit put into a unit linked fund for each new unit appropriated, i.e. created, such that the net asset value per unit is the same after as before appropriation.

Therefore, it is the price at which a company will create a unit.

Question 18

Assets

Answer 18

The assets of a life insurance company are what it holds in order to meet its liabilities and to provide working capital. It usually refers to the investments held by the company.

Question 19

Asset Share

Answer 19

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. The accumulation could be carried out for a single contract or a group of contracts. It is referred to as the earned asset share of the retrospective earned asset share.

In the case of with profits contracts, allowance may be made for miscellaneous profits from with profits contracts and from surrenders and lapses, and also for the cost of guarantees and any capital support provided.

Question 20

Bancassurer

Answer 20

A bancassurer is an insurance company that is a subsidiary of a bank or building society and whose primary market is the customer base of that bank or building society.

Question 21

Best estimate reserve

Answer 21

This reserve would be calculated using assumptions that are best estimates rather than assumptions that contain conservative margins.

Question 22

Bid price

Answer 22

In the context of a unitised life insurance contract, this is the price the life insurance company uses to redeem the units it has allocate to the contract.

Question 23

What is the IRR

Answer 23

The internal rate of return is the interest rate that gives a project a net present value of zero

Question 24

Advantages of IRR

Answer 24

Higher IRR means a greater return from the project, therefore a sensible method of project appraisal.

IRR is relatively easy to calculate

No need to determine a suitable discount rate therefore it is less subjective.

Useful for comparing similar and less complex projects

Question 25

Disadvantages of IRR

Answer 25

IRR does not allow for the inherent risks in the project

IRR could lead to a higher return but may also lead to higher risk projects being taken on. (Riskier projects should offer higher returns, but IRR doesn’t tell you about the risk.

IRR may lead to more than one solution. This is a problem when there are negative cash flows involved e.g. termination expenses.

IRR takes no account of the size of the profit. A small profitable project may be chosen rather than a larger project offering a larger profit but slightly lower IRR

To calculate IRR, cash flow estimates needed for:
- capital expenditure
- running costs
- revenues and termination costs
These are difficult to estimate for some projects

Question 26

Standalone critical illness

Answer 26

These are policies that only provide cover against critical illness and do not provide (or accelerate in the case of a standalone rider) any benefit in the event of death. Following payment of the critical illness benefit , the policy terminates.

Occasionally such policies may offer a nominal sum in the event of death before a critical illness is suffered.

Question 27

negative non-unit reserves

Answer 27

if projected non-unit income exceeds non-unit outgo on a unit linked contract, it may be possible for a life insurance company to set up a negative non-unit reserve in respect of that contract. this may be subject to certain constraints, depending on the regulatory regime.

Question 28

negative reserve

Answer 28

The valuation of a life insurance contract (using gpv reserves or equivalent) will give a negative reserve if the value of the future valuation premiums exceeds the value of the benefits plus future expense. This means that the contract is being treated as an asset.

Question 29

net premium valuation

Answer 29

this is a method for placing a value on a life insurance company’s liabilities that involves calculating a present value of the contractual liabilities and deducting the value of the future net premiums, all owing in each case only for mortality and interest.

the net premium is the premium, calculated on the basis of the valuation assumptions and payable under the same conditions as the office premium, that will provide the contractual benefits offered at the commencement of the policy.

Question 30

new business strain

Answer 30

New business train arises when the premium paid at the start of the contract is not enough to cover the initial expenses, commission payments and any reserves or additional capital requirements that the company needs to set up at that point.

Question 31

overheads

Answer 31

this term is used to refer to that part of a life insurance company’s total expense which are independent of the volumes of business it is currently writing or has already written. in practice, companies will have different views as to which of their expenses will be overheads.

A company will usually allow for its overheads in pricing by allocating them on a per policy basis using an estimate of the number of contracts it expects to write.

Question 32

persistency

Answer 32

in a life insurance company, persistency is used to refer to the rate of retention of policies that is experienced by the company. If a company has poor persistency this indicates a high level of lapses, surrenders, partial withdrawals and/or conversions to paid-up status. Persistency rates are typically measured over a defined period, e.g. 1 year, although may be expressed as a cumulative figure over the period since policy inception.

Question 33

profit test

Answer 33

A profit test is a technique that involves discounting the future cash flows arising under a contract for assessing the expected profitability of that contract. This profitability is often measured as a percentage of the first years premiums or commission under the contract. Profit testing can be used to determine the premium and/or the level of charges under a contract.

Question 34

Retention

Answer 34

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 re-insure the excess over that amount.

In the context of persistency, retention refers to the extent that a company is able to prevent policies from lapsing or surrendering earlier than expected.

Question 35

extra risk (how does extra risk arise)

Answer 35

an extra risk arises where a proposal for life insurance is not acceptable at standard rates

Question 36

fair value reserve

Answer 36

this is a reserve calculated using fair value accounting principles. a market consistent method of valuation is an example of fair value reserving.

Question 37

financial reinsurance

Answer 37

reinsurance where the main purpose is to provide a capital benefit to the ceding company. there will be an element of risk transfer.

Question 38

free assets

Answer 38

this term is used to refer to that part of a lic’s assets that are not needed to cover its liabilities. the liabilities may or may not include capital requirements.

Question 39

group contract

Answer 39

this is a contract that covers a group of lives, where the name of the group is specified but the individuals within the group may not be.

Question 40

gross premium valuation method

Answer 40

this is a method for placing a value on a life insurance companies liabilities that explicitly values the future office premiums payable, expenses and claims. claims possibly includes future discretionary benefits.

Question 41

indemnity

Answer 41

under the principle of indemnity, the insured is restored to the same financial position after a loss as before the loss.

Question 42

index linked

Answer 42

a life insurance contract is index linked if 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.

Question 43

internal rate of return defn

Answer 43

the rate of return at which the discounted value of the future profit cash flows arising under a contract is zero.

Question 44

original terms (coinsurance) reinsurance

Answer 44

this method of reinsurance involves a sharing of all aspects of the original contract.

Question 45

regular reversionary bonus

Answer 45

a regular RB is a bonus that is declared on a regular basis, usually each year, throughout the lifetime of a wp contract. once declared it becomes attached to the basic benefits and cannot generally be taken away.

Question 46

risk premium reinsurance

Answer 46

in this method of reinsurance, the cedent reinsures part of the sum at risk on the reinsurers premium basis. the sum at risk is the excess of the benefit payable over the valuation reserve.

Question 47

surplus

Answer 47

this is the excess of the value placed on a lic’s assets over the value placed on its liabilities. a negative surplus is a deficit or strain.

Question 48

surrender value

Answer 48

this is the amount that would be paid out to a policyholder who cancels their contract.

Question 49

underwriting

Answer 49

this is the process by which a lic decides whether an applicant can be accepted at the standard premium or on special terms.

Question 50

expropriation price

Answer 50

the expropriation price is the price at which a lic will cancel units in a unit linked fund. in other words, it is the amount of money that it should take out of the fund in respect of each unit it cancels in order to preserve the interests of the continuing unit holders.