Lecture 6

Question 1

Recall, what is the formula for GAAP profits?

Answer 1

profit = premiums + investment income - benefits - expenses & taxes - increase in reserves

Question 2

GAAP profit can be rearranged into 4 categories:

Answer 2

investment gain
expense gain
mortality gain
lapse gain

Question 3

write the formulas for the 4 categories of GAAP profit

Answer 3

ok

Question 4

what is a non-forfeiture benefit?

Answer 4

saves people that stop paying premiums for a small period of time

Question 5

what is the US Standard Non-Forfeiture law?

Answer 5

prescribes a minimum NF benefit (cash surrender value) that must be paid to a p/h upon surrender

Question 6

what products are non-forfeiture benefits usually available on?

Answer 6

whole life products - where there is a significant build up of reserve (unlike term contracts - which have very low reserves)

Question 7

what are the 4 types of non-forfeiture benefits?

Answer 7

1. cash - not popular bc taxes
2. Extended Term (ETI) - not used anymore, but takes cash & buys single premium term insurance for the longest term as it can
3. Reduced Paid up (RPU) - Keeps in the policy
4. Automatic premium load (APL) - this is standard, automatically lends money to pay premium, need to pay back this sum + interest

Question 8

do the example in 6A on minimum SNL

Answer 8

ok

Question 9

a company’s total assets is comprised of two things. what are they?

Answer 9

reserves (also called liabilities)

capital (also called equity or surplus)

Question 10

why is capital held?

Answer 10

for unexpected cash outflows

reserves are held for expected cash outflows

Question 11

what are the two things that you can do with capital?

Answer 11

1. invest in new business

2. pay dividends to stockholders and p/h

Question 12

draw the diagram of asset breakdown

Answer 12

ok

Question 13

what is the mechanism used for measuring if a company has enough capital?

Answer 13

capital ratio

Question 14

what are the 5 main risk elements of LICAT?

Answer 14

• asset default risk
• insurance risk
• interest rate risk
• interest spread risk
• other risk

Question 15

what is asset default?

Answer 15

when an asset permanently loses value

Question 16

what happens when an asset defaults?

Answer 16

the company must reflect the decrease in value of the asset on its books > decreases capital

Question 17

how do you calculate the required capital component for asset default risk?

Answer 17

= asset_default_factor * (solvency reserve - net loans)

Question 18

what is insurance risk, in terms of required capital?

Answer 18

the risk that either actual mortality/morbidity experience is worse than assumed in pricing

Question 19

how do you calculate the required capital component for insurance risk (both mortality and morbidity)?

Answer 19

mortality:
= factor * NAR
where: NAR = (DV - solvency reserve)

morbidity:
= factor * total premium

Question 20

what are the three types of interest rate risk?

Answer 20

1. disintermediation risk
2. guarantee risk
3. liquidity risk

Question 21

what is disintermediation risk?

Answer 21

the risk that assets will be sold at a loss to cover a substantial cash outflow

ex. when new money rate increases, people lapse par products, and go to UL

Question 22

interest rate risk: what is guarantee risk?

Answer 22

the risk that interest rates guaranteed > actual interest rates earned

Question 23

interest rate risk: what is liquidity risk?

Answer 23

the risk that assets cannot be sold fast enough to meet cash demands of liabilities

Question 24

how do you calculate the required capital component for interest rate risk?

Answer 24

= factor * (solvency reserve)

Question 25

how can a company mitigate disintermediation risk? 2

Answer 25

• invest in assets that match the liability cash flows as closely as possible
• limit exposure on products that allow surrender/withdrawal on short notice without penalty

Question 26

how do you calculate the total required capital?

Answer 26

sum of the components / (1 - asset_def_factor)

Question 27

t/f: the mortality table used when calculating ETI is loaded.

Answer 27

true - to mitigate anti-selection