Part 2 - Life Insurance Company Operations

Question 1

Surplus strain

Answer 1

Condition that occurs when a life insurance policy is surrendered and its asset share is less than its cash surrender value

Question 2

Asset valuation reserve (AVR)

Answer 2

Accounting mechanism required by regulators designed to minimize volatility in an insurer’s statutory surplus by earmarking portions of it to absorb realized and unrealized capital gains and losses not attributable to interest rates

Question 3

Interest maintenance reserve (IMR)

Answer 3

Similar to AVR except earmark is to absorb realized capital gains and losses attributable to changing market interest rates

Question 4

NAIC’s 7 core financial solvency principles

Answer 4

1) Regulatory reporting, disclosure, and transparency
2) Offsite monitoring and analysis
3) On-site risk focused exams
4) Capital adequacy and solvency
5) Regulatory control of significant, broad-based risk related transactions/activities
6) Preventative and corrective measures, including enforcement
7) Exiting the market and receivership

Question 5

Total adjusted capital (TAC)

Answer 5

Value equal to statutory capital, paid in surplus, AVR, and (for mutuals) 50% of any declared and unpaid dividend

Question 6

(Life)

Authorized control level (ACL)

Answer 6

The minimum amount of TAC that must be held to avoid possible regulatory intervention, its value derived by a formula intended to reflect the insurer’s particular contingency risks

Question 7

RBC triggerpoints and required regulatory responses

Answer 7

Trigger point RBC level/required 
percentage action:
TAC/ACL:

200+ No action
150-200 CAL/RBC plan required
100-150 RAL/RBC plan and
corrective orders req.
70-100 ACL/possible regulatory
control
Below 70 MCL/mandatory
regulatory control

Question 8

Basket or leeway clauses

(Life insurer investments)

Answer 8

Provision in state insurance law that permits insurers to invest in a limited percentage (e.g. 10%) of its assets in any lawful investment

Question 9

Market consistent embedded value (MCEV)

Answer 9

Present value of future profits attributable to in-force business and the value of surplus, based on the market derived asset and liability values (as opposed to statutory values)

Question 10

Deterministic reserve

Answer 10

Based on a gross premium valuation method: the present value of future benefits less the value of future gross premiums

Question 11

Stochastic reserve

Answer 11

Is based on a probability distribution of cash flow results using multiple economic scenarios:
it is the average of the worst losses above a prescribed level, called conditional tail expectation 70

Question 12

Tail risk

Answer 12

Outlier risk associated with low frequency/high severity losses

Question 13

Value at risk (VaR)

Answer 13

Maximum acceptable loss associated with an asset or liability, or portfolio of assets and liabilities, over a specified time period with a specified probability or confidence level

Question 14

Conditional tail expectation (CTE)

Answer 14

(aka tail VaR)

Is a refinement of the VaR and is the measure of risk adopted in principles-based approach (PBA) reserves and capital

Question 15

Hedge capital

Answer 15

Risk management asset cash flow that substitutes for and compliments surplus capital

(The two most important risk management assets for insurers are reinsurance and derivatives)

Question 16

Economic capital (EC)

Answer 16

Amount of capital required to absorb the maximum expected loss occurring with a specified probability over specified time horizon

Does not distinguish reserves and surplus; incorporates both reserve capital to cover expected losses and risk capital to cover unexpected losses in one measurement

Question 17

Dynamic financial analysis (DFA)

Answer 17

Stochastic or probability-based projection of an insurance company’s cash flows and financial condition over time, taking into account a full range of economic scenarios, asset and liability cash flows, the mutual dependencies or interrelationships of the cash flows, and the factors that affect cash flows individually and collectively

Question 18

Monte Carlo method

Answer 18

Applies randomly selected values to variables in a deterministic cash flow model that is repeated thousands of times to produce a range of possible results and their probabilities

Question 19

Asset liability risk management (ALRM)

Answer 19

Process of preserving or enhancing a life insurer’s surplus capital position as assets and liability values change in response to changing economic conditions and customer behavior

Question 20

Immunization

Answer 20

Practice of structuring assets and liabilities such that a change in interest rates affects assets and liability values equally

Question 21

Cash matching

Answer 21

Technique wherein a portfolio is constructed whose interest and principal payments exactly match a set of liability cash flows

Question 22

Duration matched

Answer 22

Property of a portfolio such that changes in asset values will be exactly offset by changes in liability values when market interest rates change

Question 23

Basis risk

Answer 23

Possibility that offsetting investments in a hedging strategy will not experience precisely identical inverse pricing changes because the notional amount or timing of cash flows of risk management assets are not precisely matched to the assets or liabilities hedged

Question 24

Interest rate cap

Answer 24

Specified interest rate (of an interest option) above which an interest rate index results in payment to its holder

Question 25

Interest rate floor

Answer 25

Specified interest rate (of an interest option) below which an interest rate index results in payment to its holder

Question 26

Counterparty risk

Answer 26

Possibility that the party or their guarantor (such as a bank or clearing company) on the other side of the transaction (i.e. counterparty) will default

Question 27

Transfer pricing

Answer 27

Pricing of goods and services between related parties

Question 28

Risk-adjusted return on capital (RAROC)

Answer 28

Project’s net economic income divided by its economic investment

Question 29

Securitization

Answer 29

Selling of asset-backed bonds that will be repaid regularly from the cash flows of specified assets backing the securities

Question 30

Convexity (or positive convexity)

Answer 30

Property of a non-callable bond (or other cash flow stream) in a normal, positive yield curve environment such that, for a given interest rate shift, its potential increase in value due to a drop in rates exceeds its potential decrease in value for the same magnitude rate increase. (As rates fall, price increases at an increasing rate; as rates rise, price decreases at a decreasing rate)

Question 31

Negative convexity

Answer 31

(Observed when the yield curve is inverted or when a bond is callable) Exists when, for a given interest rate change, a bond’s or portfolio’s potential decrease in value exceeds its potential increase at any point on the yield curve. As rates fall, price increases at a decreasing rate; as rates rise, price declines at an increasing rate.

Question 32

Vested (commissions)

Answer 32

Agent has the right to continue to be paid commissions so long as the insurance policy remains in effect

Question 33

Asset-based trail fee

Answer 33

Annual compensation paid to the producer expressed as a percentage of the accumulated account value

Question 34

Career agency (affiliated distribution channel)

Answer 34

Recruit, train, house and supervise individual intermediaries and are operated on either a general agency or a branch office basis. The general agency performs the functions as an independent business whereas the branch office (a.k.a. managerial system) is owned and operated by the insurer

Question 35

Multiple-line exclusive agents (MLEA) (Affiliated distribution channel)

Answer 35

Commissioned exclusive agents who sell the life and health and P&C insurance products of a single group of affiliated insurers

Question 36

Home service (affiliated distribution channel)

Answer 36

(A.k.a. combination or debit distribution service) Relies on commissioned agents who are assigned a geographic territory. Targeted lower income consumers.

Question 37

Four types of affiliated distribution channels

Answer 37

1). Career agency 2) Multiple-line exclusive 3) Home service 4) Salaried

Question 38

Duration

Answer 38

Weighed average time to maturity of the cash flows of a fixed income asset or liability, or portfolio of fixed income assets or liabilities

Question 39

Intermediation

Answer 39

Is the process of policyowners making payments to an insurer for investment

Question 40

Disintermediation

Answer 40

Occurs when policyowners exercise options to withdraw funds (surrenders, withdrawals, and loans) or reduce or suspend premium payments to invest these funds elsewhere

Question 41

ERM framework

Answer 41

Range of processes and techniques designed to protect and create value by assisting companies to uncover hidden risks, improve the stability of earnings, identify opportunities in assuming risk and risk arbitrage, and discovering natural synergies across business lines

Question 42

Derivatives

Answer 42

Traded securities or contractual agreements whose cash flows depend on the value of other specified securities or indices

Question 43

Hedging

Answer 43

Strategy of acquiring securities whose gains and losses offset gains and losses in other securities, or portfolio of securities, often achieved through the purchase of derivatives

Question 44

Diversifiable (ie unsystematic or specific risk)

Answer 44

That particular to a given company, usually measured by its beta. Beta: The volatility or variance of its stock performance relative to the performance of the stock market as a whole

Question 45

Five ethical duties owed to customers

Answer 45

(Proposed by the life office management association) 1) Insurers should apply underwriting decisions equitably to all applicants 2) Claims should be handled promptly and fairly 3) Customer service should be honest, objective, and fair 4) Privacy and confidentiality of customer information should be preserved in the absence of written authorization from the owner/applicant 5) Insurer should maintain adequate resources to pay claims and honor its obligations under the policies it issues

Question 46

Reserves (reserve capital)

Answer 46

Actuarially determined investment funds dedicated to the payment of future policy benefits

Question 47

Risk capital

Answer 47

Unencumbered amounts set aside and expected to remain idle but available to pay unexpected claims and benefits, is necessary to provide confidence to policyowners and their advocates (regulators and rating agencies) that an insurer will remain solvent under reasonably extreme circumstances

Question 48

Corporate governance

Answer 48

Set of factors that affect the direction, administration, and control of a corporation An important theme is the nature and extent of accountability of management

Question 49

Coinsurance with funds withheld (type of proportional reinsurance)

Answer 49

Coinsurance under which the ceding company retains premiums normally paid to the assuming company, while the assuming company keeps the allowances normally paid to the ceding company

Question 50

Modified coinsurance (type of proportional reinsurance)

Answer 50

Ceding company pays the assuming company a proportionate part of the gross premium, as under conventional coinsurance plan, but at year’s end, the reinsurer pays to the ceding company a reserve adjustment equal to the net increase in the reserve during the year, less one year’s interest on the total reserve held at the beginning of the year

Question 51

Nonproportional reinsurance

Answer 51

Reinsurance that does not specify in advance the amounts or percentages of risk for which the assuming company is liable, but specifies the loss limits, time limits, or conditions beyond which an assuming company will assume some or all of the benefit payments

Question 52

Proportional reinsurance

Answer 52

Reinsurance that specifies in advance the amounts or percentages of risk for which the assuming company is liable

Question 53

Substandard risks

Answer 53

Insureds who are expected, or do exhibit, higher than average mortality or morbidity experience

Question 54

Numerical rating system

Answer 54

Process under which an insurance company relies on a system of debits and credits representing adverse and positive expected marginal mortality rates to derive an expected mortality classification for a proposed insured

Question 55

Retaliatory tax laws

Answer 55

Require out of state insurers to pay the higher of the tax due using their homes state’s laws or the host state’s law

Question 56

Regulatory arbitrage

Answer 56

The shifting of activities within the group to take advantage of different regulatory approaches in different industries, can also change reporting in capital appearances with no real change in the group’s economic risk

Question 57

Double gearing

Answer 57

The double counting of subsidiary capital to prop up conglomerate capital

Question 58

Twisting

Answer 58

Practice by an agent of inducing a policyowner through misrepresentation to replace an existing life insurance policy with another one

Question 59

Rebating

Answer 59

Practice by an agent (or insurer) of giving something of value (e.g. a portion of the agent’s commission) not specified in the insurance contract to an applicant in return for the purchase of a policy

Question 60

NAIC’s mission

Answer 60

To protect the interests of the policyholder and those who rely on the insurance coverage provided to the policyholder first and foremost, while also facilitating an effective and efficient marketplace for insurance products

Question 61

Closed blocks

Answer 61

In a demutualization, a specified group of policies with participation rights protected by the allocation of specific investment, expense, and mortality results to such policies

Question 62

Dodd Frank Wall Street reform and consumer protection act

Answer 62

Enacted in 2010 Established federal insurance office (FIO) Provided for the possibility of a federal role in the resolution or liquidation of insurers but only when there is a systemic importance potentially damaging to the national economy and when states do not act effectively Consumer protection elements do not apply to life insurance and annuities

Question 63

Financial services modernization act

Answer 63

A.k.a. Gramm Leach Bliley act Passed in 1999 Eliminated restrictions on financial services integration in the US Allowed creation of financial holding companies and authorized them to engage in a range of financial activities

Question 64

McCarran Ferguson act

Answer 64

Passed in 1945 Maintains the central role of the states in insurance regulation Congress reserves the right to regulate insurance only where it expressly addresses insurance (specifically related to the business of insurance)

Question 65

Capture theory of regulation

Answer 65

Holds that special interest groups, being well organized and well financed, influence legislation and regulation for their own benefit

Question 66

Public interest theory of regulation

Answer 66

Holds that government regulation exists to protect the public interest by correcting market imperfections and promoting allocative efficiency and social welfare

Question 67

Facultative reinsurance

Answer 67

Reinsurance on a policy by policy basis under which applications received by primary insurer are submitted to an assuming company that chooses whether to accept (or reject) the risk based on its own underwriting standards

Question 68

Automatic (i.e. treaty) reinsurance

Answer 68

Reinsurance under which the direct writing company must transfer an amount in excess of its retention of each applicable insurance policy to the assuming company immediately upon payment of a direct premium and the issuance of the policy, and the reinsurer must accept transfers that fall within the scope of the agreement

Question 69

Assumption reinsurance

Answer 69

Total transfer of assets, liabilities, and risk from one insurer to another in which the assuming company legally replaces the ceding company in transactions on sections or books of business, and issues assuming certificates to affected policyholders

Question 70

Indemnity reinsurance

Answer 70

Reinsurance that indemnifies the ceding company for some or all of its reinsured underwriting losses

Question 71

Multiple extra table method (Rating substandard life insurance)

Answer 71

Most common method used to classify substandard life insurance risks, it divides them into groups according to their numerical ratings for which additional charges or premiums are levied

Question 72

Flat extra premium method (Rating substandard life insurance)

Answer 72

Method used in writing substandard risks in life insurance under which a constant extra premium is charged to provide for expected additional mortality

Question 73

Mutually exclusive (Probability concepts)

Answer 73

Condition wherein the occurrence of one event precludes (ie makes impossible) the possibility of the occurrence of another In other words, they can't both exist, be true, or happen at the same time

Question 74

Exhaustive (probability concepts)

Answer 74

Condition wherein events under consideration cover all possibilities (e.g. a person will either live or die during a given year)

Question 75

Compound probability (Probability concepts)

Answer 75

Likelihood of the occurrence of two independent events calculated by taking the product of the simple probability of the occurrence of each event

Question 76

Four elements of gross premium rate structures (Life insurance actuarial applications)

Answer 76

1) The expected amount and incidence of claims 2) An appropriate rate of investment return 3) Amounts to cover expected expenses, taxes, profits (or surplus), and contingencies 4) Withdrawal rates and amounts withdrawn

Question 77

Mortality tables: Basic vs valuation (Mortality concepts)

Answer 77

Basic – tabulation that displays yearly probabilities of death drawn from records of the actual experience of the population from which the data were drawn Valuation – Tabulation that displays yearly probabilities of death used in the calculation of minimum reserves and cash surrender values; usually contains margins

Question 78

Mortality tables: Select vs ultimate vs aggregate

Answer 78

Select – shows probabilities of death by age, duration of insurance for newly insured lives only, and other possible criteria such as sex of insureds Ultimate – shows probabilities of death by age and other possible criteria such a sex of insureds after the select mortality period Aggregate – shows probabilities of death by age and other possible criteria such as sex of insureds within both the select and ultimate mortality groups

Question 79

accumulated book profits model

Answer 79

Simulation of an anticipated operating experience for a block of policies with profits and losses carried forward each policy year at a selected hurdle rate and maintained separately in a profit account

Question 80

Asset share model

Answer 80

Simulation of anticipated operating experience for a block of policies using best estimates for what the individual factors will be for each future policy year

Question 81

Hurdle rate

Answer 81

Minimum acceptable investment return an insurer expects from a product line

Question 82

Expense margin

Answer 82

(in pricing) – Also called safety margin – Amounts added to anticipated expenses and taxes to provide for contingencies, profits, surplus accumulation, and to cover losses associated with early policy lapses

Question 83

Investment generation method

Answer 83

Technique to determine the interest crediting rate applicable to a block of policies by allocating segmented investment portfolios to the blocks of policies based on the timing of investment acquisitions

Question 84

Portfolio average method

Answer 84

Technique to determine the interest crediting rate applicable to policies based on the investment return of its entire general account investment portfolio

Question 85

Fractional or modal premiums

Answer 85

Premiums paid other than annually

Question 86

Nonforfeiture factor

Answer 86

Adjusted premium when it is amortized over a period shorter or at an uneven rate than that permitted

Question 87

Standard nonforfeiture value method

Answer 87

Descriptor indicating that nonforfeiture values are higher than required minimums because of the use of nonforfeiture factors

Question 88

Adjusted premium And Adjusted premium method

Answer 88

Adjusted premium – under the standard nonforfeiture law (SNL), the level premium necessary to pay guaranteed policy benefits (the net level premium) plus the level equivalent of a defined special first year expense allowance Adjusted premium method – descriptor indicating derivation of minimum nonforfeiture values

Question 89

Commissioner’s reserve valuation method

Answer 89

Modified reserve method permitted under SAP that allows deferred reserve funding by dividing policies into two groups: 1) Those where net level premium for the second and subsequent policy years do not exceed the corresponding modified net premium for a 20-payment WL policy in which case the full preliminary term method is applied; and 2) Those with higher premiums in which case the additional amount for expenses is limited to that amount permitted under the full preliminary term method for a 20-payment WL policy

Question 90

Full preliminary term method

Answer 90

Modified policy reserve method permitted as part of the commissioner’s reserve valuation under US SAP that allows an insurer to assume that the first year’s premium under some policies pays only for term insurance for the first policy year and that the actual policy for reserve purposes comes into operation one year later than the age of issue and will have a one year shorter premium payment and coverage year

Question 91

Initial reserve

Answer 91

Reserve at the beginning of the policy year and equals the terminal reserve for the preceding year increased by the net level annual premium (if any) for the policy year

Question 92

Mean reserve

Answer 92

Arhythmic average of the initial reserve and the terminal reserve for any year of valuation

Question 93

Terminal reserve

Answer 93

Value of a policy reserve at the end of a policy year, equal to the present value of future expected benefits less the present value of future expected premiums

Question 94

Net level premium reserve

Answer 94

Policy reserve established in recognition that early net level premiums are intended to pre-fund future insurance charges, derived for any policy year as the present expected value of future benefits less the present expected value of future premiums

Question 95

Policy reserves

Answer 95

Liabilities that represent the present amount that, with future premiums and interest earned, is expected to cover future benefit payments under existing policies

Question 96

Net single premium (NSP)

Answer 96

(Termed “aggregate approach”) Present value of future benefits promised under a life insurance policy

Question 97

Net level premium (NLP)

Answer 97

Periodic premium equivalent to the net single premium, annualized over a specified premium payment period derived by dividing the net single premium by the present value of a life annuity due for the premium payment period

Question 98

Net rates

Answer 98

Insurance rates calculated to recognize the probability of the insured event, the time value of money, and the benefits promised, with no allowance for loading

Question 99

Gross premium

Answer 99

1) Net premium and loading 2) Premium paid to an insurer for an insurance policy

Question 100

Annuity due

Answer 100

Annuity whose payments are made at the beginning of each period

Question 101

Temporary life annuity

Answer 101

Life annuity payable for the lesser of a set number of years or until the annuitant dies

Question 102

Composite mortality table

Answer 102

Mortality table whose death rates include experience from both smokers and non-smokers

Question 103

Select and ultimate mortality table

Answer 103

Mortality table that shows probabilities of death by both age and duration of insurance

Question 104

Radix

Answer 104

With a mortality table, arbitrary number of persons assumed to be alive at the youngest age for which death rates are shown

Question 105

Law of mortality

Answer 105

Concept that the death rate increases exponentially with age, as the body at first slowly then more rapidly deteriorates or fails (From 1825, Benjamin Gompertz)

Question 106

Simple probability

Answer 106

Likelihood of the occurrence of an event calculated by dividing the number of events satisfying a stipulated condition (e.g. death) by the total number of events or exposures (e.g. lives)