Past Exam Questions

Question 1

Economic influences of bond yields

Answer 1

1. Interest rates
2. Inflation rates
3. Exchange rates
4. Government deficit
5. Institutional cashflows

Question 2

Why would bonds outperform equities?

Answer 2

1. Why do we expect equities to outperform bonds
   * If equities and bonds are held from the same company, we would expect equities to outperform bonds, because equities rank behind bonds and thus carry more risk
   * Government bonds are also more secure, thus we would expect higher returns for equities to compensate for the additional risk
2. Why would bonds actually outperform equities?
   * Bonds continue to perform strongly while equities under-perform
   * Yields on bonds fall during the year so prices increase
   * Fall in bond yields might be associated with
   - Associated with a period of economic instability and cause a flight of investors to less risky assets
   - Demand by investors for bonds has increased, e.g., regulation might require a greater level of bonds to be held
   * Increased supply in equity and decreased supply in bonds might influence returns
   * Lower expectation for future economic growth reduces returns on equities
   * Increased perceived riskiness of bonds
   * Random market fluctuations
   * Expenses on equities might be more than bonds
   * Higher liquidity/marketability premium for bonds

Question 3

How can government influence the exchange rate?

Answer 3

Direct intervention

• Government can set the exchange rate
• Exchange controls can be set in place to limit the flow of monies in and out of the country
• Government can set a narrow range within trades that are permitted

Indirect intervention

• Changing the short-term interest rate, e.g., a cut in interest rates will reduce the demand for the currency and lead to currency depreciation
• Quantitative easing, buying back bonds in the market which will result in fewer bonds available, resulting in a fall in bond yield which will reduce the demand and therefore for the currency
• Government could buy holdings in other currencies causing the exchange rate to depreciate
• Government could provide assistance to exporters which will lead to increased activity of exporters hence demand the currency by overseas customers.
• Government can increase import tariffs which will decrease imports and thus the demand for other currencies
• Print money
• Increase the supply of government bonds which will increase the yield on bonds - attract institutional cash flows from overseas

Question 4

Impact of a reduction in the exchange rate

Answer 4

Imports

• Imported goods appear expensive relative to domestic goods, thus increasing demand for domestic goods and reducing demand for imported goods
• Raw materials from overseas will be more expensive, this will be passed on to consumers

Exports

• Exports will appear more attractive to overseas markets, so increased activity for exporters
• Increased economic activity and employment

Overseas investments

• Will be worth more
• Overseas investment in local government increase

Question 5

Reasons why claim experience may be different between insurers

Answer 5

1. Differences in products
   * Products sold between different companies may have different definitions of what justifies as a valid claim
2. Different mix of policyholders
   * Different net worth
   * Different geographical areas
   * Sales channels used
   * Differences in sum assured
3. Underwriting
   * Level of underwriting and claims control can differ
4. Random variation
   * Experience of smaller companies may be more prone to random fluctuations
5. Reinsurance
   * If the claim experience is net reinsurance, then the difference may be due to different reinsurance terms

Question 6

How to access the reinsurance product

Answer 6

• Model the cost forward for say next 10 years.
• It is reasonable to have the premiums higher than the benefits as they do include profit, expense and contingency margins
• The forecast should be carried out on a BE basis and appropriate sensitivity analysis should be considered with the assumptions chosen
• Compare results on different types and levels of reinsurance

Question 7

How to access the reinsurance provider

Answer 7

• Consider the financial strength of a reinsurer, chose one with a low default rate. Credit rating can be a good proxy here
• Consider technical ability, e.g., administration and actuarial strength and their ability to loan staff in the initial set-up of the product
• Consider the products, are they the best fit for the insurer and its products
• Does the reinsurer have the capacity to accept new business, heavily exposed to one class of business?