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3. Exam 3.1 > Past Exam Questions > Flashcards

Past Exam Questions Flashcards

1
Q

Investment Strategy: Main Considerations

A

Nature, term, currency and uncertainty of their liabilities and assets
Cash flow requirements
Variability of market values
Return from different asset classes (net of expenses and tax)
Level of free assets
Risk aversion and dislike of volatility
Diversification
Cost of investment especially when investing small amounts

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2
Q

Main characteristics of a defined benefit scheme

A

Scheme rules define the benefits independently of the contributions payable and benefits are not directly related to the investments of the scheme.

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3
Q

Main characteristics: defined contribution scheme

A

Scheme provides benefits where the amount of an individual member’s benefits depends on the contributions paid into the scheme in respect of that member, increased by the investment return earned on those contributions.

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4
Q

Defined contributions:

Name the risks that employees face

A

In a DC scheme, the members will take on both the investment and longevity risk.
Expense risk may be present.

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5
Q

DC Scheme: Investment risk

A

If the fund’s investment performance is poor, the members will have to live with the shortfall.

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6
Q

DC Scheme: Longevity risk

A

Generally the member takes on the risk of outliving his/her retirement savings. If an annuity is purchased at retirement, then this risk is transferred to the annuity provider, otherwise it remains the risk of the retiree.

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7
Q

DC Scheme: Expense risk

A

The presence of expense risk depends on whether the expenses are paid for by the employer or not.

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8
Q

Defined contributions: Name the risks that the employer/sponsor face

A

Neither longevity nor investment risk is carried by the employer. Therefore, the main risk is expense risk, if this is paid for by the employer. If expenses are higher than expected, then the employer will have to stand in for this.

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9
Q

Name 3 possible types of advice

A
  • Indicative advice
  • Factual advice
  • Recommendations
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10
Q

Indicative advice

A

Giving an opinions without fully investigating the issue

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11
Q

Factual advice

A

Based on researching facts (or due to prior research or learning).

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12
Q

Reccomendations (as type of advice)

A
  • Research and modelling is performed
  • Forecasts made
  • Alternatives evaluated and recommendations made
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13
Q

Fidelity Guarantee insurance

A

Fidelity guarantee is a type of general (non-life / short-term) insurance contract, that

  • covers the insured against financial losses caused by dishonest actions by its employees
  • including fraud or embezzlement

This will include loss of money or goods owned by the insured or for which the insured is responsible, as well as the reasonable fees incurred in establishing the size of the loss (auditors, etc.).

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14
Q

Define a “rating factor”

A

A factor used to determine the premium rate for a policy which is measurable in an objective way and related to the likelihood or severity of the risk.

It must therefore be a risk factor as well, or a proxy for one or more of the risk factors.

It should be relatively easy to measure/obtain and not be open to easy manipulation or used by the policyholder to anti-select against the insurer.

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15
Q

Propose 7 rating factors when issuing a fidelity guarantee contract

A
  • Turnover of the company
  • Number of employees
  • Average amount of cash on hand at any time
  • Type of industry
  • Amount of cover required
  • Duration of the cover and whether multiple events are covered
  • Past claims experience.
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16
Q

List 10 main uses of data in an insurance company

A
  • Administration of policies
  • Accounting
  • Statutory returns and reporting
  • Investment management
  • Financial Control
  • Risk management / UInderwriting
  • Setting provisions / Valuation
  • Experience analysis / Statistics
  • Premium setting
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17
Q

List general data you’d require to do a mortality experience analysis for a particular time period.

A
  • Premiums received
  • Claims details including incurred, notification and payment dates
  • In-force policy data
  • Lapses
  • An analysis of trends
  • Any details of product changes over time.
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18
Q

What check do you need to make on the data before performing an experience analysis?

A
  • Reconcile the total number of policies (using previous data and movement data)
  • Reconcile the claims payments and premiums received (against accounting data or previous data and movement data)
  • Checks for an unreasonable or unusual values for example impossible dates of birth/death
  • Check two sets of policy data (at start and end) against each other to ensure there are no substantial changes to records.
  • Consistency between the averages of the datasets for example the average sum assured or the average premium received.
  • Random spot checks of the data for individual policies for reasonableness.
  • Check against other data eg. compare claim amounts to the accounting data.
  • Reconcile against the premium analysis.
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19
Q

Written up book value

A

The historic book value (the price originally paid for the asseT), adjusted periodically for movements in the value.

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20
Q

Shortcomings of written up book value

A
  • The value might be subjective

- The book value method does not lend itself to the use of a consisten liability valuation.

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21
Q

Valuation Methods:

Market Value

A

The value determined by some market mechanism.
the market value of an asset varies constantly and can only be known with certainty at the date a transaction in the asset takes place. Even in an open market, more than one figure may be quoted at any time.

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22
Q

Valuation Methods:

Shortcomings of Market Value

A
  • Subject to wide fluctuations in the short term.
  • Difficult to value liabilities in a consistent manner.
  • Market value is not always practical for unlisted investments.
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23
Q

Valuation Methods:

Fair Value

A

The amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties at arm’s length.

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24
Q

Valuation Methods:

Main shortcomings of “Fair Value”

A
  • The definition/approach does not specify how its calculated.
  • Difficult to value liabilities in a consistent manner.
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25
Q

Valuation Methods:

Discounted cash flow

A

This method involves discounting each expected future cash flow from an investment using an appropriate discount rate.

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26
Q

Valuation Methods:

Main shortcomings of discounted cash flow

A
  • It relies on the assessment of a suitable discount rate. This is straightforward, where the assets are - for example - high-quality fixed interest stocks, but less so otherwise.
  • It requires information on the cash flows which may not be known or require further assumptions.
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27
Q

Outline the points regarding the importance of good risk management

A
  • improve the quality of business
  • improve the stability of business
  • improve growth/returns by exploiting risk opportunities
  • improve growth/returns by better management and allocation of capital
  • identify opportunities arising fromsynergies
  • give stakeholder/shareholders in their business confidence that the business is well managed
  • price product in line with their inherent level of risk
  • improve job security for employees
  • detect risks earlier thereby avoiding any surprises meaning they are cheaper and easier to deal with
  • determine cost effective risk transfer strategies
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28
Q

Name factors that typically influence bond yield in the investment markets

A
  • Inflation
  • Short-term interest rates
  • Public sector borrowing - the fiscal deficit
  • The exchange rate
  • Institutional cashflow
  • Returns on alternative investments
  • Credit ratings
29
Q

Influence on bond yield rates:

Inflation

A

Erodes the real value of income and capital payments on fixed coupon bonds.
Expectations of a higher rate of inflation are likely to lead to higher bond yields and vice versa.

30
Q

Influence on bond yield rates:

Short-term interest rates

A

Yields on short-term bonds are closely related to returns on money market instruments so a reduction in short-term interest rates will almost certainly boost prices of short bonds.

31
Q

Influence on bond yield rates:

Public sector borrowing - thre fiscal deficit

A

If the government’s fiscal deficit is funded by borrowing, the greater supply of bonds is likely to put upward prressure on bond yields, especially at the durations in which the government is concentrating most of its funding.

32
Q

Influence on bond yield rates:

The exchange rate

A

A significant part of the demand for government bonds in many markets comes from overseas.
Changes in expectations for future movements in the exchange rate will affect the demand from overseas investors. It will also alter the relative attractiveness of domestic and overseas bonds for local investors.

33
Q

Influence on bond yield rates:

Institutional cashflow

A

The demand for bonds can be affected by institutional cashflow. If institutions have an inflow of funds because of increased levels of savings, they are likely to increase their demand for bonds. Changes in investment philosophy can also affect institutional demand for bonds. Regulatory changes can also be a cause for increase bond demand due to associated capital requirements.

34
Q

Influence on bond yield rates:

Returns on alternative investments.

A

The relative attractiveness of alternative investments, both at home and overseas, will influence the demand for bonds, and hence the yields that they offer.

35
Q

Influence on bond yield rates:

Credit ratings

A

The underlying credit ratings of the corporates could make a significant difference to the yield.
These credit ratings would be driven by the financial strength of the corporate.

36
Q

Systematic risk

A

Risk that affects an entire financial market or system.

It is not possible to avoid systematic risk through diversification.

37
Q

Diversifiable risk

A

Risk that arises from an individual component of a financial market or system.

38
Q

3 Types of credit risk

A
  • Counterparty risk
  • Asset default
  • Debtors failing to pay
39
Q

Name key issues when forming a long-term investment strategy

A
  • Nature, term and currency of liabilities
  • Future accrual of liabilities
  • Level of uncertainty of the existing liabilities
  • Size of the assets, both in relation to the liabilities and in absolute terms
  • Statutory, legal or voluntary restrictions on how the fund may invest
  • Statutory valuation and solvency requirements
  • The institution’s risk appetite and business objectives
  • Tax
40
Q

Advantages of a reinsurer

A
  • Might provide technical expertise you don’t have
  • They have overall market knowledge and experience which you won’t have
  • For pricing, they might have a wider range of experience that will help you price more accurately.
  • It will reduce volatility
  • It should lower capital requirements
41
Q

Disadvantages of a reinsurer

A
  • They will make profit on the reinsurance
  • It will decrease your felxibility as they might impose requirements on pricing, underwriting and claims assessment.
  • It will increase your administration
  • By reinsuring you introduce counterparty risk which you don’t currently have
42
Q

Marketability characteristics of equity.

A
  • Varies significantly between company. The larger the company, the better the marketability.
  • The relationship is not perfect. For example, where a few investors hold a large proportion of the shares in a particular company, marketability could be low.
  • The extreme in poor marketability will be shares that are not listed on any recognised stock exchange. Such share can be sold only if you can find another party who wishes to buy the shares.
43
Q

Return characteristics of equity

A
  • Historically, equities have provided a real yield over the long term. This is because company profits tend to rise with inflation and economic growth, and hence so do dividends.
  • There is, however, no guarantee of inflation protection.
  • Equities are perceived to be more risky than bonds and would be expected to give a higher return to compensate.
  • Historically, the running yield on equities has been lower than that on bonds as the potential for capital growth is greater than that on bonds.
  • Both equity prices and dividends can be volatile.
  • The price of individual shares is determined by the interaction of supply and demand. Some buy or sell for speculations, whereas others base decisions on an assessment of its value based on the present value of future dividends.
44
Q

Factors to consider when pricing a share

A
  • Size and existing business
  • Tarket market and the penetration thereof
  • Success/Track record of entering new African countries
  • Other countries to be entered, and the market potential of these countries.
  • Competitor trends in existing and new countries
  • Quality of the company’s research and development
  • Profit margins
  • Income margins
  • Expense levels and the managing of these
  • Historical profit margins
  • Dividend policy
  • Historic dividends paid
  • Financial Ratios (P/E, Earnings per share, Debt-to-asset, ROE, Current Ratio)
  • Legal and regulatory environment and its impact on telecommunication market (in each country)
  • Economic climate in the targeted countries.
  • Political climate in the targeted countries
  • Inflation levels and outlook in targeted countries
  • Quality of the management
  • Skills, qualifications and experience of management,
  • Quality of previous management decisions
  • Diversification strategies
  • Marketability of the shares
  • Volatility of historic share price.
45
Q

Whats the difference between a mutual insurer and a public insurance company.

A

A mutual insurer has no shareholders and so the profits belong entirely to the policyholders.

46
Q

Advantage of a mutual insurer

A

No shareholders, so profits belong to the policyholders, so this should mean better benefits for policyholders.

47
Q

Disadvantage of a mutual insurer

A

Cannot raise capital easily in the financial markets as they have no shareholders.

48
Q

List characteristics of a well-run project

A
  • Clear definition of the aim of the project which reflects the needs of the customer
  • Full planning
  • Thorough risk analysis
  • Monitoring of development
  • Measurement of performance and quality standards
  • Thorough testing at all phases
  • Care in managing different strands of the project to ensure that there are no unneccessary delays.
  • To move along at the appropriate pace so that the right things are done at the right time
  • Stable but challenging relationships with suppliers of external components of the project.
  • A supportive environment
  • Excellent communication between those involved.
  • Positive conflict management, which uses conflict as a source of ideas and a tool for development.
  • A schedule of what needs to be considered at each milestone review point.
49
Q

Process to identify risks that may arise due to accounting regime and auditing standard changes.

A
  • High-level preliminary risk analysis
  • Brainstorming session with relevant and experienced colleagues
  • Desktop analysis
  • Set out all the identified risks in a risk register
50
Q

Term characteristics of money market investments

A
  • Short-term. Generally less than one year and often very much shorter. (can be as short as overnight money)
51
Q

Security characteristics of money market investments

A

The security of money market investments is mainly dependent on the issuer.
In most cases, the security will be very good due to the short-term nature of the instruments, and default is very rare.

52
Q

Marketability characteristics of money market instruments

A

With the exception of call and term deposits, most money market instruments are highly marketable.
However, they are unqoted - they typically do nto trade through a stock exchange, but rather directly with banks or intrabank.

53
Q

Advantages of a Stochastic model

A
  • A large number of simulations can be run to create a distribution of results that can help to understand the risks/dynamics inherent to a process.
  • A stochastic model takes into account the variability of the model parameters and the covariance between them.
  • A stochastic model may be useful to model options and guarantees, since the likelihood of guarantees biting can be explicitly allowed for.
54
Q

Disadvantages of a Stochastic Model

A
  • Can be longer and more expensive to run
  • More complex to design and test, which may lead to increase operational risk.
  • Output may be difficult to interpret and communicate to senior management.
  • Model output heavily dependent on choices of probability distributions for its parameters.
55
Q

Advantages of Scenario Analysis

A
  • Easy to explain to a non-technical audience, since it doesn’t involve probability distributions, etc.
  • It is easy to understand what scenarios have been examined.
  • Simpler than stochastic models, and hence less time consuming and costly.
56
Q

Disadvantages of Scenario Analysis

A
  • It may be difficult to determine which economic scenarios to test.
  • May not cover a sufficient range of outcomes to base a decision on.
  • Does not explicitly allow for all possible interactions between variables.
57
Q

Discuss the steps necessary to develop a stochastic model

A
  • Collect, group and modify data about the business that is being modelled
  • Choose statistical distributions for both the frequency and severity of claims.
  • Assign correlation factors between the variables being modelled.
  • Construct a model that can stochastically simulate claims per policy / benefit per risk, as well as the reinsurance recovey, if any.
  • The model should calculate the reinsurance premium expense per time period.
  • Include estimates of the insurer’s future income statement and balance sheet after each time period.
  • Check that the goodness of fit is acceptable, by comparing actual with expected results.
  • Modify the model if the initial estimate doesn’t fit well
  • Perform some sensitivity testing on the model by varying some of the parameters of the distributions.
  • Run the model many times, each time sampling randomly from the chosen density functions
  • Produce a summary of results that shows the distribution of outcomes.
58
Q

Discuss factors to take into account when deciding on retention limits.

A
  • Achieve a balance between the benefit of reinsurance and cost of the reinsurance.
  • Management and shareholders’ attitude to risk should be taken into account in the light of the modelling results.
  • Shareholders may prefer lower retention limits as thiss will give more stable results and hence stable dividends.
  • Take into account the company’s current capital position.
  • The arrangements need to be practical and simple.
  • The reinsurer may insist on a minimum level of business.
  • How will the market react to a significant change in the reinsurance arrangements.
59
Q

Explain the concept of materiality

A

Matters are material if they could, individually or collectively, influence the decisions to be taken by the users of the related actuarial informations.

60
Q

Lists reasons to perform an analysis of surplus on a defined benefit pension fund.

A
  • Show the financial effect of differences between actual and expected
  • To determine the main reasons/contributors of surplus
  • To help adjust the expected experience and feedback into the actuarial control cycle.
  • To provide a check on the valuation basis.
  • Help with decisions on distribution of surplus
  • Help with decisions on pensions increases and increases to other benefits.
  • To fulfill a statutory requirement.
61
Q

Possible sources of surplus

A
  • Mortality
  • Morbidity
  • Early withdrawal
  • Investment income
  • Expenses
  • Salary growth
  • Inflation
  • Taxation
  • Contributions made
  • Level of pensions increase awarded
62
Q

Key stakeholders to consider when setting reserves for an insurer

A
  • Policyholders
  • Shareholders
  • Regulator
  • Tax authority
  • Employees
  • Board of Directors
63
Q

Reasons why we need to calculate reserves at different times

A
  • To determine the reserves for the published accounts
  • To calculate solvency for regulatory purposes
  • To determine the reserves for management accounts
  • In case of merger or acquisition to place a value on the reserves
  • To determine if descretionary benefit payments could be made
  • To calculate surrender or discontinuance benefits
  • To feed into the investment strategy of the company
64
Q

Why might we reinsure

A
  • Reduce volatility
  • Ability to take on larger risks than it could on its own
  • Could be capital efficient for the insurer - releasing capital to be used on other projects or in other ways.
  • We may lack expertise in certain specialist lines of business that we might need to rely on areinsurer for.
  • It may be cost effective to reinsure.
65
Q

Downside of reinsuring

A
  • There is a cost, as the reinsurer needs to make a profit.
  • It decreases your flexibility, as you cannot tak eon any risk - you need to consider whether it is allowed in terms of the reinsurance agreement.
  • It introduces counterparty risk as the reinsurer could default on its obligations.
  • Administration increases.
  • It introduces legal risk as there is a risk that you have contractual disagreements with the reinsurer.
  • You lose full control of your business.
66
Q

Why would funeral coverage be subject to statutory regulation?

A
  • To protect the policyholders
  • Maintain the confidence in the funeral parlour system
  • To have the market behave in an orderly way
  • To make sure it is as efficient as possible.
  • To help address the incidence of crime.
  • To address information asymmetry between the provider and policyholder.
67
Q

Describe the characteristics of Immunisation

A

The investment of assets in such a way that the present value of the assets less the present value of the liabilities is immune to a general small change in the rate of interest.

  • Requires the exact match of the discounted mean term or duration as well as the volatility of the asset and liability profile.
  • Requires that the convexity of the assets should be strictly more than the liabilities’.
68
Q

Main shortcomings of immunisation

A

Simplifying Assumptions that lead to:

  • It will only immunize the portfolio against interest rate changes. It does not solve for any other risks.
  • Assumes a flat yield curve and requires the same change at all times.
  • Relies on ‘small’ changes, and the fund will therefore not be protected against large losses.
  • Requires regular rebalance to maintain immunized position (costly to maintain)
  • Asset with suitable long duration might not exist
  • Better suited to fixed and fairly predictable liability patterns
  • Removes changes of losses BUT ALSO the chances of outperformance

3. Exam 3.1 (56 decks)

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