Professional Documents
Culture Documents
Institute of Actuaries
EXAMINATION
19 April 2010 (am)
Enter all the candidate and examination details as requested on the front of your answer
booklet.
2.
You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3.
You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4.
5.
Attempt all six questions, beginning your answer to each question on a separate sheet.
6.
CA11 2010
Faculty of Actuaries
Institute of Actuaries
Outline the key requirements of a model that will be used to assess the variability of
an outcome that depends on uncertain future events.
[5]
(i)
List the roles that a national government can play in the provision of
benefits to individuals.
[3]
[7]
[Total 10]
Outline the information that will be needed in order to calculate the internal
rate of return on this project.
[5]
(ii)
Describe two other cash flow projection methods which can be used to assess
the viability of this project.
[4]
The results of the cash flow projections show that the project is financially viable.
(iii)
List the potential asset classes that the individual could invest in.
(ii)
State the criteria that would be used to determine whether a particular asset
class would be appropriate for the investor.
[2]
(iii)
Discuss the suitability of each asset class for a 55 year old individual
considering investing in an IPA.
[10]
[Total 17]
CA11 A20102
[5]
(i)
domestic equities
domestic bonds
[4]
(ii)
Explain why a fund that invests in domestic equities may use analysts who
specialise by industrial sectors.
[5]
(iii)
(iv)
Explain why the proportion of an equity fund held in cash may have increased
significantly over a twelve month period.
[5]
(v)
(vi)
[2]
[2]
[5]
(ii)
List the data required to calculate the value of the provisions needed for the inforce policies.
[4]
(iii)
Outline why the data used to determine these provisions would be grouped. [2]
(iv)
Explain the considerations that should be taken into account when validating
the grouping of the data.
[4]
Explain why the company needs to retain some of the surplus as capital.
(vi)
(vii)
Discuss how the distribution of future surplus would change following the
demutualisation.
[5]
[Total 32]
END OF PAPER
CA11 A20103
[6]
Faculty of Actuaries
Institute of Actuaries
EXAMINERS REPORT
April 2010 Examinations
Introduction
The attached subject report has been written by the Principal Examiner with the aim of
helping candidates. The questions and comments are based around Core Reading as the
interpretation of the syllabus to which the examiners are working. They have however given
credit for any alternative approach or interpretation which they consider to be reasonable.
R D Muckart
Chairman of the Board of Examiners
July 2010
Faculty of Actuaries
Institute of Actuaries
Subject CA1 Actuarial Risk Management, Paper 1 April 2010 Examiners Report
General comments
This subject examines applications in practical situations of the core actuarial techniques
and concepts. To perform well in this subject requires good general business awareness and
the ability to use common sense in the situations posed, as much as learning the content of
the core reading.
The examiners therefore look for candidates to apply answers to the specific situation that the
examiners asked, having read the question carefully. Too many candidates write around the
subject matter of the question in more general fashion, and gain few marks. On the other
hand, detailed specialist knowledge is not required nor is very detailed development of
particular points.
Good candidates demonstrate that they have used the planning time well an attempt to get a
logical flow is a big advantage in making points clearly and without repetition. This also
enables candidates to use the later parts of questions to generate ideas for answers to the
earlier parts. Time management is important so that candidates give answers to all questions
that are roughly proportionate to the number of marks available.
The notes that follow are not to be interpreted as model solutions. Although they contain the
majority of the points that the examiners were looking for, they also contain more than even
the best prepared candidate could be expected to write in the time allowed in the examination
room.
Page 2
Subject CA1 Actuarial Risk Management, Paper 1 April 2010 Examiners Report
Model must be valid and adequately rigorous and documented. It should reflect the
risk profile of the uncertain events, and allow for the relevant features of the uncertain
events
Inputs should take account of special features of this project.
Workings should be easy to communicate, with results displayed clearly and
communicable to the client, and outputs capable of independent verification for
reasonableness.
There should be sensible joint behaviour of variables.
It should not be overly complex or expensive to run, but capable of
development/refinement, with a range of implementation methods to facilitate
testing/parameterisation.
(i)
(ii)
The question asked about reducing benefit costs for government employees, not general state
benefits.
Page 3
Subject CA1 Actuarial Risk Management, Paper 1 April 2010 Examiners Report
(i)
To calculate the IRR will require the amount and timings of all cash flows, so
will need to know (or make a reasonable estimate of) the following:
Initial cost of installation
Any available grants
Any favourable tax treatment
Cost of electricity saved which will depend on climatic conditions
Expected inflation rate for electricity
Expected maintenance costs and timings , insurance, etc
Expected inflation for maintenance costs
Expected lifetime of the turbine
Any residual value (could assume zero residual value)...
or termination cost
Any possibility of selling any generated electricity over that needed by the
farm and expected income from this.
(ii)
Can calculate the net present value. All income and outgo will be discounted
at a suitable discount rate. This rate could be cost of raising incremental
capital. A positive NPV would be considered satisfactory.
Payback period could also be used. This is the length of time before the
capital expended on the project is recouped from the net revenues without
discounting the cash flows. This is easy to apply and easy to understand and so
can be useful for an individual without a financial background.
A variation is discounted payback period. This is similar to payback period
but takes account of the time value of money. This should still be relatively
easy to understand and is likely to be more useful for a long term project.
(iii)
Will need to consider whether this will achieve synergy or be compatible with
other activities undertaken by the farm or other local farmers.
May be suitable if the farm is eco-aware. This may be as part of the business
and can be used when selling produce or it could be a personal decision. There
may be upside potential as this decision could lead to increased sales if used in
marketing.
It will be necessary to decide if this is the best way of using what may be
scarce funds and also if this is the best way of using the farmers land? Are
there any other suitable projects which may be considered? May wish to
consider alternative renewable energy schemes.
If the farm is large, this could be considered on a larger scale. This will help
with diversification of the business.
It will be necessary to investigate the risks involved in the project and come to
a view on the best course of risk mitigation, having regard to the costs
involved, e.g. can estimate maintenance costs and mitigate against any
unplanned increases by using a long term maintenance contract to fix the
price.
Page 4
Subject CA1 Actuarial Risk Management, Paper 1 April 2010 Examiners Report
(i)
(ii)
(iii)
The suitability of the asset mix will depend on the planned retirement date and the
required form of benefit.
Cash on deposit: the investor is close to retirement; cash provides a safe
investment but returns are likely to be low
The money markets: individual is unlikely to have access to invest in
money markets and the term is too short; can use collective investment
schemes (see below)
Government bonds: safe investment with return greater than cash and
suitable terms available; can use collective investment schemes (see
below)
Page 5
Subject CA1 Actuarial Risk Management, Paper 1 April 2010 Examiners Report
Page 6
(i)
Corporate bonds: less safe investment with return greater than government
bonds; reflecting credit rating and hence risk; suitable terms available; can
use collective investment schemes (see below)
Fixed interest bonds: will be suitable for the investor; government or
corporate depending in investors attitude to risk; influenced by the
relatively short time to retirement
Index-linked bonds: provide protection against inflation; may be suitable if
investor is concerned about inflation
Equity: risky assets providing high potential real returns; very suitable if
there is a significant time to retirement but this investor is still likely to
have some equities; will depend on attitude to risk; access to equity
markets is possible directly or through collective investment schemes;
overseas markets allow access to high risk e.g. emerging markets
Property: risky assets providing high potential real returns; more likely to
be suitable if the investor has a significant time to retirement;
Access to property markets is possible directly for residential
properties
Through collective investment schemes (to include commercial
property) or property company shares
Futures and options: difficult to invest in due to exchange requirements
and access to markets; risky unless expertise; potentially included within
pooled investments
Overseas investments: similar comments to above with opportunity for
diversification but there will be currency and political risks
Collective investment schemes allow access to markets that the individual
investor may not be able to access directly
Closed-ended: can benefit from gearing and changes to
the discount to net asset value
Open-ended: will be less volatile but likely to have higher management
charges
Gold and commodities: influenced by different factors; can be considered
a safe haven; suitability will depend on investors view
Other assets: may be suitable but marketability/liquidity may reduce value
of retirement benefits
(a)
(b)
Subject CA1 Actuarial Risk Management, Paper 1 April 2010 Examiners Report
(ii)
Equity analysts will need to identify and analyse key factors affecting the
profitability of a company.
They will then be able to determine whether they consider a share is
undervalued or overvalued compared to its market price.
There are practical reasons for investment analysts to specialise within
particular investment sectors because:
The factors affecting one company within an industry are likely to be
relevant to other companies in the same industry.
Much of the information for companies in the same industry will come
from a common source and will be presented in a similar way.
No one analyst can expect to be an expert in all areas, so specialisation is
appropriate. By specialising, an analyst can become an expert in an
industry and understand it very well.
The grouping of equities according to some common factor gives structure
to the decision-making process. It assists in portfolio classification and
management.
Companies within industrial groupings tend to correlate more closely with
each other than with companies in other industries.
The share price movements reflect the changes that have occurred in the
operating environment. These changes affect companies in individual
industries in similar ways.
Factors affecting one company in a sector that are relevant to other companies
in the same sector include:
Resources: companies in the same sector will use similar resources (e.g.
labour, land and raw materials), and will therefore have similar input costs.
Markets: companies in the same sector supply to the same markets, and
will therefore be similarly affected by changes in demand.
Structure: companies in the same sector often have similar financial
structures and will therefore be similarly affected by changes in interest
rates.
Stronger candidates linked their answers to the funds objectives (such as improving
returns)
(iii)
Specialising by industry can mean that analysts miss out on companies which
are between sectors.
Some shares may not move with their industries and may be influenced by
different factors from those the analyst is focusing on. For example, a
company could have a significant overseas earnings base.
(iv)
Cash will come into the fund from new investors and from dividends received
and cannot be immediately invested. So cash may have increased if there has
been a significant increase in either of these.
Page 7
Subject CA1 Actuarial Risk Management, Paper 1 April 2010 Examiners Report
Cash may be needed for liquidity purposes and for investment. So an increase
in cash may be due to an increase in expected encashments or an expected
investment e.g. a rights issue.
Cash may be particularly attractive when the equity market is uncertain or
expected to fall. The stability of capital values will make cash investment
attractive.
This may be due to:
Equity markets could have moved adversely and so the proportion held in cash
will increase even if the amount of cash has not changed.
New regulations may require an increased level of cash to be held.
(v)
(vi)
Page 8
Subject CA1 Actuarial Risk Management, Paper 1 April 2010 Examiners Report
(i)
Surplus is generated by margins from the products and how assumptions differ
from actual experience, such as from investment returns
For a mutual, the products are designed to return profits to policyholders, by
declaring bonuses e.g. annual bonus or terminal bonus
However, mutuals like all companies have to ensure they do not distribute too
much of the surplus to allow for possible future experience being adverse,
hence the mutual will smooth the bonus declarations.
This means that if a policy is surrendered part of the profit may be retained in
the fund which gives rise to the undistributed surplus
Also, when calculating and distributing the surplus, there may be:
(ii)
To calculate the provisions the data needed includes details of each of the
policies i.e. a valuation file containing:
Policyholder details:
sex
age/DOB
smoking/health status
Product details:
product type
term to maturity
duration
sum assured
attaching bonus
premiums paid
Data would need to be grouped to value the provisions to allow for system and
model limitations
Grouping the data will reduce the time it takes for the model to calculate the
results of the investigation
This will also reduce the time required for re-running the model and/or
producing scenarios
Page 9
Subject CA1 Actuarial Risk Management, Paper 1 April 2010 Examiners Report
The grouped data needs to replicate the full policy data and to produce valid
results
This can be tested by calculating summary statistics using the grouped data
and comparing those to the ungrouped data and also checking that there is no
double counting e.g. check total sum assured, number of policies etc.
The data must be summarised in homogeneous groups i.e. similar policies can
be grouped together
Heterogeneity in data groups will serve to distort the results and can lead to an
incorrect surplus calculation
Grouping can be done using a program to summarise the policy data using
each field
If the tests do not produce satisfactory results, will need to use different grouping
(application of control cycle)
(v)
The demutualised company will need capital for similar reasons as any other
insurance company needs capital:
To determine the split, the company will need to decide on its required capital.
The benefit enhancements should not use so much of the undistributed surplus
as to leave insufficient capital.
It is likely that the regulator will require the company to provide benefit
enhancements to policyholders.
This needs to be allowed for in deriving the split between the cost of the
benefit enhancements and the shares.
Page 10
Subject CA1 Actuarial Risk Management, Paper 1 April 2010 Examiners Report
Shares:
(vii)
Will provide the company with working capital for future investment and
expansion
The shares will belong to the policyholders and so they benefit from the
future prospects of the company
This also gives policyholders a choice; they can sell the shares and get the
cash upfront or invest and receive the benefits expected under the with
profits policy
Page 11
Subject CA1 Actuarial Risk Management, Paper 1 April 2010 Examiners Report
Page 12
Faculty of Actuaries
Institute of Actuaries
EXAMINATION
29 September 2010 (am)
Enter all the candidate and examination details as requested on the front of your answer
booklet.
2.
You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3.
You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4.
5.
Attempt all seven questions, beginning your answer to each question on a separate
sheet.
6.
CA11 S2010
Faculty of Actuaries
Institute of Actuaries
(i)
(ii)
[4]
[Total 7]
(i)
Explain why the financial markets of developed economies are regulated. [4]
(ii)
(iii)
Discuss the advantages and disadvantages of using statutory regulation for all
products in the financial markets.
[5]
[Total 11]
[9]
[2]
The insurance cover is sold separately from and is not tied to any particular
mortgage product.
The level of benefit selected at the outset can only be changed on the written
request of the policyholder. Premiums payable are then adjusted accordingly.
The policy renews automatically each year until the end of the term selected at the
outset by the policyholder.
The premium rates can be varied by the insurer at each policy anniversary
provided that at least 3 months notice is given.
CA11 S20102
Claims or changes to the level of benefits are effective from the date that the
insurance company receives written notification with no back-dating permitted.
(i)
Discuss whether any of the features of the policy are potentially unfair to
customers.
(ii)
[9]
Outline any changes that could address the issues identified in (i) above. [3]
[Total 12]
An investment company manages a property unit trust fund which has a market value
of 800 million. When investors sell units, payment to the investor is normally made
within four days. However, in extreme circumstances (as defined in the governing
documentation), the investment company can defer such payments by up to six
months.
(i)
(ii)
[2]
[8]
A change in the regulations governing unit trusts has been proposed. The new
regulations will specify that payments to selling investors must be made within a
prescribed normal settlement period (as defined in the regulations).
(iii)
Discuss the actions that the fund manager could take and hence the impact that
this new regulation could have on the investment performance of this fund. [5]
[Total 15]
The regulator in a particular country has proposed major changes to the insurance
regulations that are expected to affect a wide range of activities within the insurance
industry.
An insurance company is establishing a project to implement the new regulations in
time to meet the regulators deadline. This project is expected to run for several years
and will be implemented in a number of stages.
(i)
List the key topics that should be included in a project strategy document. [5]
(ii)
Outline the differences between the roles of the project owner and the project
manager.
[5]
(iii)
(iv)
(v)
Describe four measures that could be used to monitor the progress of this
project against the objectives that were set at the start of the project.
[4]
[Total 31]
CA11 S20103
[13]
[4]
A merchant has just purchased goods from a supplier based in an overseas country.
The goods cost $7 million. Currently these goods could be sold for $10 million in the
merchants home country. It will be necessary to ship these goods from their present
location and the voyage should take one month. The expenses of the voyage and
selling the goods are estimated to be $0.5 million.
The merchant estimates that over the duration of the voyage, one or more events
could arise with the following total consequences and probabilities:
Consequence
Probability of event
1%
2%
40%
Calculate the insurance premium the merchant would expect to have to pay, in
order to cover the risks of these events arising over the expected period of the
voyage.
[2]
60% chance
25% chance
15% chance
Level of expenses:
No change:
Increase by 25%:
Decrease by 20%:
(ii)
40% chance
40% chance
20% chance
Calculate the expected profit the merchant will make on this venture. You
should ignore tax and any interest payable or receivable.
[5]
The merchant takes out a contract which guarantees that the goods will be sold to the
writer of the contract in one months time, for 97.5% of todays market value. At that
time, the merchant must supply the goods to the writer of the contract at the
merchants home port, for which he will receive the agreed payment. The effect of
taking out the contract is to reduce the expected profit to the merchant due to the cost
of the guarantee.
(iii)
Discuss the possible financial implications for the merchant if the voyage
takes longer than anticipated, for example at least an extra month.
[8]
[Total 15]
END OF PAPER
CA11 S20104
EXAMINERS REPORT
September 2010 examinations
Introduction
The attached subject report has been written by the Principal Examiner with the aim of
helping candidates. The questions and comments are based around Core Reading as the
interpretation of the syllabus to which the examiners are working. They have however given
credit for any alternative approach or interpretation which they consider to be reasonable.
T J Birse
Chairman of the Board of Examiners
January 2010
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
General comments
This subject examines applications in practical situations of the core actuarial techniques
and concepts. To perform well in this subject requires good general business awareness and
the ability to use common sense in the situations posed, as much as learning the content of
the core reading.
The examiners therefore look for candidates to apply answers to the specific situation that the
examiners asked, having read the question carefully. Too many candidates write around the
subject matter of the question in more general fashion, and gain few marks. On the other
hand, detailed specialist knowledge is not required nor is very detailed development of
particular points.
Good candidates demonstrate that they have used the planning time well - an attempt to get a
logical flow is a big advantage in making points clearly and without repetition. This also
enables candidates to use the later parts of questions to generate ideas for answers to the
earlier parts. Time management is important so that candidates give answers to all questions
that are roughly proportionate to the number of marks available.
The notes that follow are not to be interpreted as model solutions. Although they contain the
majority of the points that the examiners were looking for, they also contain more than even
the best prepared candidate could be expected to write in the time allowed in the examination
room.
Page 2
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
(i)
(ii)
For a standard bookwork question this was not answered as well as it could have been
Page 3
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
Show the financial effect of writing new business over the period.
Validate the calculations and assumptions used.
Provide a check on the valuation data and process, if carried out independently.
Identify non-recurring components of surplus, thus enabling appropriate decisions
to be made about the distribution of surplus.
Reconcile the values for successive years.
Provide data for use in executive remuneration schemes.
Provide detailed information for publication in the provider accounts.
To demonstrate that the variance in the financial effect of the individual levers is a
complete description of the variance in the total financial effect.
Variance in expenses.
Help with monitoring investments.
Assessment of effectiveness of risk management systems.
Most candidates scored fairly well, but better candidates focussed on the why as per the
question.
Page 4
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
(i)
(ii)
(iii)
In statutory regulation the government sets out the rules and polices them
This has the advantage that it should be less open to abuse than the alternatives
and may command a higher degree of public confidence
It will be independent from the industry it is regulating. This should mean that
it will take into account the views of third parties as well as those of the
industry it is regulating
The regulatory body may be able to be run efficiently if, for example,
economies of scale can be achieved through grouping its activities by function
rather than type of business
Page 5
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
(i)
In general, if all the features including conditions, premiums and benefits are
clearly set out, the insurance company could reasonably claim that the policy
is fair since all information is readily available.
However, this may depend on how and where the information is set out. If it
could be argued that the average policyholder would have difficulty in
accessing (e.g. terms available from another source) or understanding the
relevant information, then unfairness may arise.
The policy renews automatically and so there is little to remind the insured as
to what they are covered for and in what circumstances.
This requires the insured to act pro-actively to ensure that the policy and
benefit levels remain appropriate e.g. if mortgage payments change regularly it
may be too much of a hassle to also update the policy regularly.
This is exacerbated because the policy is not linked to a particular mortgage
product. The insured may not appreciate that changes in mortgage payments
may require a review of this policy.
The policyholder may be eligible for benefits when the policy is taken out
assuming that the proposal form clearly asks for employment status.
However they may not be when a claim is made. E.g. if they change status and
become self employed, is it clear that they will need to take action at their own
initiative.
Page 6
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
Page 7
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
(i)
(ii)
(a)
The starting point for the choice of property assets will be the funds
governing documentation i.e. what is the fund being advertised as.
The brief could be wide (e.g. any property assets anywhere the
managers deem appropriate)
or more narrow e.g. target certain sectors, locations (e.g. overseas)
types (leaseholds, developments etc.), sizes, direct or indirect.
Page 8
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
These criteria may be driven by what investors want (or what the
managers think they want). In particular the choice may depend on
whether the fund is targeted at individuals or institutions.
In any event, given that the fund is large, it would be expected (other
things being equal) to hold most of its assets in direct property rather
than in property company shares.
Property company shares would be more liquid and give exposure to
different activities such as property development
The large size would also enable the fund to diversify within and
between categories of properties unless a narrower brief were
specified.
The funds investment managers may have particular expertise in
certain areas and this could drive exposure.
(b)
The proportion of liquid assets held will depend on the risk appetite of
the fund managers.
In particular, the view taken over the seriousness of the issues raised in
(i). Holding more liquid assets so as to try to ensure that repayments
can always be met is likely to reduce investment returns and hence the
attractiveness of the fund.
The higher the risk of large numbers of net repayments over a short
period of time, the greater the need for liquid assets.
Such demand for repayments could rise if the outlook for the property
sector was poor or if there were internal problems with the
management company leading to a loss of investor confidence.
There will be a particular need to be aware of the size of individual
large holdings, or an accumulation of small holdings that are under the
influence of a few investors or advisors.
The management company may have the resources and desire to
provide any extra liquidity needed by buying and holding units itself
(subject to regulation).
The definition of extreme may be relevant. If delays in payment can be
easily justified, the risks involved in low levels of liquidity may be
less.
Likewise, if the sale price can also be deferred i.e. payment based on
the value of property when sold not on the value implicit in the unit
price when the unit is sold, the liquidity risk is less.
Page 9
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
Page 10
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
Also, the management company may try to compensate for its risk exposure by
increasing management charges. This would lead to lower returns to unit
holders.
The guarantee may alter the nature and behaviour of unit holders. Previously,
investors may have accepted the long-term nature of the investment and so
been prepared to sit out falls in the property market. Now they may take a
more short term view and so be more active sellers. This could increase the
need for liquidity.
Many candidates went into too detailed a discussion on property in general rather than
answering the question set. In part (iii), better candidates commented on risk issues from the
fund managers perspective.
(i)
(ii)
the aims of the project and a clear identification of the objectives of the
project
statements on how these objectives will be met
the acceptable quality standards for meeting the objectives
the risk management policy i.e. the areas of risk that could affect the
viability of the project and alternative strategies for dealing with areas of
risk
the project sponsors role
the role of any third parties e.g. consultants employed
the financial and economic objectives
details of the expected cost of the project and the financing policy
the policy for dealing with legal issues
the technical policy
a structured breakdown of the work to be completed under the project
the key milestones for reviewing the project
the information technology policy
the communications policy
dealing with conflicts of interest
The project owner is the sponsor (i.e. is responsible for the budget and
objectives) and generally works within the insurance company in a permanent
role
Hence the project owner has a vested interest in the outcome of the project and
will be responsible for using the project outcome in the business as usual
environment i.e. after completion of the project
The project manager leads the team implementing the project
Page 11
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
The project manager needs to be able to drive the project forward and hence
needs to be able to establish direction, decide on action, organise resources
and motivate the project team.
The project manager may be an external consultant/contractor or be assigned
to the project for the implementation
i.e. the project manager role is temporary and lasts for the duration of the
project only
The project owner will be involved in some of the project management issues
as the project owner will have key requirements
However, a successful project outcome requires the right balance to be struck
between the owner as the project sponsor and operator and the project
implementation specialists
Hence project owners should concentrate on the agreed milestone review
points
to ensure that they are properly scheduled and that the project is fully
reviewed each time it reaches a milestone review point.
(iii)
Page 12
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
This can be done using specialised software given the size of the project
Key statistics can be used to track the progress of the project these need to
be defined and documented
It is important that key specialists are involved in this process and their input
is used to help plan the project
The regulations will need to be monitored to ensure that they do not change
during the implementation period
The project will have a number of work streams which may have
interdependencies.
Hence the critical path needs to be defined and monitored to ensure that there
are no unnecessary delays in the implementation of the project.
A thorough risk analysis will need to be performed and options to manage or
mitigate the risks will be required.
For example, there is the risk that the project does not meet the
implementation deadline which could have regulatory implications
Or that any new valuation systems required do not work properly
Hence the software and systems should be thoroughly tested at all stages of
the project.
Technical and design changes should be avoided once implementation has
begun.
Design parameters should be broad enough to give the developers some
freedom of approach and to avoid the need for subsequent changes.
Strict change control management should be implemented.
However, there should be checks on the project manager to ensure the plan is
met.
The plan should include a master schedule that covers all people working on
the implementation including both those internal to the project and external
suppliers e.g. consultants or advisors.
The project will require a number of different professionals (actuaries,
accountants, lawyers, systems analysts etc.) and external suppliers to work
together.
Page 13
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
It is vital that setting the standards of performance required from the parties
involved is undertaken early in the life of the project, as these will have a
major impact on the whole project.
The written strategy should be shared with the key individuals who will bear
the responsibility for implementation of the project.
Where appropriate the end users of the projects output should be involved
throughout the process.
The team should have a strong leadership and management to ensure that the
right things are done at the right time to make the project a success.
It is important that all the team members are committed to the success of the
project and that the project leaders provide support.
Major project interfaces and potential conflicts need to be managed
Examples include those between:
designers and builders
specifiers and implementers
project owners and project managers
At these milestone review points, critical questions on all aspects of the
project should be raised by all those involved in the project.
In some cases, to get an unbiased view of progress, it may be appropriate for
an independent party to carry out the milestone reviews.
Clear communication to all parties throughout the project
(iv)
The progress of the project needs to be monitored and reported to both the
project owner (and key stakeholders) as well as the regulator
The regulator will be interested in progress compared to the new requirements
of the regulations
The project owner will be interested in this and also progress against the
budget
A reporting template should be designed to meet each purpose and agreed with
each of the project owner and the regulator
The project owners template could include the regulators template and
supplementary information as required
The tools for planning, monitoring and reporting on the progress of a project
should:
Page 14
be user friendly
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
The reporting process should enable the project manager to check that the
deadline is achievable and implement measures to meet the deadline as needed
(v)
Monitoring the cost of the project by comparing the amount spent against
the budget
Compare the results of any new models required against previous results
Compare the outcome of each new process against the requirements of the
new regulations
Review the progress of the project against the project plan to ensure the
project stays on track
Use status indicator (e.g. RAG (red-amber-green) status) to track activities
within the project plan and identify key areas to focus on
Identify critical path to ensure focus of the project is on key tasks
Part (i) was straightforward for those candidates who were familiar with the bookwork. In a
question with many parts, better candidates had planned their answers so did not repeat
themselves and made points appropriate to each part.
(i)
(ii)
Page 15
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
The delay will cause an increase in costs for example wages to seamen,
charges to ports and say repairs due to bad weather damage
If the proceeds of any sale are used to cover financing costs of purchase, then
these costs may also rise.
It is possible that insurance could have been taken out to cover these delay
risks and consequent costs. But even if this were the case, there could be a lot
of dispute surrounding the cause and extent of the delay e.g. whether it is
actually covered if the merchant or his employees were to blame or were
negligent.
However, the main implication will concern the forward contract and the need
to supply goods that are still in transit.
In principle, the merchant will have to buy the goods in the open market and
deliver them to the agreed location.
There will therefore be a profit or a loss v the money the merchant receives
from the writer. However, the merchant is still exposed to any price
movements from the settling of the forward until he ultimately sells the goods.
So any net profit (or loss) realised now could change to his ultimate benefit or
detriment. In effect he is back to square one with a risk that the price of his
goods falls before he can get them to market.
The buy and supply process may not be that straightforward. It depends on the
nature of the goods and on the other party.
If the goods are tradable resources e.g. oil or coal say, then in practice they can
be supplied. If they are manufactured or non-standard say toys or TV sets then
there is more of a problem.
In a conventional contract, the supply clause is often a technicality since in
practice to close out the forward, the original buyer sells to the original
writer at the prevailing price i.e. the goods dont actually have to change hands
if the contract can be closed out. But this does depend on the size of the
Page 16
Subject CA1 Actuarial Risk Management, Paper 1 September 2010 Examiners Report
Page 17
EXAMINATION
18 April 2011 (am)
Enter all the candidate and examination details as requested on the front of your answer
booklet.
2.
You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3.
You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4.
5.
Attempt all seven questions, beginning your answer to each question on a separate
sheet.
6.
CA11 A2011
Describe the key factors that influence the level and timing of contributions
for these benefits.
[3]
(ii)
Outline why the expected cost of the benefit payments may be different from
the price charged by an insurance company to insure these benefits.
[5]
[Total 8]
(i)
Excess
No claims discount
Exclusion clause
[8]
A six storey residential property is divided into three self-contained apartments, each
of which occupies two floors of the building.
(ii)
Outline the risks specific to this show for which the company may wish to take
out insurance cover.
[5]
(ii)
Discuss the factors that will contribute to the moral hazard an insurance
company will face when providing such cover.
(iii)
[4]
Set out the benefits to the insurance company, other than profits to be made on
the contract, of providing this cover.
[3]
[Total 12]
CA11 A20112
(i)
[4]
A large benefit scheme has recently completed a valuation for supervisory purposes.
The basis for the supervisory valuation is more prudent than a best estimate of future
experience. The scheme is required to disclose a summary of the supervisory
valuation report to beneficiaries.
(ii)
List the information from the supervisory valuation report that should be
disclosed to beneficiaries.
[4]
Discuss why the results of the supervisory valuation may not be appropriate
for use by the investment advisor in conducting this review. Your answer
should include commentary both on relevant specific assumptions and on
broader general issues.
[9]
[Total 17]
A large bank operates many business lines in many countries. One of the products it
offers is a derivative based on the level of property prices in a particular country with
a developed property market. The derivative increases in value if a specific property
price index (published by a local property surveyor) falls in value. An investor is
considering purchasing the derivative.
(i)
The bank has one employee in this country, who is assigned to price and monitor the
derivative.
(ii)
[4]
(iii)
Suggest ways the bank could reduce the operational risk presented by this
arrangement.
[3]
CA11 A20113
[5]
(ii)
Outline how the assumptions used to price these policies may differ from
those used for the companys existing business.
[9]
[Total 14]
An airline that only operates within its domestic country is considering expanding by
offering overseas flights. It has started a project to decide the geographical region to
which it will commence flights, from a shortlist of three regions.
(i)
Outline the steps necessary to identify the risks facing the project.
[5]
(ii)
Identify the major risks to the airline of operating in overseas markets, and for
each risk suggest a way to mitigate that risk.
[8]
The airline has decided to focus on a region in which the authorities only offer threeyear licences to new airlines. For this region the airlines project team has identified
three possible scenarios which may occur.
Probability of
Occurrence
Set Up Costs
Net revenue
Year 1
Year 2
Year 3
Scenario A
Scenario B
Scenario C
30%
50%
20%
m
100
m
110
m
120
50
50
50
40
40
45
30
30
30
(iii)
Calculate the Net Present Value of the project, using a discount rate of 5% per
annum.
[3]
(iv)
(a)
(b)
END OF PAPER
CA11 A20114
EXAMINERS REPORT
April 2011 examinations
Introduction
The attached subject report has been written by the Principal Examiner with the aim of
helping candidates. The questions and comments are based around Core Reading as the
interpretation of the syllabus to which the examiners are working. They have however given
credit for any alternative approach or interpretation which they consider to be reasonable.
T J Birse
Chairman of the Board of Examiners
July 2011
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
General comments
This subject examines applications in practical situations of the core actuarial techniques
and concepts. To perform well in this subject requires good general business awareness and
the ability to use common sense in the situations posed, as much as learning the content of
the core reading.
The examiners therefore look for candidates to apply answers to the specific situation that the
examiners asked, having read the question carefully. Too many candidates write around the
subject matter of the question in more general fashion, and gain few marks. On the other
hand, detailed specialist knowledge is not required nor is very detailed development of
particular points.
Good candidates demonstrate that they have used the planning time well an attempt to get a
logical flow is a big advantage in making points clearly and without repetition. This also
enables candidates to use the later parts of questions to generate ideas for answers to the
earlier parts. Time management is important so that candidates give answers to all questions
that are roughly proportionate to the number of marks available.
The notes that follow are not to be interpreted as model solutions. Although they contain the
majority of the points that the examiners were looking for, they also contain more than even
the best prepared candidate could be expected to write in the time allowed in the examination
room.
Page 2
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
(i)
The key influence is the level and uncertainty of the benefits that will be paid.
These benefits and the timing of contributions will present an opportunity cost
for the company.
If the benefits are low and frequent with a stable total cost for a period then
they could self-insure, for example a company with a large motor fleet may
self-insure and pay for repairs as they arise.
If the benefits are high and/or infrequent, the cost for the period is uncertain
either in timing or amount then it is usual to regularly set aside monies before
the full benefit payment becomes due. This mitigates the risks of the direct
payment approach where both the level and incidence of payments would
otherwise be uncertain.
(ii)
Surprisingly poorly answered; stronger candidates covered more benefits than pensions. In
(i) funding method in itself is not sufficient what influences the funding method? In (ii)
some marks were available for explaining how different insurers charge different prices but
candidates could score more by comparing premiums to expected cost.
Page 3
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
(i)
Excesses
The sum specified in the policy, that the insured must bear before any liability falls on
the insurer.
The excess is deducted from the amount of any claim to be paid by the insurer.
If the claim is less than the excess, there is no liability on the insurer. Which reduces
the number of claims for the insurer.
For example if a policyholder claimed 1,000 and the policy specified an excess of
250, the insurer would be liable for 750.
In many cases the policyholder can choose the level of excess when applying for the
policy, or the insurer may force a higher level of excess for risky applicants.
For example, a policyholder who can afford to meet small claims may request an
excess at a level where they can afford to pay the entire claim. This may reduce
premiums as the liability for the insurer is lower. Liability for larger claims would still
rest with the insurer in respect of the amount over the excess.
No claims discounts (NCD)
NCD is a form of experience rating where policyholders are allowed a discount from
the basic premium according to a scale that depends on the number of years since the
most recent claim.
Following a claim, the premium reverts to a lower rate of discount, or may increase
more if the insured is now viewed as higher risk.
The discount acts a discouragement against making small claims. This is because the
claim amount may be less than the consequent loss of discount on future premiums.
The discount is more likely to affect claims experience under contents rather than
buildings insurance, as contents claims are typically smaller in value.
In certain cases the discount may be protected. That is for certain types or numbers of
claims policyholders wont lose their full discount following a claim.
Exclusion clauses
A clause within the policy setting out the events causes or perils beyond the scope of
insurance cover.
Exclusions set out the circumstances where an insurer will not be liable to meet a
claim.
Page 4
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
Page 5
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
(i)
The main cover required would probably relate to having to pay out more
prize money than expected.
This could arise either from an accumulation of smaller prizes or from a
number of jackpot wins.
The company will aim to make profits from high viewing figures attracting
significant advertising revenues. Additional profits would also be made if
there was a high take up of the viewer competition
Hence they may want some form of insurance against poor viewing figures
or poor income (this will be hard to get see (ii)).
The circumstances imply that the program may be past its best and two years
is quite a long time for a show. Hence there may be considerable amount of
investment depending upon a good sustained run.
To this extent, the company may want some form of cancellation cover.
More likely, they may look at issues that cause cancellations or otherwise
reduce the attractiveness of the show.
For example, they could look at keyman insurance cover on the host or
protection against legislation changes eg restrictions on prize money.
The company will have a duty of care for contestants and any audience
(though audience cover may already exist under current policies). Hence some
form of cover against injury or trauma (emotional or stress related) caused
may be needed.
The company could be sued by contestants who have been denied prizemoney (e.g. due to suspected fraud or because the particular show wasnt
broadcast).
The new viewers competition could cause similar problems. In that if it were
not run properly, compensation (and related expenses) could be due to
viewers. There would also be the impact on viewing figures etc.
Some form insurance against fraud (fixing the result), breach of contract or
negligence by employees or third parties could be possible.
Alternatively, the company may have to sue external suppliers and so cover
against expenses incurred may be required.
(ii)
The moral hazard relates to the point that, in most cases above, the company
has significant control over potential claims so may attempt to take unfair
advantage of the insurer.
This could include, for example withholding information from the insurer.
Page 6
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
Page 7
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
For example, free tickets to shows (not just this one) or even the chance to
appear as a contestant.
The link could be exploited in marketing material by giving discounts on TV
packages or related products linked to the broadcaster (games etc.) for new
policyholders.
A fairly wide range of marks on this question. Better candidates explained the concept of
moral hazard in (ii) and then applied that to the question, and suggested risks/etc specific to
the show and to the proposed insurance cover.
(i)
Liabilities to be shown in providers published accounts and reports.
To show supervisory solvency levels or for regulatory reports.
For internal management accounts and reports.
To value the provider for a merger or acquisition.
To determine whether discretionary benefits can be awarded.
To set the future contribution rate, for both benefit accrual and correction of any
deficit.
To value benefit improvements.
Valuation of discontinuance/surrender benefits.
To influence investment strategy.
For disclosure to beneficiaries.
To review scheme experience.
(ii)
Cashflows occurring over the period, for example expenses and benefit paid, or
contributions received.
Investment policy of the scheme.
Investment return achieved over the period.
Contribution obligations for the future.
Assumptions and actuarial method used in the valuation.
Page 8
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
A large number of new entrants or deaths since the valuation may mean the
membership modelled is significantly different.
Market conditions may have changed significantly (e.g. different outlook for
investment performance or inflation).
There may have been significant one-off events since the valuation which have
changed the nature of the scheme (e.g. regulatory change to dependent benefits).
The supervisory valuation may not have produced all the information required for the
investment strategy review, for example:
Overall basis
The investment advisor should be looking for a best estimate of provisions.
The supervisory valuation is more prudent than this so may not be appropriate.
In particular this means the supervisory valuation may overstate liabilities or
projected cashflows compared to a best estimate basis, so need to consider how
supervisory basis is prudent, and in particular which individual assumptions may be
inappropriate.
Though it may be necessary to model development of the funding position on the
supervisory basis using realistic assumptions for the projections. The size of
supervisory surplus/deficit may influence the level of risk appropriate
Page 9
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
Individual assumptions
Investment advisor will be primarily interested in cashflows, so discount rate or
investment return are less relevant.
A number of assumptions may be prescribed on a supervisory basis, which may not
be appropriate for the investment strategy review.
Expenses: will need to consider timing and linkage (to inflation/earnings) in order to
assess cashflows arising from expenses.
Inflation: investment advisor will require a market related rate; supervisory allow for
an inflation risk premium.
Consider how the inflation assumptions impacts on revaluation in deferment and
pension increases in payment. Depends on how benefits are linked to inflation.
Mortality: investment advisor will require a best estimate of mortality considering the
characteristics of scheme membership for a base table, and for future improvement.
Salary growth: if benefits are linked to salary growth, investment advisor will need a
best estimate assumption including promotional scale. Consider if supervisory basis
restricts this, or if this is a discontinuance valuation.
Valuation of options and guarantees: may be differences in approach, for example use
of stochastic models to value guarantees and member options. Would require
consistency with a market based approach.
Commutation of pension: Will have an impact on benefits, but may be ignored under
the supervisory valuation. This could have an impact on both the total value of
benefits, and more significantly on the timing of cashflows.
Other assumptions impacting on cashflows including: Proportions married,
withdrawal rates, ill-health retirement or other sensible suggestions.
Some assets may have been inadmissible under the solvency valuation and can be
included for investment strategy purposes.
Most candidates scored well on the bookwork in (i) and again in (ii), though some diverted
onto individual benefits. In (iii) most commented well on prudence overall but didnt answer
the question on specific assumptions or on general issues such as the need for cashflow
information and the time lapse since valuation date.
Page 10
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
(i)
Market risk
Market risk will be the most significant risk for investors.
Movements in the property market will directly impact on the price of the derivative.
If the derivative is geared there may be a further increase in price movements and
market risk.
There may also be market risks relating to the index. For example if the index ceases
to be produced, or if the surveyor changes its methodology.
Prices will be influenced by the broader global property market as well as local
pressures.
Additional market risk will also occur due to the performance of alternative
investment classes.
Credit risk
Credit risk will exist as there is a counterparty risk, i.e. risk that the bank may default
on any payment.
Credit risk should be relatively small for the investor because:
The bank is large;
The bank is diversified across many business lines and countries.
Risk may be higher if there are broader fears for the financial sector.
Business risk
This will be a low risk for the investors.
May be a business risk relating to the derivative not being commercially viable, i.e.
few buyers for investment, at which point product may cease to be offered.
If product ceases the long-term investment expectation will be lost and will be
replaced by returns in the market at closure.
In general it is the bank which will be exposed to business risk, rather than the
investor.
Liquidity risk
Liquidity risk may be material, but will not be the most significant risk.
Liquidity of the derivative dependent on bank which packages and markets product,
hence will not be as low as for direct property investment.
Page 11
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
The actual liquidity will depend on the secondary market available for these products.
The secondary market will be greatly improved if the bank is willing to buy back
before the full term, although this may be on penal terms.
If the bank is in financial difficulty the liquidity risk may rise significantly.
(ii)
There is dominance risk from the individual controlling this aspect of the banks
business.
This gives potential for fraud or error if work cannot be reviewed
As a single individual resiliency will be low, leading to issues with:
Business continuity planning, in the event of an emergency;
Sickness or holiday cover and alternative contacts.
There will also be difficulties with succession planning and handover.
Given the small workforce there may be a need to rely on outsourcing or use of third
parties to maintain capacity. This will expose the bank to any operational risks within
the third party.
Depending on the relative significance of the banks business relative to all work
carried out by the third party these risks may be significant.
The computer system and programs used by the employee will need to be usable by
other bank employees, there would be additional risk from standalone processes set
up by the employee.
(iii)
Use two employees on job share or expand the team.
Have contingency plans in place for employee replacement or rotation.
Appropriate remuneration package to aid recruitment and retention.
Employment contract should state clearly notice periods and restrict employees ability
to leave.
Management contact to monitor difficulties and spot check work of employee,
addressing problems before they become significant.
Identify and implement any training requirements for the employee.
Encourage consistency with procedures in other business areas (easier to transfer).
All procedures must be documented with complete audit trails.
Page 12
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
Reduced volatility
If the property market falls, the value of the derivative will rise.
If the property market falls, the value of the mortgage portfolio and hence the second
derivative will fall.
This is because the underlying security for the mortgages will reduce in value as
property prices reduce.
Movements in the two elements of the portfolio may therefore offset each other.
The extent of any matching will depend on the proportion of the product relating to
each derivative.
(b)
Additional volatility
Lag in production of the property index, which could lead to delays relative to
movement in the second derivative.
Mismatch between properties backing the index and those in the mortgage portfolio:
for example different locations/geographies and perhaps also types of property
Subjectivity in the components of the property index could lead to changing exposure
over time relative to the property underlying the banks mortgage portfolio.
Expenses could impact on the relative performance of the mortgage portfolio.
There is gearing in the mortgage portfolio, so profitability not directly proportionate
to prices.
A wide range of marks on this question. In (i) better candidates set out their answers clearly
with good discussion of financial risks rather than discussing general risks associated with
property.
Page 13
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
(i)
(ii)
Some assumptions will be derived in the same way as for other lines of
business for example investment returns
But many assumptions will need to be tailored. Historical data will usually be
a primary source of data in determining assumptions about future experience,
but the company may not have data relevant to the group of individuals
(students) about whom assumptions are to be made.
Past data will usually need to be adjusted in a subjective manner to allow for
differences in the characteristics of the individuals concerned.
Particular care will be needed over the choice of the assumptions that will
have the most financial significance.
With contents insurance, the likelihood of theft may be higher as the
accommodation is shared and it is unlikely that security measures are in place.
The value of the contents is likely to be much lower than that of the
companys usual business.
For cover away from home, it is again likely that the value of the contents is
different than for the usual policies, for example in a shared house each
resident may have their own television.
For the more specialist insurance, the value of the sum insured will not be
expected to be different from those of other such policies. Loss or damage
may, however, be more likely. Whether and how assumptions are changed will
depend on how much experience the company has with the particular
specialist area.
Page 14
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
(i)
A high level preliminary risk analysis to confirm that the project does not obviously
have such a high risk profile that it is not worth analysing further.
Need to look at whether any of the three areas is not viable using the high level
preliminary risk.
Hold a brainstorming session of project experts and senior internal and external
people who are used to thinking strategically about the long term.
This would involve people that have worked in the areas being considered particularly
understanding the risks that are relevant to those areas (for example pilots or
stewardesses that have worked in those locations).
Page 15
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
Identify project risks for each of the three areas, both likely and unlikely, and upside
and downside.
Discuss identified risks and their interdependency.
Attempt to place a broad initial evaluation on each risk, both for frequency of
occurrence and probable consequences if it does occur.
Generate initial mitigation options.
Carry out a desktop analysis to supplement the results from the brainstorming session,
by identifying further risks and mitigation options researching similar products
undertaken by the airline or others in the past and obtaining the considered opinions
of the experts in those locations who are familiar with the details of the project and
outline plans for financing it.
Carefully set out all the identified risks in a risk register, with cross references to other
risks where there is interdependency this should be done for each of the 3 areas.
(ii)
Risk Language of other areas may be different from the domestic airlines.
Mitigation Employ people who are bi-lingual and can work in different cities
Risk Competition, considering the approach of other airlines and how the
competition may react if an area is selected.
Mitigation Monitor the competition is doing and assess the strength of localised
competition in each area.
Risk Demand for airlines in the areas may make the projects unprofitable.
Mitigation Research demand and sensitivity of demand in each of the areas.
Risk Currency risk, as will need to price flights in different countries and therefore
will be exposed to exchange rates affecting the prices of the flights.
Mitigation Hedging currency with derivatives.
Risk Market risk, the stock market may regard the new venture as very risky and put
a lower valuation on the whole group.
Mitigation Explain to investors the plans for expansion and the strategies that are
being put in place to minimise the risk and maximise the return.
Risk Fuel prices may be higher in other areas increasing costs.
Mitigation Consider fuel prices as part of the assessment of risks, and explore the
possibility of planes avoiding the need to refuel in expensive areas.
Risk The legislation/rules on airlines running outside of the domestic country may
have significant differences to the domestic country.
Mitigation Research the rules that will need to be considered as part of the analysis
of each of the countries, and ensure that local experts are actively involved in the
project team.
Page 16
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
Risk Equipment currently used by the airline may not work in the new areas. For
example planes may not have the range required, or computer systems may not work
without access to local intranet.
Mitigation Consider whether any upgrades are required as part of the risk review.
Will need to consider upgrades required for each area.
Risk The airports in the areas being considered may have a bad reputation, for
example for losing luggage. There may be a reputational risk for the airline.
Mitigation Include individual airports under the risk review.
Risk If planes are grounded in airports they may not be covered should accidents,
for example fire, occur under the current insurance arrangement.
Mitigation Extend any insurance held to either cover other areas.
Risk The planes may break down in the new areas and availability of parts and
engineers may lead to higher costs.
Mitigation Consider what contracts could be set up for maintenance and/or explore
setting up pool of own maintenance staff either travelling with flights or based in the
areas.
Risk Operational costs, such as wages may vary in each region
Mitigation Research cost in each region and consider extent to which they must be
incurred locally (or sourced centrally)
Risk As a new business venture there may be significant unknown hazards not
considered in advance of set up.
Mitigation Consider use of experts from each region, or targeted hiring of
established individuals.
Risk Overseas regions/route may be more subject to natural disasters or war.
Mitigation consider availability of insurance.
(iii)
Assume that the set up costs are on day one but the yearly cashflows are on average
half way through the year. (or alternatively at year-end)
Scenario A NPV = 100 + 50v0.5 + 50v1.5 + 50v2.5 = 39.5m
Scenario B NPV = 110 + 40v0.5 + 40v1.5 + 45v2.5 = 6.0m
Scenario C NPV = 120 + 30v0.5 + 30v1.5 + 30v2.5 = (36.3)m
Expected NPV = 0.3 * 39.5 + 0.5 * 6.0 + 0.2 * (36.3) = 7.6m
(iv)
The project shows that it will make a profit 80% of the time and a loss 20% of the
time. The range of profits vary quite significantly, with a very high loss 20% of the
time.
Page 17
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, April 2011
The decision to proceed will depend on the risk appetite and required return on capital
for the airline.
The cash available to invest in any project will impact on the decision to proceed.
Alternative projects, particularly those with higher return or lower risk may provide a
more attractive investment.
Availability of insurance, or other mitigation options, could change the risk associated
with the project and influence the investment decision.
May wish to consider possible cashflows beyond the three year time horizon.
May wish to consider further developments since the initial risk analysis was carried
out.
This was generally well answered, though some candidates did not make their answers
specific to the question in (ii) and didnt comment in (iv) on the variability of outcomes.
Page 18
Enter all the candidate and examination details as requested on the front of your answer
booklet.
2.
You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3.
You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4.
5.
Attempt all seven questions, beginning your answer to each question on a separate
sheet.
6.
CA11 S2011
Describe the tools that can be used to aid risk management over the life cycle of a
general insurance product.
[8]
[9]
An individual has won a sum of money equal to three times his net annual salary. He
has a mortgage that is due to be paid off over the next ten years. He has decided to
invest in various types of asset classes with the aim of paying off the mortgage within
five years, ideally leaving him with surplus funds.
(i)
Explain by setting out a suitable formula how he could use portfolio theory to
assess the best way to maximise the surplus.
[6]
(ii)
Discuss the factors the individual would consider in choosing the asset classes
to invest in.
[3]
[Total 9]
(i)
(ii)
(b)
(c)
(d)
CA11 S20112
(i)
[5]
Explain why the performance of the two trusts over the same time period may
differ.
[9]
When the security is issued, the issuing company specifies the term of the security
(typically 510 years) and the maximum coupon rate.
The purpose of the auction is to agree the coupon to be paid for the next three
months, subject to the maximum coupon rate.
The auction works by investors bidding a coupon rate they would be willing to
receive on the security and the amount of stock they would accept.
The agreed coupon rate is the lowest rate needed to fully allocate the security, and
the security is then allocated to investors who bid at that rate (or lower).
If existing holders of the security had bid higher than the agreed coupon rate (and
so are not allocated stock), then their capital is repaid at par value by the new
investors who bid lower and have been allocated stock.
If there are not sufficient investors to fully allocate the security, then the existing
holders will continue to hold the security and will receive the specified maximum
coupon rate.
New investors wishing to buy the security will bid for a low coupon, and existing
investors who want to sell the security will bid for a high coupon.
Security-holders can sell stock at any time, provided they can find a buyer.
(iii)
CA11 S20113
In three years time, a small provincial town will be celebrating the 750th anniversary
of its founding. The organising committee is planning large and expensive
celebrations to be held over a weekend during the anniversary year. The committee is
worried about the festivities being disrupted or ruined by bad weather.
The part of the country where the town is situated has notoriously unpredictable
weather that can cover the full range of possible conditions from mild to extreme.
Data exists covering local, regional and national weather records over the last few
centuries. However, the more local the data is, the less complete and accurate it is.
A senior lecturer at the towns college is proposing to use this data in a model that
will predict the best date for this event.
(i)
(ii)
Suggest the criteria that could be used to assess whether the weather on a
particular weekend is likely to disrupt or ruin the event.
[3]
Discuss the extent to which the available data may be appropriate for the
prediction model.
[9]
(iii)
Outline other considerations that could influence the committees choice of the
date for the celebratory weekend.
[2]
(iv)
Set out the difficulties that the committee could face if it tried to fully transfer
its financial risks on this project to a third party.
[4]
[Total 18]
(i)
[3]
Describe how the insurer analysed the mortality experience of the contract
over the three-year period
[8]
(iii)
Suggest other possible reasons why the insurer made a profit on this contract
over the three years
[4]
END OF PAPER
CA11 S20114
[6]
[Total 21]
EXAMINERS REPORT
September 2011 Examinations
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
Page 2
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
The starting point of the product life cycle is the design of the general insurance
product.
At the design stage risk management is used to optimise the capital requirements by
taking advantage of diversification. The diversification can be optimised partly by
balancing benefits that diversify each other. E.g. diversification by geographical
region will be important.
Reinsurance can also be used, for example reciprocal quota share reinsurance to
increase the diversification within the portfolio.
Alternative Risk Transfers could be used to aid the risk management of the business
(e.g. Securitisation)
Underwriting stage: risk management is used at the underwriting stage prior to the
acceptance of risk. The aim being an assessment of the potential risk so that each can
be charged an appropriate premium.
Claims stage: risk management is used at the claims stage to mitigate the financial
consequences of a financial risk that has occurred. Risk management is used to guard
against fraudulent or excessive claims. However, the costs of implementing and
maintaining a control system must be compared with the benefits gained from it.
Management control systems: Management control systems can be used to reduce the
exposure to risk.
These include:
Ensuring that the company holds and maintains good quality data on the risks it
insures.
Care of offering options and guarantees, particularly those that viewed as having
little value as the value can change particularly if the market or other conditions
change.
Generally well answered. Many candidates wrote extensively about reinsurance and
alternative risk transfer, but did not give sufficient attention to other risk management
techniques.
Page 3
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
The State has a major role in the provision of benefits. This may be through direct
provision, through encouragement of provision or through the regulation of provision
from other providers.
The political, economic and fiscal viewpoints of the State will determine the precise
roles that it will play.
Although the question refers to women, the actions will be suitable for all individuals
without adequate pension provision, and the State may not wish to positively
discriminate.
In this case, it is likely that the State will want to encourage provision from other
providers. This would have the economic and fiscal advantage of making women
better off in retirement and so less dependent on state benefits, and may also have
political advantages.
They will need to educate about the importance of providing for the future. This could
be done through a marketing campaign focusing on pensions required for a
comfortable retirement and comparing this to any actual provisions made. Such a
campaign would be via media that are suitable for the target audience
They could then educate or require education on the type of vehicles which could be
used to provide this benefit.
They could regulate to encourage or compel benefit provision for those in
employment; contributions could be made by both the employers and employees. The
State could also add to these contributions, possibly as tax benefits. It could consider
additional contributions to those on low earnings (more likely for those in part time
employment).
The State could regulate to require equal pay/benefits for males/females.
The state could ensure that pension contributions continue to be paid when on career
breaks (e.g. when on pregnancy leave)
The state could improve access for part time workers (these are potentially likely to be
females)
A major problem will be with women who are not economically active for part of
their working lives, for example because of childcare (or looking after elderly
parents).
Benefit provision can still be made regardless of current earnings and it could
encourage other providers to enter this market. Tax benefits or additional
contributions may be needed to make this option attractive. This will only be suitable,
however, for those with the finance available. For those without available finance the
State may need to provide contributions.
Tax benefits could be targeted for the low income earners
Page 4
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
The State could also provide some form of additional pension to those not earning or
on low incomes.
If currently it is typical for women to have lower pension entitlements than men, the
State could require sharing of pensions on divorce so that the ex-wife has more
adequate pension.
The state could make spouses benefits compulsory rather than an option
The State will need to regulate bodies providing benefits, and bodies with custody of
funds, in an attempt to ensure security for promises made, or expectations created.
This will be needed to create confidence.
The State could provide financial instruments which could be used to make provisions
for future benefits.
As an employer, the state could provide adequate benefits for their employees
Disappointingly answered. Most candidates did not reflect sufficiently on issues particular to
women such as maternity and childcare issues, or the prevalence of part-time working. Few
candidates commented on the role of the government as employer.
(i)
Formula:
S = A Sum(xi (1 + Ri)) L
Where:
Page 5
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
A low risk investor will want to ensure that they do not lose the prize
money but ensure that it can at least help pay off some of the mortgage
i.e. may not be completely tied to paying off in five years. They could
consider matching their position to ensure this happens
A more aggressive investor might have chosen the assets with the aim of
trying to pay off the mortgage at the quickest rate.
The time frame is only five years and hence the selection of the assets may
be dictated by the need to have liquid assets in five years time to achieve
the objective.
Will need to consider the tax position of each of the assets and the possible
desire of the individual to invest in tax efficient products.
Also may choose the asset with the lowest investment costs.
Part (i) was poorly answered: many candidates did not explain how portfolio theory would
be used to address the investigation of asset proportions in the investor's portfolio. Some
candidates wrote as if maximising the surplus was the only priority, ignoring the prior
objective of paying off the mortgage within five years with reasonable confidence in turn
requiring a given return. Many that did get the bookwork out didnt add much to it.
Part (ii) was better answered, although points were sometimes made too generically. Many
went beyond the scope of what was asked. That is they looked at other assets, income or
liabilities. With short questions and a specific circumstance, candidates are advised to keep
answers directly relevant.
(i)
Page 6
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
(a)
Page 7
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
(c)
Page 8
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
(d)
Generally good answers were made to part (i), although a significant number of candidates
suggested that a higher discount rate would be used in establishing prudent provisions. The
better answers were thorough on the detail, e.g. about which way to alter the discount rate
and about the level of margins and what they were added to.
Answers to part (ii) did not reflect sufficient familiarity with the characteristics of the product
lines set out in the question (or a failure to assess these). The most disappointing aspect was
a failure to recognize and act on the key words in each section. For example a reported
claim in (a), groups and short mission in (b), new class in (c) (the implication being that
marine as a whole isnt new but this type is) or large and mature in (d). There were plenty of
marks available for drawing obvious conclusions from specific words.
(i)
Page 9
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
In an open ended scheme units are purchased and sold at the net asset value of
the units.
The other difference between collective investment vehicles is their legal
form. They can be set up and governed by company law or under trust law.
Examples of different types of collective schemes are:
Investment trusts These are closed ended schemes governed by company
law
Unit trusts These are open ended schemes governed by trust law
Open-ended investment companies (OEICS) These are open ended schemes
governed by company law
(ii)
Page 10
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
In a unit trust, the managers will buy in units offered to them when investors
need to sell their units (although there may be a delay). For this reason unit
trusts may need to be more liquid than investment trusts to ensure they are not
forced sellers if faced with a high level of selling. This will affect their
performance.
The price of unit trusts will be directly related to the underlying assets. The
price of investment trusts will be determined by supply and demand. The price
of an investment trust will usually be at a discount to net asset value, changes
to the discount would affect investment performance.
Investors preferences for property unit trusts or property investment trusts
may have changed altering their relative attraction. This may be due to:
Page 11
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
The presence of a maximum coupon will mean that there is the risk that when
money market rates rise the coupon paid will be lower than money market
rates.
If this happens, the auction would fail: that is, the market wants a higher yield
than the maximum rate and therefore the price of the bond should fall to
reflect that higher yield.
So an investor who purchased a money market like security can suddenly end
up holding a long-term fixed rate bond, a very different investment.
This risk should be reflected in the coupon bid in the auction with higher than
money market rates being bid and therefore higher returns achieved.
The coupons bid in the auction will reflect money market rates, a margin
above this to reflect credit risk and a margin to reflect the risk that there will
not be bids less than the maximum rate.
Each of these elements will change over time, for example it will become
more likely that the maximum rate applies when money market rise or the
credit risk rises.
In the situation where the maximum coupon applies, the security will then
behave more like a long-term bond. But with the risk that the coupon will fall
at subsequent auctions, which risk would be reflected in the price paid by an
investor who wants a long-term fixed income.
The investor will be concerned with the marketability of the bond within the 3
months if they need to sell in the time between the auctions will they be able
to.
In answering part (i), many candidates seemed to believe that investment trust prices were
set by managers relative to NAV, rather than being determined by market supply and
demand. A number of candidates seemed confused about open and close ended
characteristics of the vehicles.
On part (ii) most candidates got the majority of the points.
Answers to part (iii) were generally weak, with candidates showing little appreciation of the
impact of money market conditions on the auction results. Many did the right thing on
hard questions and developed the obvious basic points and what flowed from them. Some
candidates did not differentiate between the risks for the company and investor as asked, for
example the term of borrowing is known for the former but nor the latter.
(i)
The first step is to look at the types of weather that would cause problems.
This is likely to cover rain or snow (too much), temperature (too hot or cold)
and maybe strong winds or storms.
Page 12
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
Two sets of issues arise: weather that disrupts and weather that ruins.
Hence for each condition, criteria that would cause problems at each level
would be set e.g. ruined if below freezing say or disrupted if between 30 and
40 degrees.
For each weekend, for each condition, it would be necessary to estimate
probabilities of both ruinous and disruptive weather. For example 25% chance
of a major storm or 30% chance of uncomfortable heat say.
Criteria would then be set to exclude particular weekends e.g. reject if say
more than 10% chance of ruin conditions and/or say 50% chance of disruptive
conditions
Could reject if failed for a combination.
(ii)
Page 13
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
It is possible that global warming or other trends means that older data is no
longer relevant or that fluctuations are becoming more unpredictable.
Any possible developments of such trends and patterns noted above need
consideration given the gap until the events.
It will be necessary to check that what is recorded is consistent and presented
in the same way (Fahrenheit v Centigrade say). Hence some adjustments may
be needed.
Likewise, technology may mean that older data is less accurate e.g. obtained
using poor instruments, or by well meaning amateurs.
Similarly, they may be issues with interpretation or clarity. For example
handwritten data on crumbling paper recorded by a Bavarian monk in an
obsolete language may have to be worked on.
(iii)
The date of the founding charter may be widely known and be the basis of
smaller regular celebrations
Likewise a date associated with a local hero or patron saint may be significant.
It may be desirable to tie celebrations into periods of local holidays or festivals
(e.g. musical or dramatic) so as to promote citizen participation.
Likewise, periods of national or regional holidays may boost visitor numbers.
But it will be important to avoid clashes with other regular festivals or events
that could be viewed as competition (for customers or suppliers).
Similarly, if the country was holding a big one-off event e.g. world cup then
this could be a distraction.
The need to obtain permits or licences (e.g. to sell alcohol on religious
holidays etc.) could dictate which dates are available.
(iv)
The main difficulty with a full transfer could be assessing the extent of any
financial loss for the purposes of traditional insurance.
Costs of preparations, building etc. would be incurred whatever the outcome
and so are unlikely to be viewed as losses by insurers.
Losses will relate to low revenue e.g. fewer visitors spending less.
Or damage to reputation e.g. they create a bad impression and future trade or
visitors suffer.
Such amounts are very difficult to quantify or express in monetary terms. For
example what are target receipts?
Page 14
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
There is the difficulty of defining and measuring the risk event e.g. what
would trigger any claims and who would verify them.
For example was bad weather the problem or poor preparations or marketing
there is scope for a lot of dispute.
Who suffers the loss and who is insured? The town may suffer e.g. lower tax
receipts but local businesses would as well. How will premiums, losses and
claims be allocated?
It may be possible to obtain insurance that pays out if bad weather occurs, but
unlikely that the claim payment received would fully cover the losses.
Other ways of transferring risk suffer from similar problems. For example,
selling tickets in advance may be tricky due to uncertainty and purchasers may
want their money back if problems arise. Though ticket revenue for specific
events say could be insurable.
Money could be raised from sponsors or advertisers but again they may want
some guarantees or protection. They may not want to commit too early.
Possible to obtain insurance for fixed amount payable on certain adverse
weather events, but this only partially covers the risks.
There were generally poor answers to part (i), few candidates reflected sufficiently on the
distinction between disruption and ruin of the planned event. Many did not reflect how
the historical data would be used to assess the probabilities of threshold criteria occurring at
particular times.
In this case simplicity and practicality are paramount, given the circumstances.
On (ii) many showed a good awareness of potential problems with the data given the
situation, and how these could be overcome given the right circumstances. Responses that
were too generic on data issues lacked quality and did not score well.
Most candidates got the majority of marks for part (iii), although there was a tendency to
repeat the same underlying point.
On part (iv) few candidates were able to address more than the problems of placing the risk
due to its one-off nature or observing that insurance would be expensive. Few considered
deeper issues such as defining (and if necessary later agreeing!) the risk event and the
problems caused by non-financial losses.
(i)
Page 15
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
(ii)
Page 16
The company will seek to compare the actual deaths it has experienced
with the expected death rates when the contract was designed, or with
those in the current supervisory valuation basis.
The aim will to be split the data into the homogeneous groups while
keeping the volume of data within each group credible.
It is important to be clear about the definition of the exposed to risk for the
denominator of the ratio.
Normally this will be the average of the in-force policies at the year start
and the year end (but more accurate if the data is available).
Data should only reflect the scheme that is being considered so some data
checks should be done.
The most important levels at which to carry out the investigation are:
Sex
Pensioner versus Dependent
Age i.e. is any age band dominating the number of deaths
Pension Size is the experience dominated by one or two individuals
with very large pensions dying and hence not reflective of the whole
scheme
Location (if available) given that the manufacturing company is
based over the country is the number of deaths based in any particular
location and how does the experience differ in other locations
Type of occupation i.e. is there any difference between staff
experience and executives experience
Duration since pension commenced
Smoker/Health status (if the company has this information)
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
Is there any particular reason why the mortality experience is heavier than
expected that should be taken into account (e.g. were the workers exposed
to chemicals/asbestos that has only come to light now).
May want to consider if any experience of the scheme before the three
years is available and see if this is in line with the experience it has seen
(probably should have asked for this at the pricing stage).
If available may want to consider if the members that have died retired due
to ill health or normal health (again this should have been looked at during
the pricing stage).
The initial expenses of setting up the scheme could have been lower than
expected.
The investment assumption used in pricing might have been over achieved
and there could have been lower than expected defaults meaning that
more profit has been achieved.
The expenses of maintaining the scheme may have been lower than
expected, or there may have been lower contribution to fixed costs and
overheads.
If the pensions have escalation related to inflation then if the inflation cost
had not been hedged at outset then it may have been lower than expected,
alternatively if it was hedged it could have been done at a lower rate than
anticipated in the pricing.
Claims management (checking annuitants are alive) may have reduced the
cost of claims.
On death of the pensioner the spouses benefit may be lower than expected
(or the pensioner did not have a spouse where the company had assumed
they did)
The company would have added a profit loading into the product,
everything has gone as assumed and the profit has emerged
The use of this analysis for other schemes will depend on the industry of
the other schemes that the company is aiming to win, if it is another
manufacturing company then the analysis might be useful in indicating
possible mortality assumptions. Equally if the experience reflects the
experience of the county then it might be useful
(iii)
(iv)
Page 17
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
Could be used to reflect any difference in pension size (those with smaller
pensions may have heavier mortality) again this could possibly be used in
the new schemes pricing basis.
Use will also be dependent on how many lives (years of exposed to risk) is
available if the scheme won before was only a small scheme with few
lives then the data is unlikely to be credible and hence using in future
schemes may not be suitable.
The experience has only been done over three years and this is not
sufficiently long to base any future schemes pricing on.
The experience may give the company a better understanding of the base
mortality tables (split between male/female) and therefore may want to
adjust the standard pricing mortality tables.
This scheme may have had a higher proportion of ill health retirements and
hence more likely to have higher than expected mortality (especially if this
was not taken into account at the pricing stage).
Should also consider the competitive position, the information that has
been obtained could be used to the companys advantage
Page 18
Subject CA1 (Actuarial Risk Management), Paper 1 Examiners Report, September 2011
Most candidates scored well in part (i) although some went into far too much detail and
hence failed to see the wood from the trees. Some failed to draw out the consequences of
establishing adverse experience or trends.
Part (ii) was well answered although a few took completely the wrong approach by over
complicating what is in essence a simple deterministic investigation.
Responses to (iii) and (iv) were reasonable, although some included issues relating to active
and deferred members, which categories were not mentioned in the question.
Page 19
EXAMINATION
16 April 2012 (am)
Enter all the candidate and examination details as requested on the front of your answer
booklet.
2.
You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3.
You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4.
5.
Attempt all seven questions, beginning your answer to each question on a separate
sheet.
6.
CA11 A2012
(i)
Discuss why a pension scheme would carry out a review of its investment
strategy.
[4]
The investment strategy for the equity portfolio of a large pension scheme for the last
three years has been to invest 50% in a passively managed equity fund and 50% in an
actively managed equity fund. The funds are run by different investment
management companies and over the last three years have achieved the following
annual returns, which have been calculated consistently.
Year
Active benchmark
Active fund return
Passive benchmark
Passive fund return
(ii)
1
8%
7%
5%
5%
2
20%
15%
10%
9%
3
7%
7%
5%
6%
(a)
(b)
Suggest the main reasons why actual returns may have differed from
the respective benchmark returns.
[4]
The pension scheme carries out due diligence of the investment managers.
(iii)
CA11 A20122
(i)
Discuss the characteristics which will influence the credit rating of a new bond
issue.
[5]
An investor is evaluating fixed interest bonds to add to their bond portfolio. The
bonds being evaluated are:
a corporate bond issued in the local currency by a large multi-national firm, which
has extensive overseas operations.
a corporate bond issued by a small firm, which only has local operations.
(ii)
Explain why the redemption yield on the bond issued by the small firm may be
higher than the redemption yields on the other two bonds.
[3]
(iii)
Outline the main factors which may influence the investors decision as to
which of the three bonds above to invest in.
[3]
[Total 11]
(i)
Outline why companies in the financial services sector have moved to using
more complex models when designing and monitoring products.
[3]
Explain why the need to use a complex model may make it difficult for the
directors of the institution to understand the actual financial risks associated
with the investment of the insurance policy premium.
[5]
(iii)
Discuss why the proposed hedging arrangement may not result in guaranteed
profits for the institution.
[4]
[Total 12]
CA11 A20123
A country has a large horseracing industry. Horses generally start racing between the
ages of two and five. Most horses are retired from racing when they reach the age of
thirteen. A very small number of horses are retired at younger ages for breeding.
Revenues from breeding fees can be very high but are very volatile.
It has been proposed that a proportion of all breeding fees should be used to provide
contributions to a general fund that will be invested in order to provide benefits to
look after horses in retirement.
All horses actively involved in racing would be covered by the fund.
Benefits would normally only be payable when horses retire from racing aged
thirteen.
Benefits would only be available in respect of retirement before age thirteen if the
horse is certified as injured by a registered vet.
No benefits would be payable on the death of the horse either before or after
retirement.
(i)
CA11 A20124
(ii)
As an alternative to proposal (a), it has been suggested that instead of paying income
until the horse dies, the fund will reimburse the cost of housing the horse at a
retirement farm approved by the fund.
(iii)
Describe the additional risks that the fund may face if this alternative were
adopted.
[4]
[Total 19]
High Power is a domestic construction firm specialising in the energy sector. Over
the last ten years it has built a number of traditional power plants (which rely on fossil
fuels). With increased consumer demand for green energy High Power is currently
bidding for a contract to construct a dam and hydro-electric plant project for the
government.
Under the terms of the project contract one quarter of the project fee will be payable
to High Power upon exchange of contracts. The balance of the fee will be paid as a
lump sum on completion and handover of the dam and hydro-electric plant. It is
expected that the project will be completed within three years.
As part of the bidding process High Power will prepare a written strategy document.
(i)
List the particular items, which should normally be included in such a strategy
document.
[6]
(ii)
Describe four distinct non-financial risks that High Power could be exposed to
under this project. Your description should include of a way of mitigating
each risk.
[8]
Most of the fee will be paid on completion of the project. Hence High Power believes
that a key financial risk will be maintaining company cash flows for the three-year
term of the contract.
(iii)
Discuss options for managing the cash flow problems arising from the
staggered project payments.
[5]
[Total 19]
CA11 A20125
The Wetsock music festival has been running for 25 years. The festival is open air
and based in a remote location. Popularity has increased in the last five years with a
large number of visitors choosing to camp at the site over the weekend. Although the
acts at the festival are known in advance, late changes to scheduled performances are
common.
There are two kinds of ticket and both require wristbands to be worn for the duration
of the festival:
Silver band
Provides access to the festival and campsite.
Gold band
Provides access to the festival, campsite and VIP areas. In addition mobile text
message alerts are provided when scheduled performances are confirmed or altered.
Next year, an insurance company will sponsor the festival. The insurance company
has negotiated with the organisers to provide free insurance to gold band ticket
holders. The insurance company will receive a share of the gold band ticket price in
return for providing the insurance.
(i)
List the perils a visitor may wish to insure against during the festival weekend.
[4]
The cover the insurance company decides to offer to gold band holders includes two
key benefits:
Mobile phone cover: a compensation payment if a visitor has their mobile phone
stolen or damaged at the festival; and
Cancellation cover: a full refund of the ticket price if the entire festival is
cancelled due to poor weather.
(ii)
Discuss the factors that would need to be considered when determining the
cost of providing the mobile phone cover at this particular festival. Your
description should include possible sources of data.
[8]
(iii)
Explain why the claims experience for the cancellation cover is likely to be
markedly different and more difficult to predict compared to that for the
mobile phone cover.
[4]
(iv)
Outline the factors, which could lead to the price the insurance company
would charge the organisers being different to the expected cost of claims. [6]
[Total 22]
END OF PAPER
CA11 A20126
EXAMINERS REPORT
April 2012 Examinations
T J Birse
Chairman of the Board of Examiners
July 2012
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
Page 2
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
Life insurance costs rise as individuals get older. This is because mortality rates
increase at older ages. As a result, the cost for the renewable term will be higher than
the initial term.
There is also a value to providing an option which will increase the price of the
special policy.
One option would be to have a higher premium on the initial term of the special
policy. This higher price would reflect the value of the option and uncertainty in
pricing after five years.
Under this options the renewal term could be priced at the standard rate for an
individual five years older. Another option would be for the initial term to have the
same price as the standard policy. If this option is taken the renewable term would
have a higher price than the initial term to allow for the increased cost at older ages.
A further increase may be required to allow for potential changes in market conditions
during the next five years. As the price is agreed in advance the insurer will not be
able to change the price if conditions are worse after five years. However, if
conditions have improved the policyholder could simply let the policy lapse and buy a
new policy.
There may be a cost saving on renewal if administration costs are lower on renewing
compared to starting a new policy.
If the same price is used for both policies for the initial term then the insurer is
effectively providing a guarantee at no additional cost. Potential policyholders should
always choose this policy as they gain an additional option and give up nothing in
return. It may mean the first policy becomes irrelevant in the market. Therefore the
initial premium for the special policy is most likely to be higher than the premium for
the standard policy.
The insurer could decide that it would like the renewable term to be priced at the same
premium as the initial five year term. If this will be the case then the initial term will
need to have a higher premium than the first policy.
This would make the policy less attractive initially than the first policy. Although it
may make it more likely that the policyholders will renew at the end of the term as
they will have already paid up front for the option.
Page 3
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
(i)
(ii)
(a)
The active fund has underperformed the benchmark in two of the three
years. The most significant underperformance was in year two, where
the benchmark was missed by 5%.
The passive fund has matched the benchmark over three years,
underperforming once and outperforming once both times by 1%.
The active fund has achieved higher returns than the passive fund in
each year. However, as the benchmark for the active fund is higher its
performance is more disappointing than that achieved by the passive
fund.
(b)
Page 4
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
Generally well answered. However, many candidates covered issues relating to review of
performance rather than strategy in part (i). The purpose of part (iii) was to provide a
balance that a pension scheme would consider other aspects than just the performance in
selecting an investment manager, however, candidates identified fewer of these points.
(i)
Page 5
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
Repayment of the loan. How certain is the source of repayment and what
safety margin is built into projections and assumptions. Does the borrower
have free cashflow to cover loan repayments?
Past practice. If the borrower has defaulted on a payment the credit rating will
be lower.
Other counterparties. The borrower may be exposed to other creditors
(customers with outstanding credit, or companies with outstanding tax bills).
The quality of these other creditors will impact on projected cashflow and
security.
The size of existing bonds relative to the size of the issuer will impact on the
security of any new issue. If any existing bonds have higher priority, for
example if they are secured on specific assets, then this will decrease the
security of any subsequent bond issue.
Exposure to other risks. Exposure to market, currency and operational risks
will affect the security of any loan as these will influence the range of
scenarios under which the loan can, or cannot, be repaid.
Future developments. There may be other events in the future which could
impact on the borrower. For example fears of an economic downturn may
spark concerns on the security of government debt.
(ii)
Page 6
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
(iii)
Generally well answered. The marks for part (i) were generally lower due to narrow
answers being given. A consideration of the influence the characteristics of the bonds set out
in the preamble to part (ii) would have on their credit rating could have improved the
breadth of answers to part (i). In parts (ii) and (iii) most candidates scored close to the
marks available.
(i)
More complex models are now being used because the ability to construct and
run such models has increased.
Increased computing resources in terms of power/capacity and an ability to
handle complex calculations is the main factor.
Such resources are now relatively cheap to access.
In particular, there are now more trained people capable of performing the
tasks required to set up and maintain these models.
More complex models allow companies to innovate and offer refined
products, which could give them a competitive advantage.
In particular products may be made more attractive through the use of options
and guarantees, which require complex models.
Asset classes such as derivatives have become more developed, this means
more complex models are required to analyse investment potential.
Companies are more aware of the benefits these assets can provide and so
models have been developed to help companies understand investment return
and associated risks.
Page 7
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
A greater emphasis on risk monitoring and control has increased the use of
derivatives requiring more complex modelling.
It could be argued that, in a more globalised environment, even relatively
simple products are subject to many influences and therefore complex models
are required to assess simpler products and their associated risks.
Regulators may stipulate modelling requirements for reporting purposes, and
hence complex models may be effectively required by regulation.
(ii)
The directors are unlikely to be experts either on the particular product being
developed or on technical modelling.
Hence they may find it very difficult to interpret or understand the model and
its output themselves.
They will have to rely on the advice of others who are experts in those areas.
These experts will have a vested interest in the use of the model (bonuses etc.)
and so may be incentivised to underplay any risks.
Full appreciation of modelling results may require a lot of output, which
makes understanding difficult, and can lead to summary statistics being used.
This means the directors must rely on the summary produced and
communicated by the development team. Use of jargon and misleading or
incomplete summaries may mean that understanding is limited.
Given the detail and complexity, there is a further risk that directors may be
forced to assume that the model is right. This may arise if they are unable to
challenge the method or assumptions proposed (i.e. are blinded by science and
presentation).
There will be many assumptions underlying a complex model, and these
assumptions may also have a number of associated correlations.
It may be therefore be difficult to appreciate the significance of particular
assumptions. The directors will need to consider which assumptions are most
important and how best to appreciate these.
To understand the risks the directors will need to consider the sensitivity of
results to changes in assumptions, and how assumptions have been derived.
Subjective assertions regarding the efficiency of markets or investment
assumptions relying on rational investor behaviour may be difficult to estimate
reliably.
Some assumptions may be hard to model or require the use of probability
distributions. These assumptions will be particularly difficult to communicate
to directors.
Page 8
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
The use of distribution functions can mean that low likelihood but high impact
risks are not fully appreciated. This is especially relevant for the insurance
policy as the aim is for no risk hence big shocks could be very significant.
Shocks may be particularly difficult to model if the policy relies on hedging or
geared investments. Small errors in the assumptions or their correlations for
geared investments could have a significant impact on results.
(iii)
This was the least well answered question on the paper. Many candidates did not reflect on
the practical issues involved in parts (ii) and (iii). Part (ii) and (iii) were testing candidates
appreciation of the limitation of financial models. Financial models incorporate
simplifications and either implicit or explicit assumptions and it is important that the user of
the results from models understands the limitations that arise from this.
(i)
This will depend on expected rates of death and retirement at each age up
to age ten.
Page 9
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
The assumptions will need to be broken down into homogenous groups of race
horses, for example assumptions will vary according to:
(ii)
Sex of horse.
Type of racing undertaken, for example jump racers may be more likely to
be injured and retire at younger ages.
Proposal (a)
This is broadly a final salary scheme with a uniform salary for all members.
As such, the owner has more certainty over the benefit which will be payable
in retirement, making it easier to plan and put arrangements in place.
Investment risk falls on the fund and not on the owner/member.
Benefits are in the form of pension and so are not dependent on annuity rates
at retirement.
The suitability of this proposal crucially depends on the basic amount of
benefit provided for each year of a horses racing career. If the benefit is
significantly less than the cost of care then the proposal may be unsuitable.
Clarification will be needed in respect of ill-health benefits. In particular
whether accrued benefits be reduced to allow for early payment, or will be
increased to allow for prospective racing career.
For horses that retire due to injury after a short career, an accrued pension may
be too low to provide adequate benefits, particularly if cost of care for an
injured horse is higher than normal.
Page 10
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
Page 11
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
This option is likely to significantly increase risks to the fund and probably
contributions required. This is because the level of benefits to be paid is under
the control of a third party.
There is less certainty over both the initial cost and how it will increase in
payment. The risks of rising costs of retirement provision are now transferred
from the owner/member to the fund.
In particular, increased costs due to regulation (more likely with formal
providers) will be passed on to the fund.
It is possible that retirement farm providers will inflate costs to boost their
income. There is also greater risk of fraud/collusion between horse owners and
providers.
More formal providers will also look to make profits, which will increase
costs.
Expenses will be incurred in monitoring and approving farms and in checking
that claims are valid and reasonable. These expenses could be high.
Even so, should any farm provide poor care, there is a reputation risk to the
fund as they may get the blame. Expenses could be incurred in sorting out any
problems.
Page 12
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
(i)
(ii)
Contract risk. The exact terms and specification of the plant and delivery
timelines will be set out in the contract. If the government has drafted the
contract and full details are either not available or are ambiguous at the
bidding stage there is a risk that the terms may be penal. This risk could be
avoided by High Power specifying contract terms attached to their bid, i.e.
specifying exactly what they would deliver under the contract.
Political risk. As the project is sponsored by local government, there may be a
risk that funding is withdrawn or reduced due to changing budget constraints
or priorities. This risk may be reduced by considering whether buy in from
national government can be obtained as a guarantor for the project. The
contractor should also consider whether the project is in line with stated policy
aims and known budget constraints of the local government.
Page 13
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
Reputational risk. This project is outside the normal area of expertise for High
Power. As a result they may experience additional difficulties in managing the
project, which could damage the reputation built up in their core areas of
expertise. This risk could be reduced by bringing in market experts in hydro
plant construction, or working in partnership with a third party who is
established in this field and can help avoid known pitfalls in hydro plant
construction.
Business continuity and external risks. Construction of the dam and plant
could be seriously impacted by the local environment. In particular high
rainfall, which would increase water flow, could make dam construction
difficult leading to delays. This risk could be reduced by taking out business
interruption cover, or specific insurance against conditions which would delay
completion of the project.
Logistical risks. The transportation of building materials to the site may be
difficult due to the location of this project (which must be near a large body of
water and probably hills). In particular any geographical features of the region
could lead to increased transportation quirks. As High Power has not operated
in this field it may wish to sub-contract the movement of materials to a thirdparty on a fixed contract to transfer this risk.
Operational risks. While High Power will be familiar with the construction of
power plants, it has no expertise in the construction of hydro plants. This
could lead to uncertainty in terms of the time, cost and specialist expertise
required to complete the project. Further research into similar projects, and
research into the local region may reduce the uncertainty and risk associated
with the project.
Environmental risk. Construction of a dam could have unintended
consequences for the local area, for example flooding of the natural habitat of
local wildlife which could lead to objections from local residents. These
risks could be reduced by engaging with local environmental groups to
determine if there are any specific local risks.
(iii)
The company may have a sufficiently strong balance sheet to finance the
project from its own cash reserves.
Whether cash reserves can be used will depend on the volatility of the reserves
and whether this position can be sustained for the three year period as part of
the companys business plan.
Alternatively there may be other projects undertaken by High Power with
positive cashflow which could subsidise the project.
The opportunity cost will also need to be considered. For example, if there is a
more effective way to use reserves.
The company could issue bonds to raise the finance required.
Page 14
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
Bonds with a three year term would match the duration of the project and
therefore rectify the cashflow difficulties placed on the project.
These could be unsecured, or alternatively linked to the dam and hydro plant
providing additional security for bond holders. By securing bonds the rate of
interest paid could be lowered, reducing the cost of finance.
Secured bonds could also be used to provide security in the event of late
payments within the three year term. For example, providing increased
security if there are any outstanding coupon arrears.
The company could enter a partnership with another party to share interest in
the project. This partner may be willing to provide finance, while High Power
manages the actual running of the project in exchange for a share of any
profits.
This could also provide an opportunity to build relationships with the third
party that could be used for future projects.
The company could consider making a rights issue to raise additional equity
interest. However, the time involved in making a rights issue could make this
a less practical option.
The company could consider taking a bank loan or using an agreed credit
facility to finance the project. However, the ability to use any facility will be
dependent on the terms attached and the willingness of the bank to maintain
any agreement over the term of the project.
Generally good answers, particularly for candidates providing wider answers. Most
candidates scored close to the maximum parts for part (i). In part (ii) many candidates
described a range of similar risks rather than wider distinct risks resulting in lower marks.
In part (iii) many of the practical issues of managing cash flow timing were not identified.
(i)
Page 15
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
The cost of benefits is the amount that should theoretically be charged, so will
depend on the frequency of claims and value of payments made.
To assess the frequency of claims the insurer will need to consider the
proportion of visitors with a mobile phone.
It will then need to consider what proportion of those mobile phones may be
damaged or stolen at the festival.
An allowance may be made for mobile phones covered by other insurance
arrangements, for which a benefit payment may be excluded.
The number of thefts will be influenced by the level of security at the festival,
as well as the profile of festival goers.
The cost of claims will depend on whether a fixed amount will be paid or if
the amount paid will reflect the phone value. If a fixed amount will be paid
then the costs will be more predictable.
If amounts paid will be variable and linked to the value of the phone, then the
insurer will need to predict the value of phones. The insurer would then need
to collect data on typical mobile phones owned by typical festival goers,
broader information on the value of phones in the market may be available
from other insurance policies for example contents insurance or from
mobile phone retailers.
If only a proportion of a phones value will be paid, or a maximum claim level
is put in place this may improve predictability as well as reducing costs.
Moral hazard could significantly impact on costs. This could include visitors
bringing more expensive phones to the festival, or an incentive to falsify
claims in order to benefit from the insurance. The insurer may wish to
consider whether exclusion clauses could be used to reduce the impact of
moral hazard (i.e. reduce the possibility to falsify claims).
Claims underwriting will be required to avoid fraudulent claims. This may
involve some verification that the phone was in the possession of the visitor on
entry to the festival and pursuit of lost handsets to ensure they are lost.
Page 16
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
The ideal source of data for theft would be based on number of phones stolen
from the festival in previous years, but this is unlikely to be available. As a
result it may be necessary to consider alternative data which may show similar
characteristics.
Data from the festival in previous years is unlikely to be available in a
meaningful form, or with a sufficient volume of data to make analysis
credible. Alternative data may be available from other insurers, or possibly
from police records if high level summaries are available for other events.
For damage to phones data may be more difficult to collect as typical
breakages may not be reported with users just replacing handsets. It may be
possible to obtain data on breakages from mobile phone retailers.
(iii)
If the event is cancelled then a refund will be paid to all visitors, so there will either
be a large number of payments or no payment at all. This differs to the mobile
phone cover where there are a larger number of (more) independent insured
events.
This increases the volatility of total payments, making it more difficult to
price.
Ticket price would be known in advance which means there would be no
volatility of payment amount per claim.
Weather is difficult to predict in advance. The share of ticket price received
will be agreed in advance but tickets may be purchased much nearer the date
of the festival.
This means there is a risk of anti-selection, as nearer the festival the weather
can be predicted more reliably. If there is a high chance or poor weather more
visitors may choose to purchase gold band tickets.
Cancellation of the festival would be at the discretion of the festival organiser;
this introduces an element of control into the cancellation event. With
cancellation insured the organiser may be more inclined to cancel if the
weather is poor.
There would also be the possibility that the event is cancelled for other
reasons, there would need to be clear rules in place to avoid the weather being
blamed for such cancellations to trigger an insured payment.
There could also be reputational risks to the insurer if a cancellation event
occurred that was not weather related and gold band ticket holders did not
understand why a refund would not be covered.
It may be possible for the organisers to take steps to reduce the chance of
cancellation, for example by improving drainage at the site or providing
pavilion areas. By encouraging, or insisting on these steps, the insurer may be
able to reduce the probability of a claim.
Page 17
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
(iv)
The price charged will be the cost of providing benefits plus the value of
expenses and contribution to profit.
The contribution to profit may be positive or negative.
Expense of administering the benefits, including the cost of recording and
holding details of visitors and their mobile phones.
Contribution to overhead expenses.
Insurance premium tax, or any other taxes.
No need to allow for commission as policies are only sold alongside festival
tickets.
Capital cost for any upfront investment in infrastructure to support product.
Marketing to encourage take up of gold band tickets, and hence the policy.
There may also be marketing costs at the festival to help festival goers
appreciate the cover they have been provided.
If tickets are bought, and fees received well in advance of the festival date
then there may be an allowance for investment income. This would also be
considered if claims are likely to be paid well after the date of any claim.
Margins for contingencies.
Reinsurance costs if the insurer chose to take out reinsurance.
Contribution to profit, the level of which will depend on how the policy is to
be used by the insurer i.e. whether used to generate profit, or geared more
towards marketing.
Consider the reserving requirements which may apply to the policy and if the
insurer will have appropriate reserves to meet these or any other statutory
requirements.
The price of insurance will need to be proportionate to the additional cost of a
gold band ticket (compared to a silver band ticket). The additional cost must
cover both insurance and other benefits, and there may be limited facility to
tailor the price of gold band tickets to allow fully for insurance costs.
The insurer will also need to consider the share of ticket price received in the
context of the sponsorship fees paid to the festival. Any difference between
the insurance cost and the price charged could be seen as additional (or
reduced) sponsorship money for the event.
There may also be consideration of an investment into an ongoing relationship
with the festival organisers, if this insurance may be offered in future years as
well.
Page 18
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report April 2012
Question reasonably answered. Part (i) was answered well. In part (iv) the difference
between having to pay all or no one for cancellation, compared with the mobile phone cover
was not fully appreciated.
Page 19
EXAMINATION
24 September 2012 (am)
Enter all the candidate and examination details as requested on the front of your answer
booklet.
2.
You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3.
You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4.
5.
Attempt all seven questions, beginning your answer to each question on a separate
sheet.
6.
CA11 S2012
A country is hosting a major international sporting event. The opening ceremony for
the event will be preceded by a procession involving celebrities and a torch-bearing
relay through a large number of cities of the country.
Describe the risk management process that the country should follow when preparing
for the procession.
[8]
A large defined benefit pension scheme has made a significant profit from selling fine
art assets that were part of its investment portfolio and now has a substantial surplus.
(i)
[3]
(ii)
Discuss the factors that will influence how and when the surplus is used by the
scheme.
[6]
[Total 9]
Describe how useful this data would be in determining these premium rate
assumptions.
[4]
The government of the subsidiarys country has banned the use of both age and
gender as rating factors for all general insurance products.
(ii)
Discuss other rating factors that could be used to ensure that premiums
charged by the subsidiary accurately reflect the risks associated with each
policyholder.
[7]
[Total 11]
List the types of information that would be asked for on the application form
for this product.
[4]
(ii)
Describe how underwriting and other control systems could be used to manage
the risks the company faces in writing these policies.
[9]
[Total 13]
CA11 S20122
(i)
Describe the principal differences between the nature of the benefits payable
under the following types of insurance contract:
[5]
Explain why the reserves required would be higher compared with a similar
policy that does not have the guaranteed death benefit.
[3]
(iii)
Discuss factors that could influence the level of the additional reserves
required.
(iv)
[5]
Set out the most appropriate approach to calculating the level of the additional
reserves required.
[3]
[Total 16]
A professional sports club that is currently leasing its stadium, is looking to move to a
new larger stadium that it will develop and own. It needs to raise finance in order to
fund the development.
(i)
Describe the features of the types of investment assets that the club could issue
or use to raise the necessary finance.
[7]
(ii)
Discuss the factors an investor would consider when providing such finance.
[6]
A wealthy individual based in an overseas country has decided to buy the sports club
and fund the development of the stadium. The individual will sell all his existing
property company shares and use the proceeds to fund the new stadium.
(iii)
(iv)
[4]
CA11 S20123
A new financial institution believes that it has spotted an opportunity to offer a new
type of loan product. In general, loans will be for relatively low amounts and be over
very short terms. However, the annualised interest rates charged on the loans will be
extremely high.
Customers will select the amount they wish to borrow. They will then select a
repayment date and the total amount to be repaid will be calculated. The quotation
system will be flexible enabling customers to easily and quickly consider a range of
borrowing and repayment options. Customers will earn trust points based on
repayment history, which gives them access to higher loans and lower interest rates.
The principal features will be:
(a)
(b)
(c)
(d)
(e)
(f)
Describe the characteristics of the likely target market for these loans.
[3]
(ii)
Explain how each of the specific features listed above could mitigate the main
risk to the lender that it is designed to deal with.
[15]
Discuss the advantages and disadvantages to the lender of asking for such
proof.
[4]
[Total 22]
END OF PAPER
CA11 S20124
EXAMINERS REPORT
September 2012 Examinations
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Examiners Report
Page 2
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Marking Schedule
Risk identification is the recognition of the risks that can threaten the assets of the
country and in particular here the risk that the procession is not successful.
Will want to look at the possible risks that might cause an issue here this will need a
significant brainstorming of the possible issues. e.g.:
There could be a risk that the event is not a success lack of people turning up
and any sponsorships not getting good value.
The weather might be very poor and the event might need to be cancelled and the
sponsor may want to have their sponsorship money back.
The costs of organising each city might be more expensive than expected leading
to the country having to pay out more for the procession than expected.
Failure of transport to get the celebrities there or torch does not make it from other
cities.
Limiting the financial consequences of the risk (there may be a knock on impact
to the major sporting event ticket sales if the procession is a disaster and or
sponsors of the procession may want their money back). The financial
consequences comprise the losses if the risk event occurs, together with the costs
of mitigation techniques used.
Limiting the severity of the effects of a risk that does occur.
Reducing the consequences of a risk that does occur.
Page 3
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Examiners Report
Risk monitoring is the regular review and reassessment of the all the risks previously
identified, coupled with an overall review to identify new or previously omitted risks.
Or could review previous processions that the country or other countries have done
and ensure all risks have been mitigated.
For example there could be a lessons learned session after each city procession
(especially if they are on different days) to see if things could be improved (e.g. what
to do if weather is poor or if celebrities fail to turn up).
On average this question was reasonably well answered. A number of candidates suggested
carrying out a high level preliminary risk analysis to decide if there were too many risks.
This point was not relevant as the procession had already been decided on.
(i)
(ii)
Page 4
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Marking Schedule
If there are benefits subject to discretion, for example additional annual benefit
increases dependent on the scheme financial position then this indicates where
the surplus is anticipated to be used first.
There is a need to consider the financial strength of the scheme sponsor. If the
scheme sponsor is financially weak then the scheme may need to retain a
higher surplus to enhance the financial security of the scheme members.
Where funds are set aside are subject to beneficial tax treatment, it is possible
that the surplus may be excluded from this beneficial treatment.
Also likely that the sponsor would be required to pay tax if receiving surplus
funds.
The proceeds from the fine art assets may be taxed differently if they are
distributed to members rather than staying in the fund.
Need to consider what would happen to the tax position of members following
any increase in benefits.
If the sponsor is exposed for making up any shortfalls in the schemes funding
it might be felt that they should benefit from any surplus.
Given this surplus has come from a good investment decision it might be
decided to review the investment strategy and use to de-risk to safer but lower
returning assets to ensure more security for the scheme.
If the scheme sees high volatility either from its longevity experience, benefits
escalating at higher than assumed or investment strategy the scheme might
want to retain the surplus to distribute later to allow for possible shortfalls in
the future.
Also depends on just how substantial the surplus in both absolute terms and
relative to the size of the total liability of the scheme.
Care would need to be taken to ensure any increases to benefits were to be
seen as fair to all members (e.g. between deferred members/active members
and also pensioners).
Overall this question was reasonably well answered. Part (ii) was less well answered with
many candidates not focusing on the one-off nature of the gain, the scheme rules and
thereafter taking into account the various stakeholders to the scheme.
Page 5
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Examiners Report
(i) The usefulness of the internal data from elsewhere within the multinational
group on motor accident risk will depend on how good a representation it is for
the smaller country.
The usefulness of the internal data will also depend on the quality of the data
(i.e. how complete is it and how up to date is it)
We are interested in both in the frequency of claims by type and the size of the
claim for each type of risk.
Factors influencing both claim frequency and size of loss include:
Driving standards (including tests) may also be very different between the
two countries.
There may be significantly different rules for driving in the other countries
compared to the smaller country e.g. the speed limits may be
significantly different.
The differences in road conditions between the countries is one
consideration.
For example if the other countries the types of road and maintenance of the
road may be very different resulting in accident experience differences.
The social factors in the smaller country may be very different than the other
companies for example there might only be a small proportion of drivers in
the larger country of a particular type of person and therefore the data might
not be detailed enough anyway.
There may be other factors that are different in target market that is not
representative of the aims of the smaller company (e.g. target drivers may not
be well represented in the data anyway).
The terms of the contract (e.g. policy excesses) may be different resulting in
differing claims experience.
The types of cars (for example top speeds) in the smaller country may differ
significantly meaning accidents may be both more likely and more expensive.
(ii)
There are 2 ways for dealing with this issue, i.e. by allowing for proper risk
factors in assessing the risk the driver gives the company or using proxy rating
factors that look for ways of rating gender and age. It maybe that the latter
would be considered by the regulators and challenged/ruled illegal if this was
not in line with the legislation
Different age and sex profiles will have a preference or need for different
levels or types of cover. The company could introduce different levels of
cover and use this instead for rating the sub-group that represents a narrower
or more predictable age/sex profile.
Page 6
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Marking Schedule
A more sophisticated form of pricing could be used that more directly reflects
the risk and that age and sex are themselves used a proxies. For example
satellite monitoring which identifies time, speed and location of driving.
The company could simply just combine females/males statistics and come up
with one standard rate but if other companies use more sophisticated rating
factors they could be selected against.
The company could look at average distance travelled in a journey as a rating
factor possibly shorter durations are more accident prone than longer
journeys.
Another factor could be how many miles driven in a year.
Data could be used to correlate the journey time to the accident rate.
But this may not have been recorded so could be difficult to get.
Number of accidents in the last x years could be used to rate and price
accordingly for higher risks.
This could be linked to a No Claims Bonus policy (could be linked to time
without having an accident).
Types of road driven on could be asked reflecting higher speed accidents on
the motorway as an example, it might be possible to get data on where the
accidents occur (what types of road) but again this might not have been
recorded and tracking the roads used could be very difficult.
Number of road traffic offences could be used to assess the ability of the
driver and therefore the likelihood of having accidents.
Occupation some occupations may have safer drivers than others (e.g. more
experienced because regularly driving).
Types of car some might indicate female drivers rather than male drivers and
some might indicate older drivers than younger drivers also the specs of the
car might indicate whether accidents are more likely than other cars.
Uses of car whether the car is used for business, commuting or pleasure).
Could look at number of years driving with more driving experience
reflected in the premium.
Postcode of member could also be used as a proxy if certain areas were
populated by certain parts of the driving population.
Data might be available on the types of car that are more likely to have
accidents again the data might not have been collected.
Page 7
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Examiners Report
Overall this question was reasonable well answered. Candidates need to be aware that ideal
data is often not available, but by understanding both the strengths and the limitations it can
still be used. The use of verifiable data with the limitations clearly understood is better than
use of expert judgement alone.
(i)
Postcode/Address
Date of Birth/Gender
Marriage status
Height and weight of the applicant
Smoker status/number of cigarettes smoked
Alcohol consumption
Questions about:
The medical history of the applicant
The medical history of family members
Questions around lifestyle/hobbies
Amount of cover or premium required/term required and possible options
Occupation (or previous occupations) or income
Is anyone else going to be included on the policy
And if so similar questions to the ones asked about the first life will need to be
asked.
(ii)
Page 8
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Marking Schedule
Page 9
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Examiners Report
what terms would they be offered suggestion would be not to offer anything
as standard.
This question was the best answered on the paper.
(i)
(ii)
Page 10
On death before the end of the term, it is possible that the guaranteed cash
benefit will exceed the value of the units held in respect of the policyholder.
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Marking Schedule
This will be especially true if death occurs shortly after the policy is taken out
when the number of units held will be relatively low.
Hence the insurance company may be liable to pay a benefit in excess of the
assets it holds.
In order to cover this extra potential liability (relative to a policy without the
guarantee), the insurance company will need to set up reserves.
This will need to be a cash reserve (since the extra benefit is expressed in cash
terms) as opposed to the unit reserves that will be needed to cover maturity
benefits (where the benefit is in the form of unit values).
The problem is exacerbated because unit values and hence reserves required
will fluctuate and so the extra potential liability is unknown. In particular, if
unit values exceed the minimum at a given time, there is no guarantee that
they will continue to do so in the future.
Policies that do not have the guarantee will not need these extra reserves since
any benefit will be covered by the unit fund.
(iii)
Clearly the level of the reserves required will depend on the level of the
guarantee (in relation to premiums payable). The higher the guarantee in
absolute terms, the higher the potential extra benefit.
Likewise, the term of the policy will be a factor. A longer term will mean that
there is relatively less chance of the guarantee biting as more premiums are
paid (and assuming positive investment returns). However a longer term may
imply greater volatility and uncertainty.
The extra reserves are required to cover a death benefit. Hence mortality rates
will be an issue. This will primarily relate to average age and sex of
policyholders. But factors such as underwriting, selection and general trends in
mortality will need to be considered.
Withdrawal rates might affect the level of reserves that need to be held for
example if these are significantly higher than expected then there might be a
need to hold larger reserves for the remainder (particularly if linked to the
better lives leaving).
To an extent such factors may be driven by competition in terms of how many
companies offer similar products and the nature of the guarantee relative to
other products in the market.
Legislation may specify the level of reserves to be held and/or the
methodology and assumptions used to calculate them.
The general risk appetite of the insurance company may be a factor. In
particular, they may be more cautious than is strictly necessary i.e. introduce
Page 11
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Examiners Report
The weaker candidates struggled with parts (ii), (iii) and (iv). This question required
candidates to consider the broad range of factors that affect the expect cost of guarantees.
(i)
The sports club is looking for an injection of cash probably in return for
payments back over a period of time.
The sports club could issue a fixed interest bond.
It issues bonds of a stated nominal amount.
The holder of the bond will receive a lump sum of a specified amount at some
specified future time together with a series of regular level interest payments
until the repayment of the lump sum.
Page 12
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Marking Schedule
The main focus of the investor will be to get a good return for the risk it is
taking on.
The investor of the bond will want to ensure that the sports club will pay the
coupons and the final repayment, or that there is an adequate charge over
assets as security i.e. they will be concerned that the club will default on the
asset.
Page 13
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Examiners Report
In order to be convinced of this the investor will want to look at the plans for
the club (as well as the character of the club, e,g. past history and its likelihood
to repay) particularly around how it will grow and perform well (e.g. what
gate receipts does it expect to see over the time, will the ground be filled with
new supporters or is the demand already there).
They will want to understand how the large repayment at the end will be
financed is this expected to come from holding back any profits made and
if so will this hamper its ability to grow and maintain the support that it is
expected.
Or will it be funded by player transfers or is there expected to be prize money
if the club is successful, or collateral value of the stadium.
If the investor is for equities they will be looking at similar things as above but
will want to know when they are likely to get their investment back, i.e. when
will dividends start to be paid, at what level and will they be sustainable.
What is the expectation for the value of the shares to rise (i.e. capital growth).
The investor will also be interested about the liquidity of the assets i.e. will
they be able to sell on their investments should they need to and will there be a
clear view of the valuation.
If they purchase index linked bonds they will want to have a good view of
expected inflation in the future.
Alternatively the investor may be looking for an ego trip in owning a sports
club.
The investor will also need to consider the size of the amount required and the
size of the club is it reasonable.
The investor will also need to understand his current status (i.e. with regards to
the other investments they currently hold and the tax position) along with
possible other opportunities.
(iii)
Holding property shares means the individual will have better diversification
when holding just the stadium the individual is exposed to the success of the
club and the possible issues this might cause.
The volatility could be huge holding just the stadium may have no true
picture of its value on a regular basis it could move significantly over time
compared to shares which can easily be tracked.
Control the investor will have little or no control over the management of the
portfolio of property shares with the stadium they could expand to make it
more valuable possibly having more uses than just for the sports club (e.g.
music gigs).
Page 14
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Marking Schedule
Loss on forced sale property shares are less likely to be forced sellers if the
investor needs to sell the club/stadium then they might not get good value.
Marketability Property shares are individual shares that can be sold
separately (i.e. portfolio is divisible) and are more marketable (i.e. sold in a
shorter time period) than the stadium/sports club would be.
Nature of the asset There are differences in the nature of the underlying
investment. The sports club introduces an exposure to both a sports business
risk and property risk which is quite different to property shares.
Taxation Treatment they may differ and there might be benefits for the
investor.
(iv)
If the investor is using this as an asset to back liabilities then there might be
currency mismatch.
Further problem might be the need to appoint an overseas custodian this is
probably not a big issue in buying a sports club.
There might be rules on overseas ownership of sports clubs.
There might be rules on the control of the sports club, so ownership may not
correspond to full control over the management of the club.
Legal risk, the laws and legal environment will be different between the two
countries altering the risks and the options available for legal remedy. There
could also be a risk that funds are repatriated in the future. There is also a
regulatory risk that the club breaks the rules.
There might be different accounting practices between two different countries.
There may be language problems between the investor and members of the
board of sports club and may therefore mean the club is run in a different way
to what the investor would like.
There could be time delays between where the investor lives this could lead
to difficulties in managing the club.
Taxation could vary between the two different countries.
The club may be poorly regulated leading to the board using a separate
company to take the transfers of players and hence the investor losing out in
terms of possible profits.
Overall this question was reasonably well answered. However, there were a number of
candidates who presumed that securities issued to fund the development of the stadium would
need to the listed on a trading exchange; however, this need not be the case, particularly for
smaller issues.
Page 15
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Examiners Report
(i)
Potential customers are those who may have difficulty in obtaining credit from
other, more traditional, sources.
This could be due to a poor credit history.
Such relatively small amounts for short terms would often be covered by
credit cards or overdrafts hence these facilities may be restricted for these
borrowers. Perhaps they have high debts with other lenders, or do not meet the
other credit underwriting criteria for other lender.
Potential customers are likely to be on low, variable or uncertain incomes.
Potential customers have an urgent need for cash.
Potential customers are unlikely to be financially aware.
Almost certainly, they will have low readily accessible savings to act as a
reserve source of funds so need loans to absorb the variability of income.
The main motivation behind taking out such loans could be to manage
cashflows. That is income doesnt match outgoing. For example, many low
paid workers may be paid monthly (or state benefits could be paid monthly or
fortnightly).
However, it is likely that their expenditure could be more frequent or less
predictable e.g. emergencies or unexpected outgoings (repair car, buy a new
fridge etc.).
Hence, such loans could be used as advances on wages or benefits to be repaid
out of known future income.
(ii)
(a)
A short maximum term will tend to reduce default risk. In that it will
be easier for the borrower to plan and this loan will be foremost in their
thinking. A longer term would mean more uncertainty i.e. unexpected
events that reduce the chance of repayment. The term of the loan
should be aligned to its intended purpose.
(b)
A low maximum loan for new customers will also reduce default risk.
In that smaller amounts may be easier to repay. Also it will mean that
the institution is less reliant on particular individual loans i.e. it is
diversified across customers. It is a crude way of underwriting given
the lack of information about new customers.
But the main objective could be linked to business risks. In that by not
giving better customers something more suited to their risk profile,
these customers could go elsewhere. Hence the company could be left
with lots of potentially unprofitable business.
Page 16
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Marking Schedule
The interest rate should reflect the operating expenses, expected losses
and risk. The high yield will be primarily designed to mitigate the
risks of making losses. These could arise from many sources but given
that we have a new company in a new market in general the institution
is looking to add in margins against unexpected poor experience.
Clearly the higher the gross return on successful loans, the more
cushion the institution has against unsuccessful loans or other revenue
shortfalls.
(d)
Internet only business will tend to mitigate expense risk. In that such a
route will involve lower sales, communication, admin and staff costs.
An Internet only route will also mean a standardised approach, which
will also reduce costs i.e. no negotiating or special terms or options.
(e)
(f)
(g)
A simple and fair early repayment facility will reduce default risk. In
that borrowers may have the funds to pay back now but they may not
do later on. Hence these loans may be a priority for borrowers to repay
and allowing them to do so will protect the institution.
(h)
Page 17
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Examiners Report
(j)
(k)
(l)
(m)
(n)
(o)
Page 18
Subject CA1 (Actuarial Risk Management) Paper 1 September 2012 Marking Schedule
(iii)
As described above, the aim of employment and income data is to better assess
risk and so charge a suitable interest rate or reject applications.
Clearly reliable data will help to determine the ability of an applicant to meet
projected repayments.
In particular, it will help to identify people who should clearly be rejected
low or no income.
As such it will reduce losses from very high-risk business.
Asking merely for a declaration may not be good enough to assess risks.
People who are desperate for credit will embellish or exaggerate income.
Given the circumstances there will be little penalty the institution could
impose for false declarations. Someone who defaults wont be able to pay
penalties or civil compensation.
Having proof e.g. payslips or bank statements will give more certainty to the
assessment process.
However, income is only one part of the equation. High income but high
outgoings will also be risky. So proof may not help in most cases since it
doesnt give the full picture. Combined with a credit check however, it could
help. But, past or even current income may not help as things can change
even over the short term. Loss of job, fluctuations for the self-employed or
new debts will make proof less relevant.
However, the main problems will be extra expenses, hassle for applicants and
delays that proof will entail.
The whole business model is based upon speed, simplicity and low cost.
Hence asking for proof would be a fundamental contradiction of the basic
philosophy for little real benefit.
Asking for proof could also assist in the detection of identity fraud.
Most candidates scored reasonably well on all parts of this question. However, the weaker
candidates did not consider fully the relevance of the principal features of the loan product
and this was required.
Page 19
EXAMINATION
15 April 2013 (am)
Enter all the candidate and examination details as requested on the front of your answer
booklet.
2.
You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3.
You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4.
5.
Attempt all seven questions, beginning your answer to each question on a separate
sheet.
6.
CA11 A2013
A general insurance company sells insurance covering several types of risks for
restaurants and bars. A ban on smoking inside all public premises is about to be
introduced by the government.
Discuss the implications for the insurance company of this ban.
[6]
Describe the requirements which should be satisfied when planning, designing and
building a model.
[8]
(i)
Outline how the risk portfolio (or risk register) approach could be used to
estimate the relative importance of various risks to this company.
[5]
(ii)
(iii)
Discuss how the company can deal with low probability high impact risks. [4]
[Total 11]
[2]
A large insurance company is reviewing the profitability of its pet insurance product.
The pet insurance pays out a fixed amount of money on the death of the insured pet
and will also pay 75% of any veterinary bills as long as the treatment provided is on
the approved list set out in the policy document. A number of exclusions and
restrictions apply.
(i)
(ii)
Outline factors which might lead to the actual profits for this product being
worse than expected.
[5]
[Total 12]
CA11 A20132
[7]
(i)
State four tools that a financial institution can use to aid the management of
risk.
[2]
(iii)
Comment on the risks involved, and suggest how they might be managed. [4]
The trustees of the pension scheme have now invested in the railway line
construction.
(iv)
Outline how the trustees would assess the risks of the pension schemes total
asset portfolio (including this railway investment).
[3]
[Total 12]
An insurance company has introduced a new term assurance product. At outset, the
policyholder selects an initial term of 10, 15, 20 or 30 years where the premium will
be level, thereafter the policy continues without further underwriting with increasing
yearly reviewable premiums. The policy ceases at age 95. The regulator requires that
the initial policy documents specify guaranteed maximum premium rates for the
yearly reviewable premiums.
(i)
Describe the sources of data that could be used to price the contract.
[4]
(ii)
[2]
(iii)
Discuss how the insurance company might set the guaranteed maximum
premium rates.
[8]
After the insurance company has been selling the product for 12 years, they have
decided to charge less than the guaranteed maximum premium rates.
(iv)
Suggest reasons why the insurance company has decided to charge rates lower
than the maximum.
[6]
[Total 20]
CA11 A20133
(i)
[13]
(ii)
Outline how an increase in government bond yields may affect the price of a
corporate bond.
[8]
An individual is planning to retire in ten years time and has a large amount of money
to invest. She is considering investing in either government bonds or corporate
bonds.
(iii)
(iv)
Explain how the individual could maximise expected returns from these
investment choices.
[6]
Discuss how the individual could mitigate unwanted risks arising from these
investments.
[4]
[Total 31]
END OF PAPER
CA11 A20134
EXAMINERS REPORT
April 2013 Examinations
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
Page 2
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
The introduction of the smoking ban will change the claim experience
Lower frequency of fire claims
lower property and contents claims
consequently lower business interruption,
and public liability claims decrease
Improvements in the environment within the insured premises should lower employer
and public health claims (eg from passive smoking). This will decrease the tail of the
business i.e. shorter tail.
The combined effect is that this should reduce the claims cost, and reduce premiums.
However, the businesses that currently have high patronage from smokers will be
disproportionately affected by the change with at least temporarily lower footfall
Lower patronage of businesses will lower their profitability resulting in increased
business failures, this will lower business volumes for the insurer, and defaults on
periodical or end of year balancing premiums (this may be offset by other businesses
attracting new customers and becoming more profitable)
Fewer policies with lower premiums is more likely to reduce profits rather than
increase.
There is also likely to be lower persistency as businesses shop around to reduce their
premium or reduce cover to reduce premiums
Claims experience may deteriorate as businesses increase the risk due to the need to
lower costs in the face of lower patronage
The mix of the business will also change as the smoking ban will affect some
businesses more than others, for example higher risk, higher premium, higher
profitability businesses may be disproportionately affected.
Failure to review premium rating factors to anticipate this change may result in a
premium rate out of line with the market, leading to either higher volumes where
premiums set lower than the market, or lower volumes where premiums set higher
than the market. Both of these likely to be adverse to profitability
Reinsurance arrangements should also be reviewed. Insurer may need lower
aggregate cover to reflect lower business volumes.
New risks will arise in relation to people smoking outside premises in designated
smoking areas; these will be hard to price
There may be disputes if fires result from people who contravene the ban will the
insurer attempt to exclude such claims?
For policies in force at the time the ban starts, claim frequencies will fall, resulting in
a windfall profit
Page 3
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
Reasonably well answered. The candidates who scored best approached this question in a
methodical way considering how the insured risks could change, the resulting impact on
claims and premiums, how and why the volume of business written may change and the
resulting impact each of these would have on the insurer. Weaker candidates spent too much
time setting out the insurance lines that might be provided, rather than discussing which ones
would be most impacted by the change or the implications for the insurers profitability.
Page 4
The model being used must be valid, rigorous enough for its purpose and
adequately documented
The model chosen should be capable of adequately reflecting the risk profile of
the financial products, schemes, contract or transactions being modelled.
At the model design stage, the methods or other models available to test the model
should be considered, so that the model built can be adequately tested.
The parameters used must allow for all those features of the business being
modelled that could significantly affect the advice being given.
The inputs to the parameter values should be appropriate to the business being
modelled and take into account any special features of the provider and the
economic and business environment in which it is operating.
The workings of the model should be easy to appreciate and communicate. This
is both the structure of the model and how the parameterisation has been
determined. The model should exhibit sensible joint behaviour of model
variables.
The outputs for the model should be capable of independent verification for
reasonableness. The results should be displayed clearly and should be
communicable to those to whom advice will be given.
The model must not be overly complex so that either the results become difficult
to interpret and communicate or the model becomes too long or expensive to run,
unless this is required by the purpose of the model. It is important to avoid the
impression that everything can be modelled.
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
Most candidates did well and scored highly, but a lot were very inefficient by describing
every possible aspect of modelling and so devoting too much time to this question. The
question did not ask for detail on the process of building and running a model. The best
answers were crisp and concise and went through the bookwork logically.
(i)
The risk portfolio (or risk register) would categorise the various risks to which
the business is exposed.
An appropriate categorisation might be based on:
Impact
Probability
Regular reviews will be needed to ensure that all the risks affecting the
business are being taken into account.
There may be new risks e.g. environmental or regulatory risks or new
competition.
Existing risks may change: their impact and/or probability.
Page 5
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
There may be risks that, although they existed, havent been allowed for in the
past. Regular reviews, possibly by different individuals, make it more likely
that these will be picked up.
The company will also want to ensure that its risk management processes are
still appropriate and working as expected; regular reviews of the risks will be
needed as part of this process.
(iii)
The risk portfolio analysis in part (i) will have identified a range of high
impact but low probability risks.
These are among the most difficult to manage; they are likely to include both
risks related to normal business activities and operational risks. It is important
to manage such risks in a measured way.
Low probability, high impact risks:
Some such risks can only be accepted as part of the consequences of the
business undertaken, and the management issue then becomes how to
determine the amount of capital that it is necessary to hold against the risk
event. The techniques of scenario analysis, stress testing and stochastic
modelling enable this to be done.
The company can decide to avoid some risks eg by not operating in some
territories
The company will have determined its own risk tolerance for example the
ability to withstand an event that might occur with a 0.5% probability within
one year. This means that the company accepts that it might be ruined by a
rare event, and has decided not to take such events into account in its risk
management.
On (i) many candidates discussed how to identify all possible risks and possible mitigation
options. Few dealt with good classification of the risks in the register by funnelling down in a
systematic way to obtain the relative importance of each risk. Part (ii) was answered fairly
well although for only 2 marks it is best to get to the point quickly. Part (iii) was generally
done very well. The better answers showed good understanding of risk tolerance and
acceptance of risks (and that insurance might not be available), and gave examples suitable
for this specific scenario.
Page 6
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
(i)
Expected premiums
Investment income
Expenses
Commissions
Expected claims (including claims inflation)
Page 7
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
(i)
Diversification
Underwriting to ensure a fair price is paid
Control measures to reduce the likelihood of a risk event occurring
Claims procedures to mitigate the consequences of a risk event that has
occurred
Management control systems
Reinsurance/securitisation/ART
(ii)
Page 8
Infrastructure investment will have high initial costs during the construction
phase.
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
These are expected to be followed by stable long term inflation linked returns
once it becomes operational.
The inflation linking may be a good match for defined benefit fund liabilities
depending on the nature of the benefit structure.
The investment will have different characteristics from equities and bonds and
so there will be a diversification benefit for the portfolio.
In most cases, the long term nature of the investments should be a good match
for defined benefit fund liabilities so the investment being illiquid should not
be a problem.
The investment may offer good potential returns given the level of risk
Tax breaks perhaps or other govt support/guarantees
Investment for the social good
Possible attraction of consortium investment compared to other forms of
infrastructure investment, eg lower fees.
(iii)
There will be an initial construction risk. This is the risk that the construction
will not be completed on time and/or on budget, and there may also be an
environmental risk at this stage.
This could be mitigated by good project management. Ideally could obtain
guarantees from the government or the construction partners before taking
on the project. If this is not possible, could take out insurance, or possibly
a mixture of the two.
A long infrastructure construction phase will carry greater risk that the
requirements are changed and additional cost incurred
There is a political risk future governments may not support the project; and
there is a regulatory risk future regulation could limit the expected returns.
These would need thorough investigation. A guarantee of future returns
should be sought
There will be operational risks after the construction is completed, and risks
that the project is not commercially successful (too few passengers/freight)
The trustees should undertake thorough research and may obtain
guarantees from other consortium members who will be responsible for
operations
There is also the risk that the fund would have no experience of management
of this type of asset.
Can take advice initially and possibly employ or train an internal expert.
Page 9
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
The scheme will model the overall portfolio using one or more of scenario
analysis, stress testing and stochastic modelling.
It will consider the correlations between the infrastructure investments and
other elements of the portfolio, and also between the assets and the schemes
liabilities.
The model will consider liquidity constraints (given the nature of the
infrastructure investment)
The trustees would then assess what combined risks might be mitigated
Part (i) was answered satisfactorily, although the question asked state so no additional
credit was awarded for explaining the various types of ART. Part (ii) was generally done
well with balanced answers ie most recognized that for only 3 marks an essay wasnt
needed but that it wasnt enough to simply state matching, diversification etc.
Varied scoring on (iii): some candidates looked at risk management from the point of
view of the consortium generally rather than the trustees of the pension scheme; better
candidates used a good structure linking mitigations to each risk. Part (iv) was generally
answered poorly, generic answers were submitted which failed to consider the impact of
the new investment with the existing portfolio.
(i)
The insurer will need to construct a pricing basis for the new term insurance
contract. The key elements will be mortality experience, initial and renewal
expenses including commission, persistency experience.
The data needs to consider the level premium period separately for the level
premium and post level term periods.
Level term period
The insurer may already have internal experience of level premium term that
can be used, covering mortality persistency and expenses
Additional data will be needed beyond this to take account of product
differences, for example in underwriting, and therefore mortality experience,
underwriting and therefore persistency, persistency experience due to product
differences, experiences due to product differences.
There may be industry experience for the product from other insurers, or from
reinsurers that can be used, either directly, or to adjust the expected experience
Page 10
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
There may be experience from other insurance markets for the new market,
again either directly from industry experience or from reinsurers that can be
used to adjust the expected experience taking account of general differences
between the countries
Post level term period
The post level term expected experience is more challenging. The mortality
and persistency experience will depend on the need for cover beyond the level
premium, which will depend on original term and age, premium rates and
duration post the level term period.
There may be industry, reinsurer data, or from other markets on the post level
term experience. Granular data will be required to understand the relationship
between mortality and persistency relative to original term, age, original
premiums, post level term premiums and duration post the level term period.
There may be data for other products that provide an indication on
policyholders behaviour for example renewable term assurance
Internal data will be needed for other pricing elements such as expenses, profit
contribution, etc
(ii)
(iii)
Page 11
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
There are two approaches from here over how the premiums can be set:
Approach 1: The average health will be expected to continue to deteriorate
for this cohort so an adjustment to the expected mortality experience will be
necessary. It will be simplest to include a single loading here that captures
both further deterioration and an allowance for the uncertainty over the
experience and a set of premium rates can then the calculated based on this
expected experience.
Approach 2: The premium rate can be calculated based on this expected
experience and a loading applied to the premiums to take account of the
uncertainty of the mortality experience including further deterioration of the
health for the continuing cohort.
These approaches should be justifiable to the regulator (including any
regulatory restrictions on level of maximum premiums).
However, there will be other policyholders that continue cover, for example:
Policyholders who want continuity of cover and have not (yet) obtained
replacement cover
Policyholders who only need continuing cover for a short period, and
therefore do not want the hassle of arranging replacement cover for a short
period
General lethargy of the policyholders so they continue their policy even if
they do not continue to need the cover or could obtain cover at a lower
premium
If some policyholders will only pay the first post level term period to provide
continuity of cover whilst they arrange replacement cover then the premium
rates will still need to reflect that mortality is likely to continue to deteriorate
after the level term period.
So there is uncertainty about the type of policyholders continuing and
therefore the state of health of continuing policyholders.
The approach to setting the maximum premiums will depend on the role the
maximum premiums will take, for example:
The importance of the maximum premium on sales volumes
The extent that the insurer has an appetite for post level term experience
risk
If the insurer is tolerant of the risk, it will be more inclined to set the
maximum at a lower level than the initial approach would suggest
If the PLT premium rates are important to the sales volume then the level of
PLT premiums on competitor products need to be taken into account.
Page 12
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
(iv)
This question was the poorest answered. It was a stretching question on an insurance type
with which we did not expect candidates to be familiar. Good exam technique can help
candidates: in each question part applying general knowledge to the specific circumstances.
In part (i), better candidates did more than just list possible data sources but went on to
describe how useful they would be and commented on the specifics of this product. Again in
part (ii) most candidates started with why regulate in general, but better candidates went
on to the specific context. Part (iii) was badly answered. Most candidates just gave general
premium rating answers, without really considering whose mortality we are interested in and
what uncertainty there is in giving a guarantee. Part (iv) was also badly answered, though in
isolation it is quite straightforward with the insurer being able to use new data in its
decisions trying to maximise profits by balancing price versus demand.
Page 13
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
(i)
The expected return on a corporate bond is the gross redemption yield minus
expected defaults
If markets are reasonably efficient, the expected return can be built up from
risk free yields.
The gross redemption yield on a corporate bond is the risk free real yield
Plus expected future inflation and an inflation risk premium
Plus a credit risk premium
Plus a liquidity/marketability premium
The risk free yield will be related to the yield available on government bonds
(although this assumes that there is negligible risk of default on government
bonds)
This is in turn related to short term interest rate expectations, which are
influenced by current economic conditions, expectations for inflation, and
general government policy
Future inflation will be based on market expectations, which will be driven by
local and global markets
The risk premium will also be higher for longer term bonds as it is more
difficult to predict inflation further into the future
The inflation risk premium will be related to the volatility of expected
inflation so will increase in times of economic uncertainty
This is also influenced by supply and demand for indexed investments;
typically demand is greater than supply which decreases the yield available as
investors are willing to pay a premium for inflation protection
The credit risk premium reflects the likelihood of default i.e. the chance of
payments not being received, and the expected loss given default
Likelihood of default will be affected by the financial strength of the
underlying company and at longer durations the longer term prospects of the
firm. This will also be affected by longer term economic conditions and the
resulting impact on all companies
Expected loss given default is influenced by both the relative ranking of the
debt on wind-up and the financial resources of the company relative to the
total debts. The higher the ranking, the lower the assessment of loss given
default, so the lower the yield. The expected loss on default will depend on
the quality and value of assets on wind-up compared with the going concern
value.
Yield will also be greater if there is high uncertainty over future expected loss:
influence both by the specifics of the borrower, for example borrower from
very cyclical industry having higher uncertainty on future profitability, and
Page 14
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
The liquidity of the overall bond market is linked to its overall size. The
larger the market the higher the liquidity
Central banks will often intervene in the government bond market, both
through new issues and buying existing bonds and this improves the
overall market liquidity. The greater liquidity in government bonds results
in lower yields.
The size of individual bond issues affects liquidity. Smaller issues have
lower trading volumes so individual trades have a greater impact on the
market. For example yields are determined by supply and demand, so the
restricted ability to sell, or only sell at a discount will result in greater
compensation being demanded in terms of yields.
The income and gains from government and corporate bonds may be subject
to different taxation arrangements and rates (usually lower for govt bonds).
Where there is a relative tax cost this will result in a higher yield on corporate
bonds relative to risk-free rates
(ii)
Page 15
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
However, the effect for individual corporate bonds may differ from the general
position
This is due to some companies having less exposure to the general economic
environment, inflation or credit risk. For example utility companies are less
exposed and have more stable performance during economic cycles. Changes
in corporate bond yield for these companies may be smaller than the original
change in gilt yield
The market price change will also be affected by the duration of the bond. A
longer term bond will show a larger change in market price than a shorter term
bond for the same change in yield
The reason for changing gilt yields may also affect the market price of the
corporate bond. Gilt rate increases intended to slow down the economy may
be seen as an intention to limit company prospects and hence the market price
of the corporate bond may be depressed further than the theoretical change
implied
Gilt rate increases intended to curb inflation may be seen as positive for the
economy and hence improve company prospects if high inflation is damaging
for a company, which could lead to the decrease in the market price of the
corporate bond being smaller than the theoretical change implied
A gilt yield change which is fully anticipated by the market may have no
impact on the price of corporate bonds
(iii)
Page 16
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
This introduces the need to make assumptions about bond prices at the time
they would need to be sold and/or reinvestment yields if they mature earlier
The marketability of bonds will also affect the risk, as if bonds cannot be sold
at retirement then funds will not be available
It is unlikely that bonds are not able to be sold, however, there is a risk that
volatile market prices will reduce the funds that can be realised, unless there is
flexibility relating to the actual retirement date
Direct investment will give access to bonds that provide a better match to the
liabilities than an investment fund, and maybe lower expenses.
Fixed bonds rather than index-linked would benefit from any inflation risk
premium
Non-domestic bonds may give higher returns.
(iv)
Page 17
Subject CA1 (Actuarial Risk Management) Paper 1 April 2013 Examiners Report
The risks to be mitigated will also depend on any other savings, as decisions
made for this investment will need to be considered as part of the overall risk
profile of her investments
Part (i) was reasonably well answered. A lot of marks were available for a question that
covered standard bookwork but asked for explanation: many candidates simply did not write
enough to score well. The best answers had a clear structure ie start from the definitions and
describe each element logically. Part (ii) was poorly answered. Most realized the two yields
would generally move together, but few got to grips with how the higher govt yield would
impact on the risk premiums in the corporate yield and hence impact the bond price. Part
(iii) was disappointingly answered. Many candidates digressed into risk mitigation (part iv)
or choosing other asset classes. Part (iv) was reasonably well answered; weaker candidates
concentrated too much on default risk and diversification.
Many candidates answered Q7 last and seemed to run out of time, so did not score as well as
they might have done on a long question where many relatively simple marks were available.
Page 18
EXAMINATION
23 September 2013 (am)
Enter all the candidate and examination details as requested on the front of your answer
booklet.
2.
You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3.
You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4.
5.
Attempt all seven questions, beginning your answer to each question on a separate
sheet.
6.
Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.
In addition to this paper you should have available the 2002 edition of the Formulae
and Tables and your own electronic calculator from the approved list.
CA11 S2013
[8]
A global company is looking to raise capital by disposing of business units that are
underperforming. An actuarial consultancy has been asked to assess which units are
underperforming and also suggest potential buyers for the units.
Describe the issues that need to be taken into account to ensure that the consultancy
does a professional job.
[10]
(i)
List four ways in which scenarios could be derived for use in a capital model.
[2]
(ii)
Outline the issues that an insurance company should consider when building a
capital model.
[9]
[Total 11]
(i)
State two expressions for the expected total return (to a domestic investor) on
an overseas asset.
[3]
A wealthy individual is considering investing in one of the following assets with the
objective of maximising return:
a property currently occupied by a local business with a current annual rental yield
of 7%
(ii)
Discuss the relative merits of each of the assets above, considering the
individuals objective.
A friend of the individual has suggested swapping cash investment in the domestic
currency for cash in a foreign currency.
CA11 S20132
[9]
(iii)
[2]
The individual has found a website that allows investors to lend money to companies
seeking funding over a one-year, three-year or five-year time horizon. Each company
decides what amount of money it requires; and then each investor can decide what
level of interest to charge to that company; the company will choose to borrow from
the investors who charge the lowest interest.
The investor has approached a financial advisor to help him decide a suitable interest
rate to charge. He has asked the advisor to provide him with a suitable list of
questions to ask each company before choosing a suitable rate.
(iv)
Set out the key questions the advisor should include in the list.
[5]
[Total 19]
A manufacturing company currently pays its employees a fixed salary each month
with no additional benefits. It has decided to introduce a benefit scheme to be
available to all employees, with the following features:
The company guarantees that the scheme will have enough cash to pay the
benefits.
(i)
(ii)
[3]
Explain why the company has decided to link the annual increase to inflation.
[3]
The directors of the company have decided to invest the assets of the scheme in
index-linked securities.
(iii)
[2]
An investment manager has suggested that the scheme could be invested in a much
wider range of investments in order to improve investment performance.
(iv)
Discuss the suitability of other investment classes for the schemes assets. [8]
(v)
CA11 S20133
[3]
[Total 19]
Describe the main methods the government could use to fund this project. [5]
The government has identified the major consequences of specific risks facing the
project as:
The government has appointed a project team and identified the major stages of the
project as: planning; construction; ongoing operation and maintenance.
As part of the risk analysis, the project team has set up a risk matrix as shown below:
Consequences
Unpopular
Costs
Delays
Planning
Stages
Construction
Ongoing
(ii)
Suggest, for each of the nine cells in the matrix, one specific risk event that
could be relevant.
[5]
(iii)
Give one distinct example from the events identified in part (ii) of how risk
mitigation could be achieved.
[4]
As part of the project, the government plans to take possession of land and homes
along the proposed routes that are currently owned by private citizens.
(iv)
Discuss why the government might not pay fair value for any land or homes it
takes possession of.
[3]
The government decides to pay a fair value for any homes or land currently owned by
private citizens.
CA11 S20134
(v)
END OF PAPER
CA11 S20135
[7]
[Total 24]
EXAMINERS REPORT
September 2013 Examinations
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
General comments on Subject CA1
This subject examines applications in practical situation of the core actuarial techniques and
concepts. To perform well in this subject requires good general business awareness and the
ability to use common sense in the situations posed, as much as learning the content of the
core reading. The candidates who perform best learn, understand and apply the principles
rather than memorising the core reading.
The examiners set questions that look for candidates to apply the principles specific to the
situation set out in the questions, having read the question carefully. Many candidates gain
few marks by writing around the subject matter of the question in a more general fashion.
Detailed specialist knowledge is not required and nor is very detailed development of
particular points.
Good candidates demonstrate that they have used the planning time well to understand the
breadth of the question and to structure their answer this is a big advantage in making
points clearly and without repetition. This also enables candidates to use the later parts of
questions to generate ideas for answers to the earlier parts.
Time management is important so that candidates give answers to all questions that are
roughly proportionate to the number of marks available.
Comments on the September 2013 papers
The general performance was slightly higher than in April 2013. Question 4 on paper 1 and
question 2 on paper 2 were on average less well answered.
The comments that follow the questions concentrate on areas where candidates could have
improved their performance. Candidates approaching the subject for the first time are
advised to use these points to aid their revision.
Page 2
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
The internal rate of return is the interest rate that gives a project an NPV of zero and a
higher IRR means a greater return/profitability from the project
To calculate the IRR, will need the most likely cashflows for capital expenditure,
running costs, revenues and termination costs. For some projects it may be difficult to
estimate these costs.
If the IRR of a project is higher than a predetermined hurdle rate then the project may
be suitable. The companys approach does not consider this hurdle rate so it is
possible that none of the projects is suitable.
The IRR approach may lead to more than one solution. This is a particular problem
when there are negative cashflows involved. This may be significant for projects with
termination expenses.
It takes no account of the size of the profit involved so the approach could lead to a
small profitable project being chosen rather than a larger project with a slightly
smaller IRR. Lots of small projects could be more costly and reduce returns.
It doesnt allow for the risk involved in a project so the method could lead to the more
risky project being taken on (if this was the reason for the higher IRR).
It assumes that the single rate is suitable over the whole term of a project and that any
income can be reinvested at the IRR. This may be unrealistic especially for longer
projects.
IRR does not include any information around when profits are actually obtained
Comparing net present values of the project may be a more suitable approach.
This method takes account of the size of the potential profit and the project with the
highest NPV would be favoured. The discount rates used can be adjusted to allow for
the risk of each project and can also vary by duration if necessary.
The payback or discounted payback period could also be calculated. A payback
period that is less than a predetermined period set by the sponsor would be considered
suitable; the lower the period the better.
The IRR method is, however, relatively simple and easy to understand. It does not
involve a decision to determine a suitable discount rate and it could be suitable for
comparing less complex projects.
The financial results cannot be considered in isolation. A subjective assessment will
also be needed to ascertain whether the projects being assessed:
Page 3
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
The risk profile over the lifetime of the contract also needs to be considered along
with the actual cashflow profile
Most candidates scored reasonably well on the bookwork but struggled on the risk aspects
and the wider issues around project selection.
Long-term care insurance is used to help provide financial security against the risk of
needing either home or nursing-home care as an elderly person, i.e. post-retirement.
The contract could pay for all the costs of care throughout the remainder of life (an
indemnity contract), or could provide a cash lump sum, or an annuity, to contribute
towards the costs of care.
The level of risk and uncertainty depends on the nature of the benefits.
(a)
The insurance company charges a premium based on the expected cost of the
benefits. This may be set a long-time in advance of when the benefits become
payable.
This timeframe increases the uncertainty of the experience, e.g. because of
investment returns, trends in claim frequencies and amounts.
The insurance company is exposed to the risk that benefits become payable
earlier than expected, that the benefits are payable for longer than expected,
and that the benefit amounts are higher than expected.
There is also the possibility that deaths are not reported. This may be due to
fraud or oversight.
The insurance company manages the claim risk though claims management. It
will set criteria for deciding whether a claim becomes payable. The claim
management process will involve qualitative assessment of the claim criteria.
The insurance company faces the risk that the claims management leads to
more claims being accepted than expected and this could lead to liquidity
issues for the insurance company.
If the contract pays for all the nursing-home costs or care costs then the
policyholder may try and claim at an earlier point because of the insurance.
If the insurance company uses reinsurance then it is exposed to the risk that
the reinsurer is unable to fulfil its obligations, or that because of failures in the
insurance companys claim management process it will not pay reinsured
claims.
There could be legal disputes around what is covered in the contract
(b)
Page 4
The policyholder is exposed to the risk that the insurance company is insolvent
when a claim is made, or becomes insolvent whilst claims continue to be in
payment.
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
The policyholder is exposed to the uncertainty that the policy does not provide
sufficient cover when a claim is made, e.g. because cover is too low or not for
the full duration of a claim.
or that the policyholder does not meet the criteria to qualify for benefits when
expected. OR the benefits might not be in the form that the policyholder
requires (e.g. a lump sum might not be what is required)
Where the contract only covers part of the cost of long-term care, then if the
policyholder is unable to pay the balance then they may be restricted in the
benefits that they are able to claim.
If the insurance company chooses the care provider the policyholder might not
get the care they would like
There will also be the risk of increasing premiums, unless these are fixed at
outset.
The policyholder may never actually need to claim on the policy
This was a poor question for many candidates; few commented on morbidity, the long term
nature of the contract, reinsurance and claims management. The policyholder perspective
was better answered.
Being a Professional
Need to be reliable in particular delivering the work that meets the global
companys requirements in terms of detail, quality and timeliness
What level of detail does the global company require
Do the timescales/budget look reasonable when does the global company want the
information
Need to recognise other stakeholders and what is in the public interest as well
Need to be competent to do the job and also know their limitations such that they can
ask for advice from other professions if required
Know your client
Need to have sufficient background about the global company and in particular each
of the business units
Conflicts of Interest
Need to consider if they advise any potential buyers for the business units
Page 5
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
It is important that there are different advisors who are independent particularly if
they are looking at the same data
Consider whether Chinese walls or other procedures could reduce the possible
conflicts and also need to ensure price sensitive information is correctly protected
Also need to consider the incentives for the consultancy i.e. is commission based on
selling the targets, leading to them suggesting the targets that could generate the most
revenue for the consultancy
The actuary advising could have grounds for stepping down from sourcing buyers for
the worst performing units (massive conflict of interest)
The task
Need to consider how each of the business units will be assessed and how possible
buyers will be presented to the global company
What will the implications of the results be and for whom will this lead to impacts
on the customers of the business units and/or job losses
What resources (and ongoing contact with the insurer) are required to assess the
business units and finding possible buyers.
What is the problem
How is the consultancy going to compare each of the business units does it have a
clear metrics in which to assess them OR will they need to ask a lot of questions to get
to the answer
Is there a particular price required to make a deal work?
Answering the questions
Need to have access to all the relevant facts of the business units (including any future
benefits)
When sufficient facts about each of the business units are not available will need to
mention to the global company when giving an assessment of each of the business
units
Also need to understand who will review the results of the analysis of the business
units will the global companies strategy review the team and will they also assess
the possible buyers
Assumptions/Methodology
Any assumptions/methodology made about the business units will need to be
determined and if any metrics that need assumptions to be made will need to be
considered
Page 6
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
Particularly an assumption around what it is meant by underperforming means and
how it will be assessed
Checking the answers
When the business units has been assessed the answers will need to be reviewed to
ensure the decisions about poor performing business units looks reasonable.
Will a range of possible business units be offered with differing sensitivity analysis
attached
Communication of the answers
Global company needs to understand the recommendations of the poor business units
and hence the results need to be clear with assumptions, areas of risk and uncertainty
need to be clearly presented
Need to consider any professional guidance and regulation
Ensure that adequate documentation is kept on the work being done
Professional Implications
Need to consider the actuarial quality framework and concerns around bringing the
profession into disrepute
The better candidates had clearly thought about some of the big issues in the question and
used this as a starting point for their answer. Very few were able to lay out their answers
well.
(i)
(ii)
Page 7
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
If the model is being purchased or built externally (e.g. by consultants) make
sure that the model used is fit for the purpose for which it is being used.
The availability of expertise and funding to build and run the model needs to
be considered. Experience is required for the initial design but the eventual
running is more a case of time and manpower.
There are data issues to consider such as the availability of past data for
example claims, premiums and expenses. But also issues with validity, is the
data from a trustworthy source and is there enough of it to be credible. The
compatibility of the data with company systems and the time periods it comes
from also need to be considered
Once the model has been decided and suitable data found then parameters for
demographic, investment, expense and product details can be estimated. The
parameters must reflect the features of the company and task in hand as well
as those of the environment in which it is operating.
The model points used should represent adequately the underlying business.
Thus, the output from the model will be a reliable & credible indicator of the
likely outcome in practice.
The model needs to allow for all the cash flows that may arise from premiums,
expenses and benefits, including those arising from the need to hold
supervisory reserves and an adequate margin of solvency. It also needs to
allow for the interaction of assets and liabilities and the potential cash flows
from any health or other options.
The model should be rigorously tested and adequately documented, to
minimise the risk of an undetected error being present or the model not
representing the products or business
The results from the model should be capable of independent verification. This
provides additional reassurance as to the accuracy and reliability of the advice
given.
The results should be readily understood by the models users and easily
communicated. If they are confusing or ambiguous, inappropriate conclusions
may be drawn, and may be difficult to review.
Whilst it is important to achieve an acceptable level of accuracy, the model
should not become overly complex. Otherwise, it may take too long to run
and be too expensive to maintain. The model also needs the balance of being
flexible.
Failure to comply with these basic principles will mean that the model may be
inappropriate and misleading as a tool in managing the business. An
inappropriate model may lead to lower profits or the need for more capital or
at worst threaten the solvency position of a life company
Page 8
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
This was surprisingly poorly answered. Many candidates simply did not give sufficient detail
on part (ii)for the marks available
(i)
If assets are fairly priced then we can equate required and expected return
Hence the following formulae will be true:
GRY = risk free + inflation risk premium + expected inflation
Rental yield + Rental Growth = rfr+ expected inflation + Property risk
premium
Dividend yield + dividend growth = rfr + expected inflation + equity risk
premium
Comparing property versus equity:
Property risk premium equity risk premium + expected dividend growth
expected rental growth
The gap between the two products in this case is 3%
This could be due to a high property risk premium versus equity risk premium
Or due to low rental growth relative to dividend growth
For the property versus government bond the following needs to be
considered:
Rental yield GRY = property risk premium inflation risk premium
expected rental growth
Therefore in this case:
5% = property risk premium inflation risk premium expected
rental growth
Page 9
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
For this to be the case the following must hold:
Government Bond
This gives the lowest return and hence is unlikely to be achieving the
demands of the investor (i.e. maximising return)
It is not a real asset and therefore will give no inflation protection
Does not usually have a capital gain and hence no benefit here either
However it is the most marketable and hence if the investor needs to sell
then it could be better than the other assets
Equity
Property
Gives the highest return of the 3 assets and therefore could be suitable in
meeting the investors aims
However it is for a local business and could be very bespoke so if the
company did badly there might not be other tenants available (that is it
might not be very marketable)
The property may have some opportunity to give some capital returns
Again this is a real asset and hence will give some inflation protection
The investor needs to consider the duration of the assets because of the need to
reinvest if duration is short, or to disinvest if duration is long (or indefinite).
The government bond will normally have a defined term, and for the property
the question may be the term of the current rental agreement.
Page 10
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
Need to consider the tax position of the assets and the investor i.e. need to
consider the net returns
The security of the asset and the possible default risk also have to be
considered in looking at the actual return of the asset
(iii)
(iv)
Page 11
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
What are the companys plans longer term
Reasonably well answered overall, especially part (iv)
(i)
On Retirement
On Sickness
On Maternity/paternity
Housing deposit
Education costs (for individual or child)
Health costs for dependants
On leaving the company (e.g. redundancy)
On death
Marriage
(ii)
(iii)
The policy will reduce the risk to the company of not being able to meet the
guarantee.
Ideally, the inflation index used for the guarantee should be the same as the
index used for the securities.
It assumes that there will be index linked stocks of the appropriate term.
The term of liabilities will not be known in advance as the possible events
vary significantly in timing.
There may need to be limits on when/ how often money can be taken out and
possibly notice needed.
There may still be a marketability risk with the index linked securities.
There is also the possibility of a default if the securities are issued by
corporations rather than the government.
Page 12
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
(iv)
This assumes all the employees are domestic. Slight adjustment to overseas
category if this is not assumed.
The following investments could be considered:
Cash on deposit
Cash would give a positive return although this may not keep up with
inflation. There may be instant access and this would be very useful for
liquidity. So holding some of the fund as cash would be useful and may mean
+ that there could be more flexibility on holding other securities.
Money markets
These are also very short term instruments and will have similar advantages to
holding cash on deposit.
Fixed interest securities
These can be issued by an industrial company, a public body or the
government of a country. A lump sum of a specified amount of will be
received at a specified future time together will a series of regular level
interest payments until redemption. There will be some uncertainty associated
with the cashflows due to credit risk particularly for corporate bonds.
These securities will not provide the inflation linked return required but it is
possible that some high quality fixed interest stocks of an appropriate term
may be held.
Ordinary shares
Shareholders of a company are entitled to a share in the companys profits.
Profits are distributed to shareholders as dividends. It is expected that
company profits will increase over time and so dividends will also be expected
to increase. In the long term, this should lead to increases in share prices in
line with increases in company profits. There will, however, be risks
associated with individual companies.
Ordinary shares could provide returns in line with inflation and may give
higher returns although there is also the risk that the return may be lower.
These may be suitable for the long term events (e.g. retirement benefit) but
probably not for any shorter term events.
Property
Property is a real asset and would be expected to provide a long term hedge
against inflation. It is, however, much less marketable and less secure than
index-linked government bonds. It will also be relatively expensive to manage.
Page 13
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
Property would be useful to provide diversification but unless the fund was
sufficiently large, this is unlikely to be practical.
Overseas bonds/shares/property
Overseas assets provide diversification from the domestic equivalents (if these
are decided to be suitable). Overseas assets may give rise to higher returns due
to the higher risk involved or due to inefficiencies in the global market. There
will, however, be currency risks.
Overseas shares could be useful but additional expertise would be required.
Collective investment schemes
These provide structures for the management of investments on a grouped
basis. They provide the opportunity for investors to achieve a wide spread of
investments and therefore to lower portfolio risk. Managers of such schemes
are likely to have management expertise which is otherwise available only to
the largest institutional investors. However there will be additional costs
associated with the investment (i.e. the cost of obtaining the expertise)
These schemes are likely to be suitable for overseas and property investment.
They may also be suitable for investment in domestic equities.
Derivatives
These may be useful to hedge against changes in prices and currencies and so
could be used as part of the overall investment strategy.
It may also be possible to hedge against movements in the inflation index.
(v)
A suitable wide range of investments should lead to higher growth and could
give diversification benefits
But need to allow for additional costs.
Over a number of years, there may be considerable savings which could be
used for the business if the company has control of any surplus.
There will, however, be increased risk and the investments may not increase in
line with inflation.
There may be capital requirements (or the government may introduce them)
requiring the company to make additional contributions if a deficit arises.
There may be restrictions on what investments can actually be made
Generally well answered, although in part (iv) many candidates did not write enough about
the specifics of the question.
Page 14
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
(i)
The government could use taxation revenue (or distribute the revenue
differently e.g. taking away funding from other areas)
This would probably mean that taxes would have to rise since the project is
huge and so current revenues may not be sufficient.
They could use a general increase in taxes or have targeted taxes that apply for
a given period (e.g. focusing on those who will benefit most from the
programme).
The government could borrow money.
Given that the project is likely to be medium to long term, the government will
probably borrow by issuing bonds.
Although the country has capital markets, these may not have the required
capacity and so they may need to target overseas investors.
They may wish to arrange repayments to tie in with proceeds i.e. when the
benefits of the programme lead to increased taxation revenue as a result of
economic growth.
As a variant, the government could borrow from private citizens.
For example they could set up national savings schemes or a national lottery
with funds allocated to the project.
Part of the funding could come from tolls or other charges on likely road
users.
However, such funds would not come through until after construction is
complete, and so may need to be used in conjunction with other methods e.g.
a source of income to repay loans.
An option could be some form of partnership with the private sector.
In effect, the private sector would be responsible for funding and completing
the project. But they would receive fees from the government over a set period
as compensation. Such fees could be fixed (maybe inflation linked) or in the
form of equity e.g. a share in toll revenues.
Again, there are domestic companies who could be involved but overseas
partners with greater expertise may be needed as well.
The government could sell some assets (e.g. gold reserves or privatisation
The government could have access to funding from other parties (e.g. IMF)
Page 15
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
(ii)
[We ask for one risk per cell more are given here but only one is needed].
Planning
Unpopular Plans may involve
destruction of significant
buildings e.g. temples.
Construction
Outside as opposed to
local workers used.
Ongoing
Roads closed for long
periods
Excess noise,
pollution or
environmental
damage.
Workers strike for
higher wages.
Inflation of raw
materials prices higher
than expected.
Ground conditions
create more work e.g.
swampy or rocks too
hard or soft
Costs
Delays
(iii)
Avoid
Problems with local authorities or planners could be avoided by having central
government dictat. That is, no appeals what we say happens with no delays.
Problems with tolls for local residents could be avoided by giving certain
groups free access e.g. local businesses or commuters.
Transfer
Wage costs could be transferred to sub-contractors. The government could pay
a fixed fee to the contractor and let them negotiate wage rates. Although this
wont deal with delays caused by strikes etc.
Likewise, costs due to bad weather or disasters could be insured. Again there
are issues with delays.
Page 16
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
Share
Problems with some areas being missed out could be shared by having
agreements between all political parties, national and local. In this way, blame
is diffused since many parties are involved in final decisions.
Problems with difficult construction conditions could be shared by giving
bonuses to contractors/workers for meeting deadlines. This will encourage
them to find solutions to problems.
Reduce
Careful planning could reduce the risks of unpopular actions e.g. destroying
local shrines or significant buildings.
Careful research into future usage and traffic volumes e.g. industrial sites or
connections to ports could ensure that roads were built to cope with actual
expected impacts so mitigating costs of repairs and maintenance.
(iv)
Page 17
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
This could become expensive or messy since sentimental (family history)
values could be high, on top of monetary values. There is also likely to be a
small number of individuals who wont move whatever the price.
The most practical option will depend on traditions surrounding the power of
the state against individual freedoms.
(v)
Discounted cashflow
The value would be determined as the value of expected future income (or
capital) proceeds from the asset.
For some properties, this could be based on the rental income that could be
charged (net of maintenance costs)
However, it is likely that very few properties would be rented and so deciding
on market rents would be difficult.
To reflect capital growth, an allowance would be needed for rental growth
this would be difficult to allow for even if current rents were available.
Although a broad-brush adjustment could be made to the discount rate used.
That is value current income at a real rate net of rental growth.
Private homes may also contain a significant utility value i.e. as a place to live
in, security for the family etc. So, a purely income based method may
understate true value to the homeowner (and what they would need to buy a
similar replacement).
Some of the land would be idle and so not generate any income. Hence it may
not be reflected in any rental-based calculation.
For farmland (or land used for other commercial activities), a value could be
placed on the future proceeds by looking at say crop yields, current
commodity prices and making an allowance for future growth.
This would be a very subjective exercise.
Need to determine a suitable discount rate to use
Market value
The value would be determined as the value of asset, were it to be sold on the
open market.
For private homes, there may well be active markets with regularly agreed sale
prices that could be used as a basis.
However, given the nature of the economy, such sales especially in rural areas
may be infrequent and so it would be difficult to find comparables.
Page 18
Subject CA1 (Actuarial Risk Management) Paper 1 Examiners Report, September 2013
In any event, prices in the relevant areas may be distorted up or down due to
the proposed project and the expected attitude of the government towards
compensation.
Hence it may be necessary to look at the prices people would have to pay to
buy similar properties in similar areas where the distortions dont apply.
It would be relatively easier to include smallholdings of land as part of the
market value irrespective of usage (again assuming an active market).
Larger land holdings could be based on market values of similar land based
on usage e.g. livestock or crops. However, sales here may be very infrequent
and each holding would be unique making the exercise very difficult.
This highlights a general problem with both methods. In that heterogeneity of
property would mean that in theory each may have to be considered
individually, requiring expensive valuation process.
However, especially in urban areas, a lot of properties could be very similar
e.g. in apartment blocks and so the difficulties caused would be dependant on
the locations under consideration.
A practical approach may be to combine properties into very broad groups and
apply common factors in terms of rents or values.
In general this question was well answered. The last two parts were more difficult for
candidates we were looking for common sense applications of possible theoretical
approaches to the specific circumstances.
Page 19
EXAMINATION
22 April 2014 (pm)
Enter all the candidate and examination details as requested on the front of your answer
booklet.
2.
You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3.
You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4.
5.
Attempt all seven questions, beginning your answer to each question on a new page.
6.
Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.
In addition to this paper you should have available the 2002 edition of the Formulae
and Tables and your own electronic calculator from the approved list.
CA11 A2014
A general insurance company is looking to enter the public liability insurance market
for the first time. It intends to specialise in offering insurance to music festivals, all of
which have firework displays to end the festival.
Describe how the actuarial cycle can be used in pricing this product.
[9]
(i)
[2]
(ii)
Set out the components of total returns for the two portfolios.
[4]
The scheme has decided to increase its holding in portfolio B with the aim of
achieving higher long term returns.
(iii)
Explain how the components in part (ii) could lead to portfolio A providing
higher returns over the next twelve months.
[5]
[Total 11]
The government of a country has changed its economic policy with the aim of
reducing its exchange rate relative to other currencies.
(i)
[7]
(ii)
Describe the expected impact on the economy from a reduction in its exchange
rate relative to other currencies.
[5]
[Total 12]
A government has invited several firms to tender for a construction contract. The
project is to build a bridge, which has already been designed, across a river near a
large city.
Government advisors have suggested that the bridge is expected to take between
seven and fourteen months to construct based on a standard workforce, depending
on working conditions. The expected outlay including material and labour is $9
million.
The government will pay a fixed contract fee, to be determined during the tender
process, if the bridge is constructed within twelve months. If the bridge is not
completed within twelve months no fee will be paid.
The government has asked for the contract to be awarded to the firm that quotes the
lowest contract fee, along with a suitable supporting project plan.
CA11 A20142
(i)
Discuss how the early completion bonus may affect the quote.
[4]
[Total 13]
An individual has changed employer. The new employer offers their employees a
choice of pension arrangements. The new employee can choose to join the defined
benefit scheme or the defined contribution scheme.
Outline the factors the individual will need to consider before making their choice.
[13]
A large life insurance company sells a range of protection and savings products.
(i)
Give possible reasons why the claims experience of this companys protection
business may differ from that of its competitors.
[5]
The companys term assurance business has lost market share in an increasingly
competitive market. The company plans to introduce a new product with significantly
fewer questions on the proposal form, with the intention of improving the market
share of the term assurance business.
(ii)
State possible ways that the underwriting risks from this new product can be
limited.
[2]
(iii)
Discuss reasons why the life insurance company may want to use reinsurance
for this new product, suggesting types of reinsurance that may be appropriate.
[9]
(iv)
CA11 A20143
[5]
[Total 21]
Suggest why the insurance company may have entered this market.
[2]
(ii)
Suggest insurance products which could be suitable to sell in this country. [2]
One year after entering this market, the company has decided to monitor its
experience.
(iii)
[4]
(iv)
[9]
(v)
Outline why the results of this analysis should be used with care.
END OF PAPER
CA11 A20144
[4]
[Total 21]
EXAMINERS REPORT
April 2014 examinations
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
General comments on Subject CA1
This subject examines applications in practical situation of the core actuarial techniques and
concepts. To perform well in this subject requires good general business awareness and the
ability to use common sense in the situations posed, as much as learning the content of the
core reading. The candidates who perform best learn, understand and apply the principles
rather than memorising the core reading.
The examiners set questions that look for candidates to apply the principles specific to the
situation set out in the questions, having read the question carefully. Many candidates gain
few marks by writing around the subject matter of the question in a more general fashion.
Detailed specialist knowledge is not required and nor is very detailed development of
particular points.
Good candidates demonstrate that they have used the planning time well to understand the
breadth of the question and to structure their answer this is a big advantage in making
points clearly and without repetition. This also enables candidates to use the later parts of
questions to generate ideas for answers to the earlier parts.
Time management is important so that candidates give answers to all questions that are
roughly proportionate to the number of marks available.
Comments on the April 2014 paper
The general performance was slightly higher than in April 2013. Question 4 was on average
less well answered.
The comments that follow the questions concentrate on areas where candidates could have
improved their performance. Candidates approaching the subject for the first time are
advised to use these points to aid their revision.
Page 2
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
Page 3
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
It will then feed this back into the model.
All parts of the cycle will need to be considered in the context of the relevant
economic and commercial environment. In addition the requirements of
professionalism must be recognised at all stages of the cycle.
If the company is not winning any business it may want to consider revising the
assumptions.
If the festivals are claiming significantly more than expected then the company will
want to review the assessment of the probability and claim amounts and adjust the
assumptions accordingly.
Changes to premium rates offered by competitors will also need to be monitored to
ensure the rates do not become uncompetitive especially if each festival is being
priced on an individual basis.
The company may find that it cannot offer a price in the market that is both
competitive and makes the required return, and hence might withdraw from the
market; equally if the company has not priced the risks sufficiently the company could
have issues of claims being way too high.
Overall, candidates scored well on this question. The better candidates got close to full
marks by bringing out a few scenario related points (e.g. new line, festivals, fireworks, etc) in
addition to being precise with the basic bookwork. Disappointingly few candidates
completed the cycle with feedback from the monitoring stage.
(i)
Inflation
Short term interest rates
Fiscal deficit
Exchange rate
Institutional cash flow
(ii)
Page 4
Initial yield
Capital value change
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
The required return on equities includes:
For any foreign investments, any currency changes will also need to be
included.
(iii)
If the stocks in the two portfolios relate to similar underlying entities, then the
expectation is for portfolio B to outperform in the long term. Because a given
entitys bonds are more secure than its equity so the equity risk premium
exceeds the credit risk premium.
But this wont hold if the inflation risk premium is very high.
Also, the underlying entities in A may be less risky than B. Especially as B
includes foreign companies equity so may be broader based.
Or there may be a particularly high liquidity premium in A.
Regardless of expectations, portfolio A will outperform over the next twelve
months if bonds perform strongly and/or equities underperform.
This could be due to random market fluctuations.
A fall in bond yields would increase the price of bonds which would increase
the return on the bond portfolio.
Lower growth expectations would reduce the value of the equities.
This could happen in a period of economic instability, or falling expectation of
inflation.
Changing investor demand (e.g. regulator insist bond better for statutory
valuation).
If over the year the expected credit risk reduced there would be an
improvement in the return on bonds.
Increased supply of equity, or a decrease in supply of bonds would also affect
returns.
Returns could also be affected by the availability of alternative asset classes.
Page 5
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
Exchange rates, a strengthening of domestic currency would reduce the return
on overseas equity.
Failure of an overseas market could reduce return on portfolio B.
May be different expenses / charges.
Generally well answered for parts (i) and (ii). However, few candidates gave good answers
for part (iii). Better candidates generated valid points by using the formula from part (ii), but
then there seemed to be little understanding about how it might be impacted by changes in
market expectations.
(i)
Page 6
Changing the level of the central bank short-term interest rate. Increasing
the rate of return relative to other economies will increase demand for the
currency due to the higher interest paid on deposits, or vice versa.
Increasing the supply of government bonds will increase demand for the
currency. A higher yield may be needed to attract international investment
flows.
Printing money will also lower the exchange rate by reducing demand.
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
Indirect ways to influence exchange rates include:
(ii)
Encouraging mining of raw materials. This will increase demand for the
national currency either directly if the raw material is priced in the national
currency, or indirectly if priced in another currency and the earnings used
to buy the national currency.
A reduction in the exchange rate relative to other currencies will have the
following effects on the local economy:
Domestically produced goods and services will reduce in price relative to
overseas produced goods and services. This will increase the relative demand
for locally produced goods and services stimulating economic activity within
the local economy. Imports will reduce as their price will increase relative to
domestically produced goods.
Exports will increase as their price will reduce relative to goods/services
produced in overseas countries, increasing economic activity. This could lead
to reduced unemployment.
Goods produced using raw materials either imported or priced in another
currency will increase in cost. This offsets the benefit of a lower exchange
rate.
Inflation will also increase due to overseas produced goods and services being
more expensive.
If short-term interest rates have been reduced to cause the reduction in the
exchange rate then this will stimulate the local economy by reducing the cost
of borrowing.
Investment from overseas is likely to increase, local companies cheaper to
takeover, goods and services produced in local economy are more competitive.
If further depreciation of the local currency is expected, then countries
dependent on funding from international capital markets may have to increase
yields to attract investment flows putting upward pressure on exchange rate.
Page 7
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
Profits remitted from overseas investments will increase (when converted into
domestic currency).
It was surprising that candidates did not score higher on part (i) given that it was a
straightforward economic question many simply didnt suggest enough points for the marks
available. On part (ii) most did quite well; a minority got the question the wrong way round
but we gave some credit for valid discussion.
(i)
Page 8
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
Need to allow for scenarios where it takes longer effectively the risk of this
happening will push up the contract fee to quote. Although in these scenarios
the firm can stop work at the point the deadline becomes unachievable so
restricting costs.
The project / contract fee would also need to be assessed relative to the
possible contract fee that may be offered by competitors. And also the
alternative uses for the capital and construction resources, the opportunity
cost.
May also consider if it is possible to build a relationship with the government
based on this contract. Particularly if there may be more projects available
which the firm may wish to tender for.
More fundamental checks would also be needed, which may determine if the
firm is able to consider taking on the work. For example, if there is sufficient
expertise and resource to take on the project with a reasonable probability of
success.
The firm must also consider if this is compatible with any other projects
currently being undertaken.
(ii)
The existence of an early completion fee increases the potential value of the
project.
This is because while it may increase the potential pay-out there are no
circumstances where it would decrease the contract fee.
For the existing analysis the increase in value would be for any scenario where
the project is completed in less than twelve months.
However, there may also be other implications of this early completion fee for
the pricing of the project.
For example, if a firm was basing projections on completing work two weeks
early, they could (potentially) quote a contract fee which is 10% lower. This
would mean that when they complete early they would get the contract fee
required.
Alternatively the structure of the project could be changed.
For example, considerable additional resource could be sourced to aim for a
six month completion date. This would considerably increase the fee from the
project which may compensate for the cost of additional resource.
Any setbacks, e.g. delays due to weather, would have a materially greater
downside if the project was structured this way.
This may also reward a firm if it was willing to commission overtime,
weekend working, or more advanced working practices.
Page 9
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
There may be additional competition due to the increased compensation.
Quite a wide range of marks on this question. Good candidates scored highly on part (i) by
tailoring their answers to the question (i.e. payback period and discounted payback period
not being relevant and the discount rate not being a huge issue due to the short project). Part
(ii) was generally less well answered, especially by candidates who had struggled with
part (i).
A defined benefit (DB) scheme is a scheme where the rules define the benefits
independently of the contributions payable, and the benefits are not directly related to
the investments of the scheme. The scheme may be funded or unfunded.
A defined contribution (DC) scheme is a scheme providing benefits where the amount
of an individual members benefits depends on the contributions paid into the scheme
in respect of that member increased by the investment return earned on those.
contributions.
Benefits available
For the DB scheme, the individual will need to know the full details of the benefits
promised. For example, how the benefit is linked to salary, how it relates to period of
employment; whether the benefit will increase with some form of inflation.
There will, however, still be a risk that there may be insufficient funds available to
provide this promised benefit and the individual may wish to investigate this. This
may be as a result of:
If the scheme belongs to a protection fund, the individual may receive benefits even in
the above circumstances. There is, however, the risk that the benefits will now be
much lower than those promised.
There is a risk that the sponsor is taken over by a third party unwilling to continue to
sponsor the benefits.
There is the further risk that the benefit promise is changed. Legislation will usually
prevent a worsening of benefits that relate to past periods, unless the beneficiary
agrees to the change. Changes can, however, be made to future promised benefits;
these could vary from a change to salary definition to the withdrawal of the defined
benefit promise.
For the DC scheme, the individual should consider what choices are available in
relation to the investment funds available; and as to the types of annuity or other
forms of drawing benefits after retirement (e.g. relating to index linking, dependants
covered, etc.).
Page 10
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
The individual will want to compare the projected benefits. There is a risk that the
level of the benefits will be lower than expected if the investment return is lower than
had been anticipated, or if any expense charges deducted are higher than was
expected. The individual may wish to investigate the likely range of net investment
returns. It is also possible that the investment return will be higher than expected.
The level of benefits will also depend on the level of annuity that could be purchased.
This will depend on the time of retirement and choices made. If the terms are worse
than had been anticipated, this will reduce the benefit. Again, it is possible that the
terms are better than anticipated leading to a higher benefit.
For both DB and DC, the individual will also want to know details of any death in
service benefits and ill health retirement arrangements.
Contributions
For both schemes, the individual will need to know how much they are expected to
contribute; and whether this is likely to change in the future; and if there is flexibility
to increase (or reduce) contributions.
For the DC scheme, they will want to know how much the employer will contribute
and whether this depends on their own contributions.
Individual circumstances
Will need to consider:
The individual will also want to know whether the decision can be reversed.
The individual will also need to consider the arrangements of each fund for
transferring in any benefits from their previous employment.
Will also need to know the arrangements for each fund if the individual leaves the
company.
A wide variation of marks on this question. Many candidates generated a reasonable number
of points from standard bookwork issues. Better candidates went on to develop the
comparison with specific examples, e.g. what risks the individual would face in either
arrangement.
Page 11
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
(i)
(ii)
(iii)
Page 12
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
This also allows the life insurance company to offer larger policies, which
they may want to do e.g. IFA channel sell larger policies, to those in higher
socio economic groups who have lower mortality.
Another reason for reinsurance is to faculatively accept policies i.e. those in
very large sum assured bands (although this would be unlikely for this
product).
Catastrophe reinsurance will protect against a large number of deaths e.g. due
to a bad strain of norovirus.
If there is a risk of accumulations then the life insurance company may want
aggregate excess of loss reinsurance.
In writing the new product, the life insurance company will need to tie up
large amounts of capital.
For example in research and development, processing the policies and setting
up reserves.
Reinsurance can help to alleviate this strain by allowing lower reserves to be
held. This will depend on the existing level of free assets. This should allow
the insurance company to write more business.
Financial reinsurance may be able to be used to increase assets.
Reinsurers will also help with staff training and if necessary may spend time
with the insurer over the launch period.
The board and shareholders will want stability of profits; excess of loss would
be suitable. And will also allow stable dividends.
(iv)
(a)
(b)
Existing relations.
Technical ability from actuaries to claims specialists.
Size of team. Is the team sufficiently large enough that they can deal
with unexpected developments?
Ability to loan staff. For instance during launch the life insurance
company may need extra underwriting help for a couple of weeks.
Page 13
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
Costs from commission to direct expenses.
Company credit rating. Would want to give the business to a reinsurer
with a higher credit rating thus reducing the risk of default.
Ability to offer financial reinsurance and on good terms. Some
reinsurers may not have sufficient reserves to offer financing deals.
Product most likely to protect solvency and profit stability against
large claims (QS not so effective).
Capacity and willingness to accept the business. If a reinsurer already
has high exposure to a particular market they may not offer such good
terms, if at all.
Part (i) was answered well by most candidates. Part (ii) was often not so well-answered. On
part (iii) most candidates used the bookwork on reinsurance to pick up a reasonable number
of marks but many didnt answer at sufficient length to score very highly. Part (iv) was often
poorly answered with candidates not discussing how to model the costs and benefits of
reinsurance.
(i)
(ii)
For example:
Term life insurance or funeral products
Health insurance
Disability insurance
Property insurance
Livestock or crop insurance
(iii)
The company will monitor its experience as part of the actuarial control cycle
to check whether the method and assumptions adopted for financing the
benefits are appropriate; both for premium setting and reserving.
This is new business in a new country so there will have been limited data to
base the assumptions on at the outset.
Information for management will be needed. The company will need to know
whether the claims and expenses have been as expected. It will also need to
know if the volume and mix of business has been as expected.
This information will be needed as soon as possible. If the assumptions were
not appropriate, the company will need to consider what changes could be
made in order to achieve the desired objectives.
Page 14
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
(iv)
(v)
Page 15
Subject CA1, Paper One (Actuarial Risk Management) April 2014 Examiners Report
Given that this is new business in a country without a developed insurance
market this is unlikely to be the case. As the company has only been writing
business for one year, the period under investigation is unlikely to be typical
of the future. There is unlikely to be sufficient data to give an indication of
future trends. This year may have been affected by abnormal events or by
significant random fluctuations.
The volume/mix of business may not represent likely future experience
either unusually low because of lack of customer awareness/confidence in
insurance; or unusually high because of significant demand previously
unsatisfied.
The withdrawal experience may not be typical. There may have been a poor
understanding of the products initially which may have led to a high
withdrawal rate.
It may have been difficult to access the data needed for monitoring. The data
that has been obtained may not be accurate.
It may not have been possible to split the analysis into sufficiently
homogeneous groups.
The individuals to whom the investigation related may not be typical of the
individuals whose benefits will be affected by future experience.
Parts (i) and (ii) were both generally well answered. On part (iii) better candidates tied
the bookwork back to the question. On part (iv) many candidates wasted time by
answering why you would do an experience analysis instead of how. Part (v) was
generally reasonably well answered.
Page 16
EXAMINATION
22 September 2014 (pm)
Enter all the candidate and examination details as requested on the front of your answer
booklet.
2.
You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3.
You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4.
5.
Attempt all seven questions, beginning your answer to each question on a new page.
6.
CA11 S2014
Describe with examples how an insurance company can manage expense risk.
A medium sized company, is considering moving its manufacturing facilities from its
base in a European country to a less developed country outside of Europe. The
company currently sells products only within Europe.
[6]
Identify the major risks that this move would present to the company, together with
ways that these risks might be mitigated.
[10]
(i)
[3]
In a country, household energy bills are typically formed of a fixed charge of around
20.00 a month plus a cost of around 1.00 per unit of power used. The cost of a unit
of power used has risen significantly in recent years, having been around 0.70 per
unit three years ago.
A general insurance company is considering introducing a new product. The
proposed product will guarantee that the cost of a unit of power used for a household
will not exceed 1.05 per unit for a period of five years (i.e. prices are capped).
(ii)
Outline how the risk management process can be used to aid the design of this
new product.
[8]
[Total 11]
(i)
Describe the role of the State, employers and individuals in benefit provision.
[6]
(ii)
State three contingent events that life insurance protection is needed for and
suggest possible products for each event.
[3]
(iii)
Comment on the main differences between group and individual insurance. [2]
(iv)
Explain why the volume of different types of insurance products sold in two
neighbouring countries with similar populations and economic wealth could
be very different.
[5]
[Total 16]
CA11 S20142
State two forms of insurance she may need in her new self-employed status.
[1]
Discuss aspects that the insurance company will need to consider when
planning this project.
[10]
(iii)
Describe two scenarios in which Susan might claim under this product.
[2]
(iv)
Set out the information about Susans work that the insurance company will
require if she applies for this product.
[4]
[Total 17]
(i)
[2]
In a developed economy, the Reference Interest Rate is calculated each week based on
information provided by the four largest retail banks over the previous seven days.
By law, the interest offered on any personal savings account, or charged on any
personal loan or mortgage, must be equal to the Reference Interest Rate plus a fixed
amount specified at the outset of the contract. While not a legal requirement, the
interest charged on most business loans is also set in the same way.
There have recently been concerns that information provided by the four largest banks
may have been falsified resulting in the Reference Interest Rate being declared at the
wrong level.
(ii)
(iii)
Discuss reasons why the Reference Interest Rate may, or may not, be
regulated.
[5]
[4]
A politician has suggested that the Reference Interest Rate should be abolished. She
thinks it should be replaced by an alternative interest rate set annually by an
independent government agency.
(iv)
CA11 S20143
[7]
[Total 18]
A large insurance company offers a with profits product with the following features:
On withdrawal before the end of the 10 year term, the surrender value is the
accumulated fund value with bonuses. There are no withdrawal penalties.
At the end of 10 years, the maturity value is the higher of the accumulated fund
value with bonuses or the original investment accumulated at 3% a year.
The stated aim is to provide bonuses such that the total investment return will be
between 1% and 3% a year in excess of the return on an established domestic
corporate bond index over the term of 10 years.
The insurance company invests the premiums in corporate bonds, held equally in the
domestic market and emerging foreign markets. It hopes that the higher expected
return from emerging foreign markets will help to fund the bonuses required to meet
the products stated aim.
(i)
Explain why the valuation for internal management purposes may use different
assumptions to those used for a statutory solvency valuation.
[4]
(ii)
[7]
The insurance company intends to distribute the majority of its surplus as an annual
bonus with an additional terminal bonus for investors who keep their investments for
the full 10 year term. It expects that for a typical policyholder investing in the
product for the full 10 year term approximately 80% of the distributed surplus will be
from annual bonuses and 20% from terminal bonuses.
Returns on the domestic corporate bond index have consistently been between 5% and
7% a year. There have been recent concerns regarding the domestic economy and
some analysts are suggesting that returns in the medium term may be lower, possibly
between 2% and 5% a year.
(iii)
Discuss the impact this revised economic outlook may have on the bonus
distribution policy.
[5]
One of the insurance companys directors has suggested that, with the possibility of
falling bond yields, the proportion of surplus distributed by annual bonuses should
reduce to 50%. He has also suggested introducing withdrawal penalties.
(iv)
END OF PAPER
CA11 S20144
[6]
[Total 22]
EXAMINERS REPORT
September 2014 examinations
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
Page 2
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
regularly monitoring actual expenses against the budgeted expenses and checking
to see whether they are higher than expected
regularly monitoring new business; e.g. cost of sales versus volume of new
business/expense allowances for new business
regularly monitoring withdrawal rates; for example checking that overheads
remain proportional to the volume of in-force business
implementing cost control measures in the event of expenses exceeding budget.
For example in a declining operation sub-letting unused office space
increasing operational efficiencies, for example increasing automation to reduce
the cost of more expensive manual tasks
having a robust business planning process for future periods, for example ensuring
in future periods expense levels are proportional to the projected volume of inforce business and new business
contracting out administration to a third party who assumes the expense risk
implementing robust operational procedures with monitoring of effectiveness e.g.
to reduce the risk of additional costs being incurred rectifying errors
For a long term contract, some of the charges in the contract may be reviewable and
hence if expenses are different these might be able to come through in the charges.
[6]
Generally disappointing answers. Many candidates spent too much time describing how to
analyse expenses rather than giving examples of how to actually manage the risk.
Page 3
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
making the change, for example if the product design is planned to be maintained in
the home country, this can be emphasised and the made in country de-emphasised.
Language/Communication This is the risk arising from language differences
resulting in mis-communication. This risk can be reduce by employing managers
with experience in dealing with both countries and fluent in the languages.
Quality control The company will need to ensure that the quality of the product is
maintained. This risk can be managed through a combination of quality control
procedure at the manufacturing plant, together with quality control sampling of
imported goods. This can be combined with post sales monitoring of warranty claims.
Penalties may be included in the contract to incentivise quality control.
Time risk This is the risk arising from the manufacturing facility operating in a
different time zone and at a large distance from the European country. Part of the
time risk can be managed by employing managers locally in the manufacturing
country and robust/sophisticated logistic controls reduce the risk of delays in
importing products for sale.
Legal risk The legal risk in the contracts between company and manufacturing can
be managed by using legal firms with specialism of both the home country and the
overseas manufacturing base.
Risk of adverse political developments Political risk is inherent in both the home
country and the overseas country. This risk can be managed by detailed research of
the country. Using a manufacturing base in a country with an economy geared to
manufacturing for export will reduce the risk. The risk can also be reduced by using
several manufacturing bases in different countries.
Intellectual property This is the risk that the companys intellectual property e.g.
patents are abused. This risk can be reduced by only using manufacturing bases
where the law secures intellectual property.
Supply chain risks The risk of a breakdown in the manufacturing supply chain; this
is greatest if there is a dependency on a sole supplier. Also the infrastructure of the
overseas company may not be of the required standard. The risk can be reduced by
using several suppliers/manufacturers to remove dependence on a single company.
Project Risk there could be a risk that the benefits of moving to another country
(increased profits due to reduced costs) may not be as fast as anticipated (or at all).
This risk can be reduced by good project management and/or research
There is the risk of industrial action due to loss of jobs in the home country by
transferring manufacturing abroad. This risk could be reduced if the change is linked
to expansion so that in the initial stages the home manufacturing base is unaffected by
the change. Further changes are delayed until the alternative manufacturing facilities
are operational reducing exposure to industrial action in the home country.
Page 4
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
Taxation Rules e.g. penal duties on distributing outside the proposed country
[10]
This was satisfactorily answered by most, the better candidates commented on risks specific
to the circumstances.
(i)
Market
Credit
Business
Liquidity
Operational
External
[3]
(ii)
When designing the new product, the insurance company will need to assess
the risks faced.
They will need to start by identification of the risks.
The main risk will be that prices rise above the level of the price cap.
If they do rise, they are likely to affect all policyholders.
This will be affected by (e.g.) the price of wholesale energy, distributions
costs and taxes (and/or subsidies from the government). The taxes may
include green taxes which may be influenced by political factors.
Other risks may include operational risks; e.g. risk that policies are mis-sold or
administrative records for policies are incorrect
The company will need to measure these risks, estimating the probability of
each risk occurring and its likely severity. This will give the basis for
evaluating and selecting methods of risk control.
The company will then need to consider how the risks could be financed. They
will need to determine the likely cost of each risk and ensure that adequate
financial resources are available to cover the risk.
Risk control measures will then need to be considered. These will aim to
mitigate the risks or the consequences of the risks by:
Page 5
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
It can design the policy to reduce the financial consequences. The level of the
cap will be very important here, and it may be necessary to consider changing
the level of the price cap.
It could also limit the maximum level of protection, for example only
guaranteeing the price of 1.05 for price rises up to 1.30 (at which point there
is no further protection); or limit the period for which the cap applies; but
these may limit the attraction of the policy.
Reinsurance could also be used.
The general insurance company could consider partnering with an energy
supplier to share risks and improve marketability for both the supplier and the
insurance product.
Can also design the policy to reduce moral hazard risk e.g. base cover on
cheapest supplier to avoid disincentive to shop around
[8]
[Total 11]
Most candidates scored most of the marks for part (i). Part (ii) was generally well answered,
though weaker candidates didnt relate their answers to the scenario or digressed away from
the product design issues.
(i)
State
Direct provision e.g. a national health service or state funded pension scheme
Financed by the collection of taxes and or levies on companies/employers
Encouraging self provision e.g. a refund of taxes if you opt out and set up your
own pension fund (or employer provision)
Education about the importance of insurance products
Regulation of other providers of financial services
Employers
Group benefit schemes, e.g. pension or death in service benefits
Cheaper provision through pooling of expenses and expertise
May be compulsory as part of benefits package
Facilitating employees to make provision e.g. contribution by payroll
deduction
Individuals
Direct purchase of required products, e.g. savings products to pay off a
mortgage
Taking up optional benefits offered by employer
Taking part in group schemes e.g. unions/clubs
Maybe provision via financial intermediaries e.g. brokers
Provision for dependants/children as required
Page 6
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
Provision for themselves, especially if the state benefits are not sufficient to
meet the individuals standard of living requirements
[6]
(ii)
(iii)
(iv)
Page 7
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
While economic wealth may be similar the actual economic conditions in the
2 countries may be different
There may a general lack of confidence in the financial system (maybe due to
a failure of a particular provider)
[5]
[Total 16]
Generally well answered, although in part (iii) many candidates didnt suggest the key
differences. In part (iv) many candidates commented on possible legislative/regulatory
differences, but not on wider aspects.
(i)
Income protection
Public liability
[1]
(ii)
Page 8
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
Legal issues: cause and responsibility for accidents will need defining as
clearly as possible there are likely to be many grey areas so where possible
policy is needed; other issues such as client confidentiality and non-disclosure
need clarification
Admin Systems: this must be established at the start of the project and is
usually immovable.
Financing Policy: the company is well capitalised and therefore unlikely to
need additional funds for the new product
Key milestones: timescales, completion of steps e.g. Scenario testing, new
business volumes.
Structured breakdown: need to complete this including key phases such as
market research and pricing
[10]
(iii)
(iv)
Page 9
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
(i)
(ii)
Page 10
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
effect on the profits of the banks, and hence any incentive to falsify the
Reference Interest Rate
Business loans will impact on the ability of businesses to grow so the
government may wish to regulate. As this will have further implications for
future tax receipts as well as overall economic prospects
[5]
(iii)
The banks contributing data to the calculation: which banks are allowed to
contribute (including how many)
Whether all banks are treated equally or if, for example, the largest bank has a
greater weight
If a bank can lose, or gain, its contributing status
What data is used: whether from completed transactions or other market
pricing material; how recent the data must be, i.e. over what period is the data
valid
If there is any specific pricing applicable, for example bid / offer prices
The calculation method, for example averaging method used, or method by
which it is expressed, e.g. interest rate / discount rate or whether compounded
monthly or annually
Disclosure required: what underlying data must be made available; how soon
the index must be published
What mechanisms are in place if an error is observed, e.g. is any correction to
historic rates permitted
[4]
(iv)
Page 11
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
Disclosure requirements
Page 12
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
(i)
(ii)
The first step in distributing any surplus will be to identify the maximum
surplus available for distribution
For the product the minimum / guaranteed return is 3% each year; so if
investment return in a given year is higher than 3%, and there is no shortfall to
correct, there will be a surplus, and a choice of whether to distribute this
surplus can be made
If the company is a mutual all surplus will be allocated to policy holders
For other companies there will be shareholders and a decision will be needed
as to what proportion of surplus will go to shareholders or policy holders. That
is shareholders will want to make a return on investment
Page 13
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
(iii)
If returns are less than 3% a year then the guarantee will bite
Recent domestic corporate bond returns have been materially above this level
meaning the guarantee was unlikely to bite
The recent concerns mean that returns may be less than this level in the
medium term which will increase the value of the guarantee
Need to consider how long medium term is, if medium term is less than ten
years then there may be limited impact, as excess returns in other years may
mean overall return will continue to be in excess of the guarantee
The impact would vary for business already written, for example with only
two years left till maturity the downturn may not impact on these policies
But the impact may be more significant for business currently being written
This could lead to a number of actions:
Page 14
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
The level of the bonuses (both reversionary and terminal) may need to be
reduced to compensate for the medium term
Would need to consider if these changes are possible: for example, would they
be out of line with policyholder expectations, or even in breach of any rules
set out in the product documentation?
In considering any changes it will be important to consider the overall impact
on policy marketability, and how the product will compare to any direct
competitors
If the market is competitive it may not be possible to introduce changes
without altering the potential business volume
An alternative to changing the product would be closing to new business and
setting up a new product (or bonus series) with the desired risk profile
Bonus pattern
Reducing the amount of surplus distributed by annual bonuses is effectively
deferring profit distribution
By deferring distribution this would introduce more flexibility
And if changes to conditions make it less likely that a high level of bonuses
are possible, reducing the distribution from annual bonuses would help build a
contingency against weakening conditions
May wish to consider current level of cross subsidy between products
Implementing a change unilaterally with immediate effect could overcompensate those maturing in the next couple of years they would have
Page 15
Subject CA1 Actuarial Risk Management, Paper 1 September 2014 Examiners Report
Page 16