A311

Question 1

Define anti-selection.

Answer 1

Anti-selection occurs when individuals have more information about their own risk levels than the insurer does.

Question 2

Define underwriting.

Answer 2

Underwriting assesses the risk of applicants through medical exams, questionnaires, and other information to set appropriate premiums or deny coverage.

Question 3

Define excess.

Answer 3

Excess refers to the amount the policyholder must pay out the pocket before the insurer pays for a claim.

Question 4

Define new business strain.

Answer 4

New business strain refers to the initial financial strain a life insurance company experiences when it writes new policies, due to the upfront costs exceeding the initial premiums received.

Question 5

Describe the roles which banks play within the financial services industry.

Answer 5

Provide liquidity to the financial system (have funds to lend)

Play a role as financial intermediaries (facilitate transfer between depositors and borrowers)

Provider of economic and business information (barometer for global financial health and business trends)

Have responsibility for monetary policy, exchange controls, printing money and as a lender of last resort

Question 6

Reasons for monitoring the experience.

Answer 6

update method and assumptions so that they are more relevant to future experience

monitor any trends in experience, particularly adverse trends, so as to take corrective action

provide management (key-stakeholders) information

Question 7

Reasons for analysing surplus. (DIVERGENCE)

Answer 7

Divergence of the actual verses expected (financial effect / significance of)

Information for management and for accounts

Variance of whole is equal to the sum of the variance from the individual sources

Experience monitoring to feedback into ACC

Reconcile values for successive years

Group into one-off / recurring sources of surplus

Executive remuneration schemes (data for)

New business strain (show effects of)

Check on valuation assumptions and calculations

Extra check on valuation data and processes

Question 8

Why financial providers need capital. (REG CUSHION)

Answer 8

Regulatory requirement to demonstrate solvency

Expenses of launching a new product / starting a new operation

Guarantees can be offered

Cashflow timing management

Unexpected events cushion, e.g. adverse experience

Smooth profit

Help to demonstrate financial strength

Investment freedom to mismatch in pursuit of higher returns

Opportunities e.g. mergers and acquisitions

New business strain financing

Question 9

Reasons why disclosure is important in a benefit scheme. (SIMMERS)

Answer 9

Sponsor is aware of the financial significance of the benefits

Informed decisions can be made

Mis-selling is avoided

Manages the expectations of members

Encourages take-up

Regulatory requirement

Security of scheme improved as sponsor / trustee made more accountable

Question 10

Common aims of accounting standards (in relation to benefit scheme disclosures). (CARD)

Answer 10

Consistency in accounting treatment from year to year

Avoiding distortions resulting from contribution fluctuations

Recognising the realistic costs of accruing benefits

Disclosure of important information

Question 11

Benefit scheme information to be disclosed in accounts. (DIM CLAIMS)

Answer 11

Directors’ benefit costs

Investment return over the year

Membership movements

Change in surplus / deficit over the year

Liabilities accruing over year

Assumptions

Increase in past service liabilities

Method

Surplus / deficit

Question 12

When should information be disclosed to benefit scheme members? (PRICE)

Answer 12

Payment commencement

Request

Intervals

Combination

Entry

Question 13

What information should be disclosed to benefit scheme members? (SCRIBE)

Answer 13

Strategy for investment

Contribution obligations

Risks involved

Insolvency entitlement

Benefit entitlements

Expense charges

Question 14

What additional reports generally accompany accounts? (BRISK)

Answer 14

Board independence & governance

Risk appetite, exposure & management

Investment strategy & performance

Strategic objectives (progress towards)

Key objectives (performance against)

Remuneration report

Chairperson & CEO statement

Question 15

What are some of the reasons for calculating provisions, for a benefit scheme? (BAD MEDICS)

Answer 15

Benefit improvements for a benefit scheme

Accounts and reports - published / internal

Discontinuance / surrender benefits

Mergers and acquisitions

Excess of assets over liabilities and so whether discretionary benefits can be awarded

Disclosure information for beneficiaries

Investment strategy

Contribution / premium setting

Supervisory solvency reports

Question 16

Give a brief outline of the stages a monitoring investigation typically follows. (Exam Question - DIU)

Answer 16

Monitoring investigations typically involve the following stages:

The division of data into suitable groups that are homogeneous by risk, one needs to consider:
- the volume of data in each cell (its credibility)
- the risk factors for the investigation (age, gender)
- occurred changes that will reduce the relevance of old data

Identification of any past trends, cycles and anomalies and random variation in the past data

Using the results to revise models and assumptions used, one needs to consider:
- the purpose
- need for accuracy and margins for prudence
- allowance for future trends
- likely differences in future experience from past experience

Question 17

For what reasons would a financial provider conduct an expense analysis? (DAA FUC)

Answer 17

Determining expense loadings and calculating provisions
Analysing sources of surplus (A/E)
Analysing areas of inefficiency within an organisation

Financial planning (expense budgeting)
Understanding the profitability of a particular product
Cashflow management (ensure liquid funds are available)

Question 18

Provide a definition for capital management.

Answer 18

Capital management involves ensuring that a provider has sufficient solvency and liquidity to enable both its existing liabilities and future growth aspirations to be met in all reasonably foreseeable circumstances. It often involves maximising the reported profits of a provider.

Question 19

Describe financial reinsurance.

Answer 19

Financial reinsurance involves transferring risk to a reinsurer in a way that is primarily motivated by financial management objectives, such as improving the ceding company’s financial ratios or solvency position, rather than purely for risk transfer.

Generally the main aim of financial reinsurance is to exploit some form of regulatory arbitrage in order to manage the capital, solvency or tax position of a provider more efficiently. It frequently relies on the regulatory, solvency or tax position of a reinsurer, which may be based in a overseas state, being different from that of the provider. This is done in the form of a reinsurance contract between the reinsured and the reinsurer.

Question 20

Define securitisation.

Answer 20

Securitisation involves converting an illiquid asset into tradeable instruments. In our context the primary motivations are often to achieve regulatory or accounting (off balance sheet) treatment.

Question 21

Define subordinated debt.

Answer 21

The main aim of subordinated debt is to generate additional capital that improves the free capital position of the provider, as the debt does not need to be included as a liability in the assessment of solvency.

Repayment of the subordinate debt can only be made if solvency capital requirements continue to be met.

Question 22

Define a derivative.

Answer 22

Derivative is a financial instrument with a value dependent on the value of some underlying asset.

An example of when a derivative contract may be useful is when a provider may be concerned about the impact of a value in its equity portfolio. One could enter into a contract to prevent the portfolio from falling below a certain level.

Question 23

What are liquidity facilities?

Answer 23

Liquidity facilities are typically provided by banks and can be used to provide short-term financing for companies facing rapid growth (new business strain)

Question 24

What is contingent capital?

Answer 24

Contingent capital is generally provided by a bank, whose aim is of protecting the base of an insurance company. Under such an arrangement capital will be provided as it was required following a deterioration of experience.

Question 25

What is senior unsecured financing?

Answer 25

Senior unsecured financing directly for an insurance company would not have capital benefits as the loan would be treated as a liability on the company's balance sheet. Though at a group level this may be viable (capital can be moved around within a group of companies).

Question 26

How could equity capital be financed for a company. (PIE)

Answer 26

Parent company Issuing new shares the market Existing shareholders via a rights issue

Question 27

How could an organisation improve their capital position using internal sources of capital.

Answer 27

Retain capital Change Assets Merge funds Weaken the valuation basis Defer the distribution of surplus

Question 28

Why do individuals need capital? (CS)

Answer 28

Cushion against unexpected events Save for the future

Question 29

Why do companies need capital? (FFF FS)

Answer 29

Financial consequences of adverse events Financial expansion Finance stock and work in progress Fluctuating trade volumes Start-up capital to hire staff, obtain premises, purchase equipment

Question 30

Define economic capital

Answer 30

Economic capital is the amount of capital that a provider determines is appropriate to hold given its assets, its liabilities, and its business objectives. It is an internal, rather than a regulatory capital assessment and is usually measured given a degree of confidence and over a given time horizon.

Question 31

Define MCR.

Answer 31

Minimum Capital Requirement, which is the threshold at which a company will no longer be permitted to trade.

Question 32

Define SCR.

Answer 32

Solvency Capital Requirement, which is target level of capital below which companies may need to discuss remedies with their regulators. SCR is the total assets required to be held in excess of the provisions calculated on a best estimate basis.

Question 33

What are the three pillars of Solvency II

Answer 33

Quantification of risk exposures and capital requirements Supervisory regime Disclosure requirements

Question 34

What factors are economic capital in an ORSA assessment typically determined on (CBD R)?

Answer 34

Correlation of risks Business objectives of the provider Desired level of overall credit deterioration that it wishes to be able to withstand Risk profile of the individual assets and liabilities in its portfolio

Question 35

What is the difference between trading profit and investment profit?

Answer 35

Trading profit is the total of the premiums and investment income on the provisions for future liabilities, less claims, expenses, tax and the net increase in any provisions for future liabilities. Investment profit is the investment return, less tax and investment expenses, earned on the part of the assets not required for the provisions for future liabilities.

Question 36

List some of the possible sources of surplus for a life insurance company.

Answer 36

Mortality Morbidity Claim frequency Claim amounts Withdrawal / Lapses Investment income Expenses Commission Salary growth Inflation Taxation Premium New business levels Strategic events (counterparty failure, business restructure) Change in valuation method or assumption

Question 37

List the factors which will affect the amount of surplus to distribute for a life insurance company.

Answer 37

Provision of capital Margins for future adverse experience Business objectives of the company Policyholder expectations Shareholder expectations Stakeholder expectations

Question 38

List the ways which a benefit scheme can reduce its surplus.

Answer 38

increase the value of the benefits and hence the value of the liabilities Reduce future contributions for a period of time, so that the surplus decreases gradually as additional liabilities accrue Transfer all or part of the excess assets from the scheme (to beneficiaries or the sponsor)

Question 39

List the factors influencing the decision about the application of surplus or deficit for a benefit scheme. (LSD TRISS)

Answer 39

Legislation Scheme rules Discretion of the sponsor or fund managers Tax treatment Risk of exposure of the various parties Industrial relations Speed of corrective action Source of surplus

Question 40

List the factors affecting the choice of basis and valuation method chosen.

Answer 40

Reason for (or purpose of) the valuation Needs of the client Regulation and legislation Nature of the assets

Question 41

What are the differences between a going concern basis and a break-up basis

Answer 41

The going concern basis is based on the assumption that the insurer will continue to trade as normal for the long-term future. The break-up basis assumes that the writing of new business ceases and cover on current policies are terminated.

Question 42

What are the two definitions of fair value?

Answer 42

1. the amount for which an asset could be exchanged or a liability settled between knowledgeable, willing parties in an arm's length transaction 2. the amount that the enterprise would have to pay a third party to take over the liability

Question 43

How can sensitivity analysis be used in valuing liabilities?

Answer 43

help to determine the extent of the margins needed in assumptions, to allow for future adverse experience determining the extent of any global provisions required

Question 44

Define global provisions and what their purpose.

Answer 44

Global provisions is an additional provision which looks at the provider's liabilities in aggregate. Purpose: Acts as an additional protection for solvency Cover risks, both financial and non-financial, that cannot be attributed to individual contracts Reflect the degree of mismatching of assets and liabilities

Question 45

What are some of the different methods of allowing for risk in cashflows?

Answer 45

Build a margin into each assumption Apply an overall contingency loading by increasing the liability value by a certain percentage Adjust the discount rate to reflect the risk in the project or liability

Question 46

List some of the main accounting concepts commonly used when drawing up financial statements

Answer 46

Cost: assets are recorded at their original purchase cost and not at market value Money Measurement: only transactions that can be measured in monetary terms are recorded in the accounting records Going concern: assumes that the business will continue to operate for the foreseeable future and not be liquidated Business entity: the business is treated as a seperate entity from its owners Accrual: revenue and expenses are recorded when they are earned or incurred and not when the actual monies are recieved or paid Prudence: assets and income should not be overstated and liabilities and expenses should not be understated Consistency: the manner in which the accounting statements are produced should be in similar between periods

Question 47

What are the benefits of a good risk management process? (SAVIOURS)

Answer 47

Strategic decision making improved Avoid surprises Volatility of profits reduced Improved profits via capital efficiency Opportunities exploited for profit Understand interdependencies / aggregation React quickly to emerging risks Stakeholders given confidence

Question 48

When is inappropriate advice given (CRIMES)

Answer 48

Complicated products Rubbish adviser Integrity of advisor lacking Model or parameters unsuitable Errors in data relating to beneficiaries State encouraged but inappropriate actions

Question 49

List factors which relate to the importance of risk reporting. (FRAUD CRIME)

Answer 49

Financing (appropriate price, reserves, capital requirements) Rating agencies Attractiveness to investors Understand better (risks and their financial impact) Determine appropriate control systems Changes over time Regulator Interactions Monitor effectiveness of controls Emerging risk identification

Question 50

List the ways which you can respond to a risk.

Answer 50

Transfer Partially transfer Retain Reduce Ignore

Question 51

List the ways which you would evaluate risk mitigation options (FIRM)

Answer 51

Feasibility and cost Impact on frequency/severity/expected value Resulting secondary risks Mitigation required in response to secondary risks

Question 52

List the reasons for the use of reinsurance (SAD LIFE)

Answer 52

Smooth results Avoid large losses Diversification Limit exposure to risk (single event, accumulation) Increase capacity to take accept risk Financial assistance Expertise

Question 53

List the reasons for using ART (Alternate risk transfer mechanisms) (DESCARTES)

Answer 53

Diversification Exploits risks as an opportunity Solvency improves / Source of capital Cheaper cover than reinsurance Available when reinsurance may not be Results smoothed Tax advantages Efficient risk management tool Security of payments improved

Question 54

List the reasons for underwriting. (SAFAIR)

Answer 54

Suitable special terms Avoids anti-selection Financial underwriting against over-insurance Actual experience inline with that assumed in pricing Risk classification / rated fairly Identify substandard risks

Question 55

Define systematic risk.

Answer 55

This is a risk which affects an entire market or system due to its interconnectedness

Question 56

Define diversifiable risk.

Answer 56

This is a risk which arise from an individual component of a financial market or system

Question 57

Define enterprise risk management. (risks being managed at a group level)

Answer 57

This is a risk management function which assesses risk across all business units looking at the enterprise as a whole rather than in isolation. This approach allows for diversification, pooling of risk, economies of scale and taking advantage of risk opportunities.

Question 58

Define managing risk at a business unit level.

Answer 58

Where the parent company determines the overall risk appetite and divides this up among the different business units. The business unit management team manages the risks of the business within the risk appetite they have been allocated. No allowance for benefits of diversification and pooling of risks, so not making the best use of its capital)

Question 59

A common risk management model in financial services is to form three lines of defense, what are the three lines of defense?

Answer 59

First line of defense: line management staff in the business units, they are accountable for measuring and managing risk in individual business units on a daily basis. Second line of defense: CRO, risk management team and the compliance team, they are accountable for establishing risk and compliance programs and policies, supporting and monitoring the line management and reporting to the board. Third line of defense: the board and audit function, they are accountable for effective governance of the risk management process, setting risk management strategy, approving policies and ensuring that ERM is effective.

Question 60

Define market risk

Answer 60

risks related to changes in investment market values / features correlated with investment market (interest, inflation, asset value changes, asset-liability matching)

Question 61

Define credit risk

Answer 61

risk of failure of third parties to meet obligations (debtors, loanee, counterparty risk, credit rating)

Question 62

Define liquidity risk

Answer 62

risk that the individual or company, although solvent, does not have sufficient financial resources to enable it to meet its obligations as they fall due (liquidity defined differently for providers and the market)

Question 63

Define business risk

Answer 63

risks that are specific to the business undertaken (underwriting, insurance, exposure, financing)

Question 64

Define operational risk

Answer 64

risk of losses arising from inadequate or failed internal processes, people and systems

Question 65

Define external risk

Answer 65

risk arising from uncontrollable factor which are usually non-financial (climate change, pollution, technology)

Question 66

Define marketability.

Answer 66

marketability is how easy it is to buy or sell an asset

Question 67

Define liquidity.

Answer 67

Liquidity is a measure of how quickly an asset can be converted into cash at a predicable price.

Question 68

What are the steps in conducting scenario analysis and when is usually used.

Answer 68

Scenario analysis is useful where it is difficult to fit full probability distributions to risk events. It involves the following steps: grouping of risks into broad categories development of a plausible adverse scenario calculation of the consequences of the risk event occurring for each scenario total costs calculated are taken as the financial cost of all risks represented by the chosen scenario.

Question 69

Define stress testing and describe the two types of stress tests.

Answer 69

Stress testing involves testing for weaknesses in a portfolio by subjecting it to extreme market movements ( or credit or liquidity risk events). There are two types of stress tests: to identify 'weak areas' in the portfolio and investigate the effects of localised stress situations by looking at the effect of different combinations of correlations and volatilities to gauge the impact of major market turmoil affecting all model parameters, while ensuring consistency between correlations while they are 'stressed'.

Question 70

Define reverse stress testing.

Answer 70

Reverse stress testing is the construction of a severe stress scenario that just allows the firm to be able to continue to meet its business plan, e.g. having sufficient capital to meet solvency requirements or to cover its minimum risk appetite. The scenario may be extreme, but must be plausible.

Question 71

Define a DB scheme.

Answer 71

one where the scheme rules define benefits independently of the contributions payable, and benefits are not directly linked to the investments of the scheme

Question 72

Define a DC scheme.

Answer 72

one providing benefits where the amount of an individual member's benefits depends on the contributions paid into the scheme in respect of that member, increased by the investment return earned on those contributions

Question 73

What is the difference between a funded and an unfunded approaches to financing?

Answer 73

Funded - to some extent the monies needed to meet the benefit costs are set aside before the benefits fall due. Unfunded - finding the money to pay for the benefits as the benefit falls due.

Question 74

What are the several operational issues one must consider when modelling? (SCARCER FILES)

Answer 74

Simple but retains key features Clear results Adequately documented Range of implementation methods Communicable workings and outputs Easy to understand Refinable and developable Frequency of cashflows (balance accuracy to practicality) Independent verification of outputs Length of run not too long Expenses not to high Sensible joint behavior of variables

Question 75

What options do you have in sourcing a model and what considerations should you have in assessing different models(FENCED)?

Answer 75

Sourcing a model: Built in-house, new model developed Commercial model bought of the shelf Existing model can be reused after modifications Considerations in assessing different models: Fit for the purpose Expertise available in-house Need for accuracy Cost of the option Expected number of times the model is to be used Desired level of flexibility

Question 76

Where can data be sourced for actuarial use? (TRAINERS)

Answer 76

Tables (mortality tables) Reinsurers Abroad (data from overseas contracts) Industry data National statistics Experience investigations on existing contracts Regulatory reports and company accounts Similar contracts

Question 77

What are the potential issues when using data? (QUERIED)

Answer 77

Quantity (credibility) Up to date Errors Relevance (heterogeneity) Incomplete Exceptions Detail and format

Question 78

Factors to consider when setting assumptions (LUNCH)

Answer 78

Legislation or regulation Use of the assumptions Needs of the client Consistency between assumptions How financially significant the assumption is/are

Question 79

Considerations when using past data to set future assumptions (BEST ARCHER)

Answer 79

Balance of homogeneous groups underlying the data may have changed Economic situation may have changed Social conditions may have changed Trends over time (medical, demographic) Abnormal fluctuations Random fluctuations Changes in regulation Heterogeneity within the group to which the assumptions will apply Errors in data Recording differences (in categorization of smoker)

Question 80

Mathematically define required return.

Answer 80

required return = required risk-free real rate of return + expected inflation + risk premium the return which investors, as a whole require on any asset class

Question 81

Mathematically define expected return.

Answer 81

expected return = initial income yield + income growth + impact of change in yield the return the investors expects to achieve on the asset

Question 82

What are some of the regulatory influences on assets held (TECH SCAM)

Answer 82

Types of assets which the provider can invest in Extent to which mismatching is allowed Currency matching requirement Hold certain assets (government bonds) Single counterparty maximum exposure Custodianship of assets Amount of any one asset used to demonstrate solvency may be restricted Mismatching reserve

Question 83

List the factors which influence an institutions investment strategy. existing liability 5 institution 3 asset 3 external environment 6

Answer 83

nature of the existing liabilities currency of the existing liabilities term of the existing liabilities level of uncertainty of existing liabilities future accrual of liabilities institutions risk appetite institutions objectives institutions need for diversification size of assets relative to liabilities in absolute terms expected long-term return from various asset classes the existing asset portfolio strategy followed by other funds statutory, legal, voluntary restrictions statutory regulation, solvency requirements accounting rules taxes and expenses ESG

Question 84

What are the types of actuarial advice? (FIR)

Answer 84

Factual advice - based on research of facts Indicative advice - an opinion Recommendations - involving research, modelling and consideration of alternatives

Question 85

What are the aims of a regulator? (GRIP) & functions of a regulator (RISIP)?

Answer 85

Give confidence to the financial system Reduce financial crime Inefficiencies in the market corrected and orderly markets promoted Protect customers of financial product Influencing and reviewing government policy registering and vetting firms and individuals supervising prudential management of financial organizations imposing regulation upon suspected breaches/imposing sanctions providing information to government and the public

Question 86

List the external environment factors. (CREATE GRAND LISTS)

Answer 86

Corporate structure Regulation and legislation Environmental issues and climate change Accounting standards Tax Economic outlook (interest rates, inflation, exchange rates) Governance Risk management requirements Adequacy of capital and solvency New business environment Demographic trends Lifestyle considerations International practice State benefits Technology Social and cultural trends

Question 87

Define the strategic benchmark

Answer 87

The strategic benchmark is an appropriate asset mix established for the fund

Question 88

Define the strategic risk of a fund

Answer 88

The strategic risk of a fund is the risk of poor performance of the strategic benchmark relative to the value of the liabilities

Question 89

Define active risk

Answer 89

Active risk refers to risk that an investor does not meet their particular benchmark

Question 90

Define structural risk

Answer 90

Structural risk arises from mismatches between the aggregate of the portfolio benchmarks and the total fund benchmark

Question 91

Define overall risk

Answer 91

Overall risk is the sum of the active, strategic and structural risks

Question 92

What are the principles of investment for a provider?

Answer 92

A provider should select investments that are appropriate to the nature, term, currency and uncertainty of the liabilities, and the providers appetite for risk. Subject to the above, investments should also be selected to maximize the overall return on the assets.

Question 93

Define active investment management.

Answer 93

where the investment manager has fewer restrictions on investment choice within a broad remit. It is expected to produce greater returns despite extra dealing costs and risks of poor judgement

Question 94

Define passive investment management.

Answer 94

involves holding assets closely reflecting those underlying an index or specific benchmark. The investment manager has little freedom of choice. There remains the risk of tracking errors and the index performing poorly

Question 95

What is a tactical asset allocation switch, and what should you consider before making the switch.

Answer 95

Tactical asset allocation switch involves a short term departure from the benchmark position in pursuit of higher returns. Before making the switch consider: The expected extra returns compared with the additional risk Any constraints on changing the portfolio The expenses of making the switch Any problems of switching a large amount of assets

Question 96

List the key steps in developing and running a model

Answer 96

specify the purpose and key features of the model obtain and adjust the data set the parameters / assumptions, including any dynamic links construct the model cashflows check the accuracy and fit of the model run the model as many times as required output and summarise the results.

Question 97

What is the Actuarial Quality Framework?

Answer 97

The Actuarial Quality Framework aims to promote actuarial quality through four main drivers: methods, communication, actuaries and the environment. It is designed by the FRC and aims to complement professional and other regulation affecting actuaries and their clients.

Question 98

List properties which make a risk insurable

Answer 98

A risk is insurable if: the policyholder has an interest in the risk the risk is of a financial and reasonably quantifiable nature the claim amount payable bears some relationship to the financial loss. The following criteria are also desirable for a risk to be insurable: individual risks should be independent the probability of the event occurring should be relatively small large numbers of similar risks should be pooled to reduce variance there should be a limit on ultimate liability undertaken moral hazard should be eliminated as far as possible there should be sufficient existing data / information in order to quantify risk.

Question 99

Three possible relationships between the CRO’s office and individual business units.

Answer 99

Offence vs defense: set up in oppositions (CRO minimizing risk, line management maximising returns) Policy and policing: CRO sets policy which line management abide by (feel restrictive, policy may become out of date) Partnership: CRO staff integrated into business unit, client consultant relationships, beneficial over long term, lack of independence

Question 100

What are the direct and indirect costs of regulation

Answer 100

Direct Administering regulation Ensuring compliance for regulated firms Indirect Alteration in consumer behaviour Undermining the sense of professional responsibility of advisor/intermediaries reduced consumer protection mechanisms developed by the market reduced product innovation reduced competition