Assignment 2

Question 1

Investment Income

Answer 1

Revenue from invested assets

Question 2

3 Categories of Investment Assets

Answer 2

1. Net assets received from products being sold
2. Required capital backing product
3. Free surplus allocated to the product

Question 3

What is GAAP Basis

Answer 3

matching revenue with expenses

Question 4

What is DAC

Answer 4

allows a company to defer the sales costs that are associated with acquiring a new customer over the term of the insurance contract

Question 5

GAAP Profits vs Stat Profits

Answer 5

GAAP Profits are based on the company’s best estimate for future experience (for mortality, interest, expenses) with an MfAD
STAT Profits use set assumptions set by the government

Question 6

Risk Discount Rate

Answer 6

Rate equivalent to market rate on investments of comparable risk

Question 7

Embedded Value

Answer 7

PV by discounting cash flows at risk discount rate

Question 8

NPV

Answer 8

Difference between PV(profits) and Initial Surplus

Question 9

IRR

Answer 9

Interest rate where PV(profits) = Initial Surplus Strain

Question 10

ROE

Answer 10

Changes year to year, ratio of Profit/Equity where equity includes acquisition expenses and target surplus

Question 11

ROA

Answer 11

Profits/Assets where profits are only those that relate to those assets

Question 12

MCEV

Answer 12

Market Value of Free Surplus
= MV of required surplus + PV(future profits) - Time Value of financial options and guarantees - Frictional cost of capital - Cost of non-hedgeable risks

Question 13

Nonforfeiture Benefit

Answer 13

Result of an early regulation designed to protect policyholders from “forfeiting” the equity that had built up in their policy

Question 14

Nonforfeiture Options Include 4 what

Answer 14

Cash
Extended Term (ETI)
Reduced Paid-Up (RPU)
Automatic Premium Loan (APL)

Question 15

Why would someone elect to choose ETI

Answer 15

If the insured believes they will die before policy expiration

Question 16

Why would someone choose RPU over ETI

Answer 16

If they believe they will outlive the coverage

Question 17

What is RPU

Answer 17

Where the FA is lowered to where the accumulated CV can pay for the remainder of the policy as an NSP

Question 18

What is asset default

Answer 18

When an asset permanently loses value
Ex.) issuer of bond is unable to make portion of payments
Ex.) Mortgage no longer makes payments, value is reduced to value of collateral net forclosure expenses

Question 19

What is insurance risk

Answer 19

Risk that actual mortality or morbidity is more adverse than that assumed in pricing

Question 20

Morbidity Risk

Answer 20

Applies to living benefits (ex. disability insurance)

Question 21

Mortality Risk

Answer 21

Applies to life insurance

Question 22

What are the 3 Interest Rate Risks and describe them

Answer 22

1. Disintermediation Risk:
   Risk that assets will be sold at a loss to cover substantial cash outflow
2. Guarantee Risk
   Risk that interest rate guarantees will exceed interest rates earned
3. Liquidity Risk
   Risk that assets cannot be sold fast enough to meet cash demands of liabilities

Question 23

How do companies manage Disintermediation Risk

Answer 23

1. Invest in assets such that the asset cash flows match the liability cash flows as closely as possible
2. Limiting its exposure on products that allow surrender or withdrawal on short notice without any adjustment or penalty

Question 24

List of 6 other risks

Answer 24

• Mispriced products
• Lawsuits
• Tax changes
• Regulatory changes
• Bad publicity
• Faster than expected expense growth

Question 25

What is Reinsurance

Answer 25

Insurance for insurance companies where the company accepts the risk is called the “reinsurer”

Question 26

What is Net Amount at Risk

Answer 26

Net loss on death which would be [DB(t) - Reserve(t)]

Question 27

What is Retention Limit

Answer 27

Maximum amount that company is willing to lose when one insured dies

Question 28

What is Reinsurance Treaty

Answer 28

Contract between the company and the reinsurer that details how the reinsurance will work

1. Automatic Reinsurance
2. Facultative Reinsurance

Question 29

What is Automatic Reinsurance

Answer 29

The ceding company cannot selectively decide which policies are to be reinsured and the reinsurer must reinsure all covered policies. Typically handled on an excess or first dollar basis

Question 30

What does “Excess” for reinsurance refer to

Answer 30

The portion of Net Amount at Risk for an insured that is in excess of the company’s retention limit

Question 31

What does “First Dollar” for reinsurance refer to

Answer 31

Practice of reinsuring a percentage of every risk from the very first dollar of the death benefit, as opposed to just the excess

Question 32

What is Facultative Reinsurance

Answer 32

Involves 3 steps;

1. The company decides it would like to reinsure a particular policy
2. Reinsurer reviews the underwriting material and decides whether they want to reinsure the risk and at what price
3. The company reviews offers from various reinsurers and decides who will receive the risk, if the policy is placed

Question 33

What is Expense Allowance

Answer 33

Paid by the reinsurer to reimburse the company for expenses on the business reinsured

Question 34

What is Brute Force Method

Answer 34

• Develop distribution of policy sizes for product
• Figure percentages reinsured for every size policy
• Develop weighted average percentage reinsured for all sizes combined with the weights based on the distribution by policy size

Question 35

What is Straight Forward Method

Answer 35

Use the percentage reinsured by age group for a similar product with a similar average size and same retention limit

Question 36

What is the Finesse Method

Answer 36

Review company’s existing business and develop the relationship between percentage reinsured and ratio of average size to retention limit