Chapter 14

Question 1

Actuaries use quantitative assumptions for relevant risk, when modeling applications for products.
Assumptions made by actuaries may be classified into one of which 3 categories?

Answer 1

1) fixed assumptions
2) dynamic assumptions
3) stochastic assumptions

Question 2

What are fixed assumptions?

Answer 2

variables for which actuaries assign a specific value of proportional relationship and for which the value or proportion remains unchanged throughout multiple interations of a module.
- fixed by policy or contract terms, or dictated by regulation.

Question 3

Define Dynamic assumptions

Answer 3

variables that change over time, but in a way that is predictable and formula driven.
- used to model policyholder behaviour with respect to lapse and surrender rates, flexible premium payments, and utilization of optional benefits.

Question 4

Define Stochastic assumptions

Answer 4

variables that are selected randomly from a specified statistical distribution applied across multople simulations or scenarios.
- used when assumptions are unknown in advance and cannot be easily modeled.

Question 5

What is the best assumption model to use if the underlying risk have the following characteristics?

• volatility of the outcomes is unknown or high
• given risk is nondiversifiable
• company lacks an appropriate hedge for a given product risk.
• future outcomes from a given risk are likely to have a skewed distribution.

Answer 5

Stochastic model.

Question 6

certain products, such as fixed annuities, are affected by forces of supply and demant in the market for interest-bearing securities. Which type of modeling would be good for this?

Answer 6

stochastic modeling.

• suppots projections for future economic conditions
• accounts for relationships between key variables
• great for interest-rate risk.

Question 7

How do increases in market interest rates affect insurance products.

Answer 7

when market interest rates increase, market values of bonds decrease.

• increase interest rates = bond purchase price.
• new interest-bearing investments in the general account earn the higher market interest rate
• insurers may experience the phenomenon of spread compression.

Question 8

What is the interest spread euqation?

Answer 8

interest spread = (interest rate earned) - (interest-crediting rate)

Question 9

What is spread compression

Answer 9

refers to the narrowing of an insurer’s interest spread.

* occurs in an increasing interest-rate environment when customers immediately demand the higher market interest rate.

Question 10

How can an insurer contract a lower-than-acceptable interest spread? a situation that is likely to cause a decline in the volume of existing interest-sensititve business?

Answer 10

1) increase their current interest crediting rates and accepting a lower spread in an effort to retain customers funds.
2) leaving current interest-crediting rates at the lower levels

• could use an option of both.

Question 11

How does a decrease in market interest rates affect insurance companies?

Answer 11

when market interest rates decrease bond prices typically increase.

• when market interest rates decrease, the liabilities could lengthen. (happens when fized-rate products remain in force longer than assumed.
• here insurance companies can experience spread compression, depending on if products are supported by existing invested assets or new invested assets.

Question 12

What is spread expansion?

Answer 12

• the widening of an insurere’s interest spread. Spread expansions occu when market interest rates fall and the insurer reduces interest-crediting rates to the new market level while continuing to ear a higher overall rate of return on its existing invested assets.

Question 13

What is spread compression?

Answer 13

if market interest rates drop so as to approach an insurer’s current interest-crediting rates, the insurer could eperience spread compression on products supported by new invested assets.
- tents to emerge slowly over time.

Question 14

What is refinancing?

Answer 14

when yoiu make new borrowing arrangements at the new lower prevailing interest rates.

• insurere would lose higher-yielding older assets.
• would cause spread compression on insurance and annuity products with long-term guarantees.

Question 15

What are some strategies for managing interest-rate risk.

Answer 15

insurers rely on

• a control cycle
• Asset-liability management programs
• recourse to corrective actions for addressing potential deviations in risk standards.

Question 16

What kind of corrective deviations will a company recourse to for addressing potential deviations in risk standards?

Answer 16

1) specifying the interest-rate characteristics of new pruchases of bonds and mortgages
2) selling existing bonds and mortgages
3) directing changes in nonguaranteed benenfits,
4) nonguaranteed charges
5) other product feathers that render a given interest-rate condition risky
6) offsetting specified interest-rate risks with purchases of derivative securities.

Question 17

when is a policy holder’s benefit or ownership option considered “In the money (ITM)”?

Answer 17

when the policy holder would benefit economically from exercising the option.
- cx tent to excise ownership options in products when financial market conditions are unfavourable for the company and favourable for the policyholder?

Question 18

Policyholder behavior risk is related to the risks arising from movement in market interest rates. How do policyholders act when market interest rates are high vs. low?

Answer 18

high(increasing) - their more likely to surrender old contracts with lower interest-crediting rates and purchase higher interest-bearing financial products.
Lower (decreasing) Policyholder are more likely to hold on to existing contracts because new interest rates available in the market place may be lower.

Question 19

Which two assumption methods can insureres use to desribe the future exercise of newer policyholder products options?

Answer 19

dynamic and stochastic .

-

Question 20

What are 3 different approcahes to modeling policyholder behavior?

Answer 20

1) not modelign a product feature
2) creating a simple fixed assumption
3) creating a dynamic assumption

Question 21

Free look cancellation: no assumption. What is the controlling influence on policyholders during a free-look period?

Answer 21

length of the free-look period.
* typically has little significance on cost of benefits- so product mofels sont usually have specific assumptiosn for cost of free-look cancellations.

Question 22

What kind of assumption is premium deposits?

Answer 22

fixed assumption
- acutaries typically assume the payment of either single initial premium or premiums paid only diuring first few yrs of policies.

Question 23

What kind of assumption is Free partial withdrawls?

Answer 23

fixed assumtpion.
policyholders base their decision to take partial withdrawls based on the product partial withdrawl peercent, lveel of any surrender charge, and their own need fo rcash.
- acutaries will assume withdrawals of a fized percentage of assets.

Question 24

What kind of assumption is surrenders?

Answer 24

A dynamic assumption
policyholders will base the decision on the products surrender charge, account value, need for cash and level of investment ability.

Question 25

How do companies diversify product risks?

Answer 25

1) issue a variety of product types 2) issue contract to geographically dispered customers' 3) issue contracts to demographically divers customers. > they can also adjust product design, admin arrangements, business controls or asset management practices.

Question 26

What are some approaches insueres have established to manage product risks at the product design level?

Answer 26

1) restric loan activity 2) employ floating interest rates for policy loans 3) using surrender charges to defray the cost of surrenders 4) increasing product expense charges as permitted. 5) incorporating nonguaranteed elements in product designs.

Question 27

What are nonguaranteed elements (NGEs) in life and annuities?

Answer 27

product features that allow insurer to reward customers when the insurere has experienced or anticipates it will experience favourable devitatiosn from its assumptions or, allow the insuere to charge customers more when the insuere has experiences or anticipates it will experience unfavoruable deviations from assumptions. -

Question 28

What are some examples of NGEs?

Answer 28

can be nonguaranteed benefits or nonguaranteed charges. 1) policy dividends on participating fixed premium life policies 2) premium adjustments for indeterminate premium products 3) excess interest on products that credit interest at current rates 4) adjustment in periodic charges deducted from accumulation values.

Question 29

What additional design adjustments can be done to fixed-rate universal life and fized-rate deferred annuitis, to help control product risks?

Answer 29

1) design a lower minimum guaranteed interest-cediting rate 2) shortening the gurantee period for min guaranteed interest-crediting rates 3) decrasing current interest-crediting rates within limit 4) decreasing intervals between declarations of new interest-crediting rates on fied-itnerest asset accumulations 5) limiting withdrawals of account values by monetary amount, frequency and perentage of account value.

Question 30

What design adjustments can help limit the insurance company;s product risks for variable universal life and variable deferred annuities?

Answer 30

1) discouraging markt-timing abuses and controlling asset-trading costs by limiting cx movements of contract values between subaccounts in a specified period 2) limiting new premium additions to fized accounts in a period. 3) limiting reallocations of existing fund values to fixed acounts. 4) limiting withdrawals of account values by monetary amount, frequency and percentage of account value. 5) designing and issuing products with market-value adjustmnts instead of unit valies.

Question 31

how have insueres adjusted product designs to address specific risks associated with varriable deferred annutites?

Answer 31

1) requireing waiting periods before owners can begin drawing guaranteed income 2) imposing restrictions on the kinds of investment that contract owners can selec 3) applying age-based guaranteed withdrawls 4) using index-based guarantees, to reduce capital market risk 5) using asset transfer algorithms, for transfer of assets between equity and fixed income investments.