Things to know (Summary) Flashcards

Question

What are the 6 key outcomes of TCF?

Answer 1

* Consumers can be confident that they are dealing with a firm where fair treatment of customers is central to the corporate culture * Products and services marketed and sold in the retail market are designed to meet the needs of identified consumer groups and are targeted accordingly * Consumers are provided with clear information and are kept appropriately informed before, during and after the point of sale * Where consumers receive advice, the advice is suitable and takes account of their circumstances * Consumers are provided with products that perform as firms have led them to expect, and the associated service is of an acceptable standard and as they have been led to expect * Consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint

Answer 2

* Self-regulatory systems * Statutory regime * Voluntary code of conduct * Unregulated markets * Mixed regime

Answer 3

* In return for a single premium (or a series of payments) the provider will pay an individual or any heirs an agreed amount (or series of amounts) that start or end on a pre-specified event * This event may happen to the individual, the individual’s property or a third party

Answer 4

An insurance contract for providers of insurance, which allows the transfer of risk taken on to a third party

Answer 5

A vehicle that involves the accumulation of funds, which are paid out on a later date, usually retirement. The event may also be death, withdrawal or illness

Answer 6

In return for a series of monthly payments, the provider will pay an individual or any policy dependents’ medical costs in line with the scheme rules. These contracts tend to be short-term and are annually renewable

Answer 7

A vehicle that involves an individual paying a single premium or a series of payments to a provider with the expectation that a higher amount will be paid back on a later date

Answer 8

A financial instrument whose value depends on the value of underlying investments or variables

Answer 9

1. Insurable risk 2. Pre-funding 3. Pooling of risks

Answer 10

* Compulsion or encouragement from the State * A desire to attract and retain the services of good quality employees * A desire to look after employees and their dependents financially beyond the level provided by the State * Pooling of expenses and expertise

Answer 11

* Provide benefits to some or all of the population * Sponsor the provision of such benefits * Provide financial incentives either for other providers to establish appropriate provision, or to subsidise the cost of such provision to consumers * Educate or require education about the importance of providing for the future * Regulate to encourage or compel benefit provision * Regulate bodies providing benefits in an attempt to ensure security of promises

Answer 12

* Often long term * Typically only one claim * Claim amount may be known with certainty * Protection against the financial impact of death or ill health and for savings * May be sold to individuals or on a group basis

Answer 13

1. Without-profit 2. With-profit 3. Index-linked 4. Unit-linked

Answer 14

* To cover unexpected events * To give investment freedom * To demonstrate financial strength * For opportunities * To smooth dividends / bonusses * For development expenses * To cover guarantees

Answer 15

* Cover is typically provided for a single year and can then be renewed * There can be multiple claims * Claim amounts are generally unknown and can be volatile * There can be delays in reporting and settling claims

Answer 16

* Mortality, longevity and morbidity * Investment risks * Expenses not met by premium loadings or charges * Early withdrawals, before initial expenses are covered * New business volumes too high and hence new business strain, or too low and not enough business over which to spread the overheads * Credit risk * Operational risks

Answer 17

* Full medical underwriting * Moratorium underwriting * Medical History Disregard * No worse terms * Continued Personal Medical Exclusion

Answer 18

* They are long term * Cover usually ceases on claim * The claim amount may be known with certainty * They are used for protection against ill health or death as well as savings * Group versions are typically only for 1 or 2 years, but can then be renewed

Answer 19

**Mutuality:** * A pooled fund is created and premiums paid into the fund by policyholders * The premium paid by the policyholder is determined by the risk presented by the policyholder at the time of taking out the contract * Claims are paid out of the pooled funds in accordance with the policyholder agreement **Solidarity:** * Solidarity is similar to mutuality in that they both involve the concept of sharing losses * However, the main differences are that under solidarity principles, the premiums are not based on risk, but rather on the ability to pay, or are set equally * And under solidarity principles losses are paid according to need

Answer 20

* Claim frequency, benefit amount, volatility and settlement delays * Accumulations of risk, catastrophes and large number of large claims * Investment risk * Expenses being higher than expected * Poor persistency * Poor plan mix due to upgrades, downgrades and anti-selection * Underwriting risk * Operational risks * Availability of claims data

Answer 21

* They are short term * There can be multiple claims * Claim amounts are generally unknown and can be very volatile * There can be delays in reporting and settling claims

Answer 22

* Short-tailed means that claims are generally reported quickly and settled quickly by the insurer * Long-tailed means that there is a sizeable proportion of total claim payments that take a long time to be reported and/or a long time for the insurer to settle

Answer 23

* Outstanding reported claims reserve * Incurred but not yet reported reserve (IBNR) * Unexpired risk reserve * A catastrophe reserve * A claims handling expense reserve

Answer 24

* Claim frequency, amount, volatility and delays * Accumulations of risk and catastrophes * Investment risks * Expenses being higher than expected * Poor persistency * New business volumes too high and hence new business strain, or too low and not enough business over which to spread the overheads * Credit risk * Operational risks

Answer 25

* Reinsurance * Underwriting * Diversification across classes of business and geographically * Monitoring experience

Answer 26

SYSTEM T * Security (default risk) * Yield (real or nominal, expected return) * Spread (Volatility of market values * Term (short, medium or long) * Expenses / Exchange rate * Marketability * Tax

Answer 27

* Protect monetary value * Opportunities * Uncertain liabilities * Recently received cashflows * Short-term liabilities * General economic uncertainty * Recession expected * Increase in interest rates expected * Depreciation of domestic currency expected

Answer 28

Nominal yield = risk-free real yield + expected future inflation + inflation risk premium

Answer 29

* The factors affecting one company within an industry are likely to be relevant to other companies in the same industry (Resources, markets and structure) * 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 single analyst can expect to be an expert in all areas, so specialization is appropriate * The grouping of equities according to a common factor gives structure to the decision-making process. It assists in portfolio classification and management * Certain industries require specific expertise to value which may not be part of every analyst’s skillset

Answer 30

* Greater marketability * Greater divisibility * More information is available due to disclosure requirements * Greater security, from stock exchange regulations * Easier to value

Answer 31

* Many companies operate across sectors * The heterogeneity of companies within particular sectors * Analysts who only focus on a handful of companies may lack the broader view of the economy and other factors important to portfolio construction * There may be better opportunities outside of sector the analyst focuses on, yet he/she is reduced to only including companies in their sector * Some asset managers may not be large enough to justify an industry specialist for each and every sector of the economy

Answer 32

* Any differences between the way in which investors value shares and they way they value property * Risk of loss forced sale -cashflow requirements result in property companies being more likely to be forced sellers of properties than institutions undertaking direct property investment on their own account. A smaller discount or even a premium to NAV is possible where: * The market has a positive view of developments giving the potential for capital gains * The valuations underlying the NAV are conservative * The property company has a good management track record

Answer 33

* Investment trusts are a form of closed-ended fund. * They are public companies whose function is to manage shares and other investments * They have a capital structure exactly like other public companies and can raise both loan and equity capital * A guide to what the share price might be expected to be is the NAV per share which is the value of the company’s underlying assets divided by the number of shares * The main parties involved are board of directors, investment managers and shareholders

Answer 34

* A unit-trust is an open-ended investment vehicle whereby investors can buy units in an underlying pool of assets from the trust manager * Unit trusts are trusts in the legal sense. They have limited powers to borrow against their portfolio * The unit price is calculated by the unit trust provider as market value of underlying assets / number of units Complications include: * Whether to use the bid or offer prices of the underlying assets * How to allow for the expenses the unit trust incurs in buying and selling underlying assets * How to adjust the unit price to apply any charges to investors * How to round the answer The main parties involved are the management company, trustees and investors

Answer 35

* They are useful for obtaining specialist expertise * They are an easy way of obtaining diversification * Some of the costs of direct investment management are avoided * Holdings are divisible – part of a holding in any particular trust can be sold * There may be tax advantages * There may be marketability advantages * They can be used to track the return on a specific index

Answer 36

* Loss of control – the investor has no control over the individual investments chosen by the managers * Management charges are incurred * There may be tax disadvantages such as withholding tax which cannot be reclaimed

Answer 37

* A forward contract is a contract to buy or sell an asset on an agreed basis in the future * Forward contracts are non-standardised, the details can be tailor-made and will be negotiated between the 2 trading parties * Forward contracts are not exchange-traded, but are traded OTC * Credit risk is dependent upon the creditworthiness of the counterparty

Answer 38

* A futures contract is a contract to buy or sell an asset on an agreed basis in the future * However, futures contracts are standardized contracts that can be traded on a recognized exchange * All details are pre-determined, except the price, which the parties must agree on * Standardisation results in easy administration as well as a very liquid futures market * Credit risk is minimal as the clearing house intervenes to guarantee each side of the original bargain. Each party makes a small good faith deposit to the clearing house to uphold this guarantee

Answer 39

* An option is the right, but not the obligation, to buy or sell an asset * Options are contract agreed between investors to trade in an underlying security at a given date at a set price

Answer 40

* A warrant is an option issued by a company over its own shares. * The holder has the right to purchase shares at a specified price at specified times in the future from the company

Answer 41

1. Guaranteed in money terms 2. Guaranteed in terms of an index 3. Discretionary 4. Investment -linked

Answer 42

* The premiums for accepting the additional risks of corporate bonds are factored into the market price of the bonds – in particular the spread * The spread is the difference between the yield on a corporate bond compared with the equivalent government bond * This leads to a higher expected return on a corporate bond than on a government bond of the same terms

Answer 43

* Current market valuation * Possibility of high economic growth rate * Currency stability and strength * Level of marketability * Degree of political stability * Market regulation * Restrictions on foreign investment * Range of companies available * Communication problems * Availability and quality of information

Answer 44

1. Market value 2. Smoothed market value 3. Fair value 4. Discounted cashflow 5. Stochastic models 6. Arbitrage value 7. Historical value 8. Adjusted historical value

Answer 45

* A different market performance to the home market and the associated mismatching risk * Currency fluctuation risk * Increased expertise needed to assess the market * Additional administration functions: custodian, dividend, tracking and collection * Different tax treatment * Different accounting practices * Less information may be available than in the home market * Language problems * Time delays * Poorer market regulation in some countries * Risk of adverse political development * Liquidity – many less developed markets are not very liquid * Restrictions on the ownership of certain shares

Answer 46

* Demand-pull inflation refers to a situation in which there is excess demand within the economy so that firms are able to increase their prices * Cost-push inflation refers to a situation where if firms’ costs go up, they will tend to pass on at least part of the increase to consumers through higher prices

Answer 47

**Expectations theory:** * The shape of the yield curve is determined by economic factors, which drive the market’s expectations for future short-term interest rates * Expectations of future inflation is the biggest influence * If we expect future short-term interest rates to fall (rise), then we would expect GRYs to fall (rise) and the yield curve to slope downwards (upwards) **Liquidity preference theory:** * This theory is based on the generally accepted belief that investors prefer liquid assets to illiquid ones * Investors require a greater return to encourage them to commit funds for a longer period * The yield curve should therefore have a slope greater than that predicted by the pure expectations theory **Inflation risk premium theory:** * Investors are interested in achieving a real return * Therefore, they require a higher nominal yield to compensate for the risk that inflation is higher than expected and the real return lower than expected * The yield curve will therefore tend to slope upwards, because investors need a higher yield to compensate them for holding longer-dated stocks which are more vulnerable to inflation risk than shorter-dated stocks **Market segmentation theory:** * Yields at each term to redemption are determined by supply and demand from investors with liabilities of that term. * Principal buyers of short bonds are banks, which compare their yields with short-term interest rates * The major investors in long bonds are pension funds and life insurers, whose main objective is to achieve protection against future inflation * The 2 areas of the bond market may move somewhat independently

Answer 48

* A change in their liabilities * A change in the regulatory or tax regimes * Uncertainty in the political climate * “Fashion” or sentiment altering * Marketing * Investor education undertaken by the suppliers of an asset class * Sometimes for no discernable reason

Answer 49

**Advantages:** * Method is consistent with discounted cashflow approach to valuing liabilities * Stable, if assumptions used are not changed too frequently * Employes actuarial judgement, so can adjust out influence of market sentiment **Disadvantages:** * Subjective choice of assumptions * Time consuming * Not well understood by clients * Not suitable for short-term valuations

Answer 50

* Required return = required risk-free real rate of return + expected inflation + risk premium * Expected return = initial income yield + expected capital growth * Approximate expected return = initial income yield + income growth + impact of change in yield

Answer 51

**Advantages:** * Easily obtainable in most cases * Objective * Realisable value of an asset, so suitable for discontinuance valuations * Well understood * May be required by legislation **Disadvantages:** * More than one market value is likely to exist * Only known for certain at time of sale * May not exist or be up to date for certain assets, such as direct property or unquoted investments * Volatile * Difficult to value liabilities in a consistent, market related way

Answer 52

**Advantages:** * It is good for valuing derivatives * It gives a better picture of a valuation * Consistency with the liability valuation is also achievable **Disadvantages:** * It may be too complex for many applications * The results are dependent on the assumed distributions for the variables – these assumptions may be highly subjective

Answer 53

* Matching the nature, term, currency and uncertainty of the liabilities * A need for income to live on vs growth for the future * Risk aversion and a dislike of volatility * Diversification, to reduce specific risk * Maximising expected return on investments, net of expenses and tax * The individual’s tax status and the tax treatment of the asset * Low free assets, which constrain the ability to mismatch and take risks * Not enough assets for direct investment in certain asset classes * High relative expenses when investing small amounts * Lack of information / expertise relative to institutional investors

Answer 54

D/(i-g) or D0(1+g)/(i-g) Where: * D is the dividend payable in one year from now * D0 is the most recent dividend * i is the required rate of return * g is the dividend growth rate Assumptions: * Dividends are payable annually, with the next payment in one year’s time * Dividends grow at a constant rate, g, per annum * The required rate of return, I, is independent of the time at which payments are received * i>g * i and g are defined consistently * the dividend proceeds can be reinvested at i p.a. * no tax and expenses * Shares are held forever, as per the general model

Answer 55

1. Market value 2. Dividend discount model 3. NAV per share 4. Measurable key factor approach 5. Economic value added (EVA)

Answer 56

* We do not know the value of i or g and the assumption that it is constant might not be appropriate * The results are very sensitive to the assumed level of i-g * The equations ignore tax. Tax-paying investors should use the net dividends received and a suitable after-tax rate of return * The equation also ignores expenses * This model assumes annual dividend payments even though the payments might be half-yearly * The model is of no use unless i>g

Answer 57

* Equities expected return = dividend yield + expected nominal dividend growth * Conventional bonds = Gross redemption yield (nominal) * Index-linked bonds = GRY (real) * Property = rental yield + expected nominal rental growth * Cash = short-term nominal interest yields

Answer 58

* It can be used to describe the probability of an investment failing completely (probability of default) * More frequently it is used to signify the expected variability of the return from an investment (The variance or standard deviation of returns over a single time period) * The most practical definition however is that risk is the probability of failing to achieve the investor’s objective

Answer 59

SOUNDER TRACTORS * Size of the assets * Objectives * Uncertainty of the liabilities * Nature of the liabilities * Diversification * Existing asset portfolio * Return (Expected long term) * Tax treatment of the assets / investor * Restrictions - stratutory / legal / voluntary * Accrual of future liabilities * Currency of existing liabilities * Term of existing liabilities * Other funds' strategies * Risk appetite * Solvency requirements and accounting requirements

Answer 60

It is a tool to help determine what assets to invest in given a particular objective or objectives

Answer 61

* A provider should select investments that are appropriate to the nature, term, currency and uncertainty of the liabilities and the provider’s appetite for risk * Subject to the first constraint, the investments should be selected to maximise the overall return on the assets, where overall return includes both income and capital gains

Answer 62

* Restrictions on the types of assets that a provider can invest in * Restrictions on the amount of any particular types of asset that can be taken into account for the purpose of demonstrating solvency * A requirement to match assets and liabilities by currency * Restrictions on the maximum exposure to a single counterparty * Custodianship of assets * A requirement to hold a certain proportion of total assets in a particular class * A requirement to hold a mismatching reserve * A limit to the extent to which mismatching is allowed at all

Answer 63

* The present value of the liability-outgo and asset-proceeds are equal * The discounted mean term of the value of the asset-proceeds must equal the discounted mean term of the value of the liability-outgo * The spread (or equivalently convexity) about the discounted mean term of the value of the asset-proceeds should be greater than the spread of the value of the liability-outgo

Answer 64

The risk of underperformance if the fund managers do not invest exactly in line with the individual benchmarks as they are given

Answer 65

* Immunisation is generally aimed at meeting fixed monetary liabilities. Many investors need to match real liabilities. However, the theory can be applied to index-linked liabilities by using index-linked bonds * By immunizing, the possibility of mismatching profits as well as losses is removed apart from a small second-order effect * The theory relies upon small changes in interest rates. The fund may not be protected against large changes * The theory assumes a flat yield curve and requires the same change in interest rates at all terms. In practice the yield curve does change shape from time to time * In practice, the portfolio must be rearranged constantly to maintain the correct balance of equal discounted mean term and greater spread of asset proceeds. The theory ignores dealing costs of a daily rearrangement of assets * Assets of a suitably long discounted mean term may not exist * The timing of asset proceeds and liability outgo may not be known

Answer 66

* Active management is where the manager has few restrictions on the choice of investments, perhaps just a broad benchmark of asset classes. * This enables the manger to make judgments regarding the future performance of individual investments, both in the long term and the short term. * It involves actively seeking out under- or over-priced assets, which can then be traded in an attempt to enhance investment returns * Passive management is the holding of assets that closely reflect those underlying a certain index or specific benchmark. * The manager has little freedom to choose investments

Answer 67

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

Answer 68

The risk of underperformance if the sum of the individual benchmarks given to fund managers does not add up to the strategic benchmark

Answer 69

* The expected extra returns relative to the extra risk taken * Constraints on the changes that can be made to the portfolio * The expenses of making the switch * The problems of switching a large portfolio of assets * The tax liability arising if a capital gain is crystallised * The difficulty of carrying out the switch at a good time * The ability to absorb the extra risk

Answer 70

* The model should be adequately documented * The workings of the model should be easy to appreciate and communicate. The results should be displayed clearly * The model should exhibit sensible joint behaviour of model variables * The outputs from the model should be capable of independent verification for reasonableness and should be communicable to those to whom advice will be given * The model, however, 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. * The model should be capable of development and refinement * A range of methods of implementation should be available to facilitate testing, parameterization and focus of results * The more frequent the cashflows are calculated, the more reliable the output from the model, although there is a danger of spurious accuracy * The less frequently the cashflows are calculated, the faster the model can be run and results obtained

Answer 71

BEST ARCHER * Balance of homogeneous groups underlying the data may have changed * Economic situation may have changed * Social conditions may have changed * Trends over time * Abnormal fluctuations * Random fluctuations * Changes in regulation * Heterogeneity within the group to which the assumptions will apply * Errors in the data * Recording differences

Answer 72

* A model is a cut-down, simplified version of reality that captures the essential features of a problem and aids understanding * A new model could be developed in-house * An existing model might be modified * Or a commercial model might be purchased externally The factors that need to be considered are: * The level of accuracy required * The in-house expertise available * The number of times the model is to be used * The desired flexibility of the model * The cost of each option

Answer 73

* A money-weighted rate of return (MWRR) is identical in concept to an internal rate of return – it is the discount rate at which the present value of inflows = present value of outflows in a portfolio * The time-weighted rate of return (TWRR) is the preferred industry standard as it is not sensitive to contributions or withdrawals * For both, any cashflows generated by the fund itself must be taken into account in the figures for the fund value

Answer 74

**MWRR:** * The MWRR factors in all cashflows including contributions and withdrawals * Assuming MWRR is calculated over many periods, the formula will tend to place a greater weight on the performance in periods when the account size is highest * If a manager outperforms the benchmark for a long period when an account is small, and then (after the client deposits more funds) the manager has a short period of underperformance, the MWRR measure may not treat the manager fairly over the whole period **TWRR:** * Using the TWRR will not identify the manager who has a skill at managing small funds and is weak at managing large funds, or vice versa.

Answer 75

**Deterministic:** * Quicker, cheaper and easier to design, build and run * Clearer what scenario have been tested * Results are easier to explain to a non-techincal audience **Stochastic:** * Allows naturally for the uncertainty of outcomes * Enables better modelling of the correlations between variables * Test a wider range of scenarios * Good at identifying extreme outcomes, which may not have been thought of under a deterministic scenario * Important in assessing the impact of financial guarantees

Answer 76

* Data governance is the term used to describe the overall management of the availability, usability, integrity and security of data employed in an organization * A data governance policy is a documented set of guidelines for ensuring the proper management of an organisation’s data A data governance policy will set out guidelines with regards to: * The specific roles and responsibilities of individuals in the organization with regards to data * How an organization will capture, analyse and process data * Issues with respect to data security and privacy * The controls that will be put in place to ensure that the required data standards are applied * How the adequacy of controls will be monitored on an ongoing basis with respect to data usability, accessibility, integrity and security * Ensuring that the relevant legal and regulatory requirements in relation to data management are met by the organisation

Answer 77

* Accountability: The party responsible for processing the data is also responsible for compliance with POPIA * Processing limitation: Information must be processed in a fair, lawful and relevant manner, after consent is given by the data subject * Purpose specification: Personal information must be collected for a specific purpose. Record keeping to be destroyed when personal data is no longer relevant or authorized to be held * Further processing limitation: Further processing must be compatible with the initial collection purpose * Information quality: Data completeness, accuracy and updates to be ensured by holder of the data * Openness: Documentation to be maintained on all processing operations and maintaining transparency on data use * Security safeguards: Integrity and confidentiality of personal data must be secured and all processing done only by authorized operator * Data subject participation: The data subject may request confirmation of personal data held and request correction or deletion of any inaccurate misleading or outdated information held

Answer 78

* Data might contain errors or omissions, which leads to erroneous results * Insufficient historical data, leading to a lack of credibility * There may be insufficient data to provide a credible estimate of a risk in very adverse circumstances * Using data from other sources carries the risk of not being a sufficiently good proxy for the risk * Historical data may not be a good reflection of future experience * Homogeneous groups are too small for credibility or to obtain credibility merge groups, but then groups lack homogeneity * Data is not in the appropriate form for the purpose required * If data is collected for a purpose, it is not appropriate for a different purpose * A lack of confidence in the data reduces the confidence in an actuary’s conclusions

Answer 79

TRAINERS * Tables * Reinsurance * Abroad * Industry data * National statistics * Experience investigations on the existing constract * Regulatory reports and company accounts * Similar contracts

Answer 80

* Consider the use to which the assumptions will be put * Take care over the choice of the assumptions that will have the most financial significance * Achieve consistency between the various assumptions * Consider any legislative or regulatory constraints * Consider the needs of the clients

Answer 81

* The purpose of the valuation * The significance of each assumption to the overall result * Whether the individual cashflows are important or whether the overall value resulting from a combination of cashflows is important * The financial significance of any errors * Whether the valuation is for cash transactions (which cannot be corrected at a later date) * Implicit assumptions

Answer 82

* Questions should be well designed and unambiguous so that full information is given and so that applications / claims can be easily processed * Use questions with quantitative or tick-box answers wherever possible * Questions should be in the same order as the input into the administration systems, for quick processing of applications / claims * Ask the policyholder to verify the key information * All rating factors should be readily identifiable so that the composition of the final premium can be determined * Underwriting results should be added to the proposal form * Forms should be designed so that information can be easily analysed, and cross checks made between the two sources

Answer 83

The underlying principle to consider is fairness between: * The policyholder or scheme member who is leaving * The remaining policyholders or members * The provider of the benefits Which contracts to offer discontinuance on The form of the benefits being offered How it goes about setting the discontinuance terms Any practical considerations relating to the discontinuance

Answer 84

* Age * Gender * Climate and geographical location * Housing * Occupation * Nutrition * Genetics * Education * Political unrest * Dangerous activities * Religious attitudes

Answer 85

* Temporary initial selection: It is usually the case that mortality / morbidity rates depend on the duration since some event, up to some duration s. After duration s they are independent of duration. * Class selection: Occurs when each group is categorized by the nature of a particular characteristic of the population. * Time selection: Where a select group is taken from a population of individuals from different calendar years * Adverse selection: Taking advantage of inefficiencies in a provider’s pricing basis to secure better terms than might otherwise be justified, normally at the expense of the product provider. It usually involves an element of self-selection, which acts to disrupt a controlled selection process which is being imposed on the lives. * Spurious selection: Ascribing mortality differences to groups formed by factors that are not true causes of these differences

Answer 86

* Using a “charging out” basis e.g. computer time and related staff costs could be charged to the direct function departments based on actual use * By floor space taken up by a department, e.g. premises costs * Using an arbitrary basis, e.g. statutory fees or senior management costs could be added at the end of the analysis as a percentage loading to all the other attributed costs

Answer 87

* Fixed amount per contract * % of premium * % of Sum Assured * % of funds under management * Fixed amount per claim * % of claim amount * A combination of the above

Answer 88

* Fixed expenses: Remain broadly fixed in real terms. These expenses vary in the long term, so it is usually more beneficial to look at these expenses in the short term * Variable expenses: Vary directly according to the level of business being handled at that time and are linked to the number of policies or claims or the amounts of premiums or claims * Direct expenses: Can be identified as belonging to a particular class of business * Indirect expenses: Do not have a direct relationship to any one class and needs to be apportioned between the appropriate classes in performing an analysis

Answer 89

AMPLE DIRECT FACTORS * Administration systems * Marketability * Profitability * Level and form of benefits * Early leaver benefits * Discretionary benefits * Interests and needs of customers * Risk appetite of the parties involved * Expenses vs charges * Competition * Terms and conditions of the contract * Financing (capital requirements) * Accounting implications * Consistency with other products * Timing of contributions or premiums * Options and guarantees * Regulatory requirements * Subsidies

Answer 90

ALPACAS * Actuaries * Lawyers * Providers of benefits * Accountants * Customers * Administrators * Shareholders / financial backers

Answer 91

**Providers:** * The chosen market * The capital available * The liquidity available * The expertise available **Customers:** * The capacity to pay * The risks to be covered * The benefits that are needed at different times in the future * Attitude to financial risk

Answer 92

1. Pay-as-you-go 2. Funding all the benefits in advance 3. Regular payments building up a fund 4. Paying an amount when the benefit event happens, for example, purchasing an annuity at the point of retirement

Answer 93

* By examining the risk at group level, allowance can be made for pooling of risk, diversification achievable and economies of scale. This should prove to be the most capital efficient way of managing risk * Enterprise risk management involves considering the risks of the enterprise as a whole rather than considering individual risks in isolation * This allows the concentration of risk arising from a variety of sources within an enterprise to be appreciated, and for the diversifying effects of risks to be allowed for * It will give the group management insight into the areas with resulting undiversified risk exposures where the risks need to be transferred or capital set against them * Such an approach enables the company to take advantage of opportunities to enhance value, i.e. if they understand their risks better, they can use them to their advantage by taking greater risks in order to increase returns * It is not just about reducing risk – it is also about the company putting itself into a better position to be able to take advantage of strategic risk-based opportunities

Answer 94

* The cost of benefits can be described as the amount that should theoretically be charged for them * The price of benefits is the amount that can actually be charged under a particular set of market conditions. It may be more or less than the cost

Answer 95

* Surrender: The policy stops, there is no further cover and the policyholder receives a lump sum payment (the surrender value) * Lapse: The policy stops, there is no further cover and usually no payment is made to the policyholder by the insurance company * Paid-up: The policyholder ceases to pay premiums but the policy continues to offer the policyholder some cover. In this case, the benefit is reduced to reflect that there are no more premiums and is called the paid-up value * Withdrawal: This normally encompasses surrender and lapse, as the policy does not stay in force

Answer 96

* The theoretical value of the benefits * The value of the expenses * A contribution to profit * Taxation * Commission * The cost of capital supporting the product * Margins for contingencies * The cost of any options and guarantees * The provisioning basis * The use of experience rating to adjust future premiums * Investment income * Reinsurance cost

Answer 97

* Pay-as-you-go: benefits are met out of current revenue and there is no funding * Smoothed pay-as-you-go: the same as PAYG but with a small fund to smooth effects of timing differences between contributions and benefits, short term business cycles and long term population change * Terminal funding: A lump sum set aside to cover all the expected benefit costs when the first tranche of business becomes payable * Just in time funding: Funds are set aside only in response to an external event such as the sale of an employer * Regular contributions: Funds are gradually built up between promise and first benefit payment * Lump sum in advance: A lump sum is set aside to cover the expected benefit cost when the benefit is promised

Answer 98

1. Risk identification 2. Risk classification 3. Risk measurement 4. Risk control 5. Risk financing 6. Risk monitoring

Answer 99

* Market risk: The risks related to changes in investment market values or other features correlated with investment markets such as interest rates / inflation * Credit risk: The risk of failure to third parties to meet their obligations * Liquidity risk: The risk that an insurer, although solvent, does not have sufficient capital available to enable it to meet its obligations as they fall due. The risk for an insurer is usually low since investments usually include a large proportion of cash, bonds and stock market assets * Business risk: Risks that are specific to the business undertaken. These include underwriting risk, insurance risk, financing risk, exposure risk * Operational risk: The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events * External risk: Arises from external events

Answer 100

* Avoid surprises * React more quickly to emerging risks * Improve the stability and quality of their business * Improve their growth and returns by exploiting risk opportunities * Improve their growth and returns through better management and allocation of capital * Identify their aggregate risk exposure and assess interdependencies * Integrate risk into business processes and strategic decision making * Give stakeholders in their business confidence that the business is well managed

Answer 101

* Incorporate all risks, both financial and non-financial * Evaluate all relevant strategies for managing risk, both financial and non-financial * Consider all relevant constraints, including political, social, regulatory and competitive * Exploit hedges and portfolio effects among the risks * Exploit the financial and operational efficiencies within the strategies

Answer 102

* Systematic risk: Risk that affects an entire financial market or system, and not just specific participants. It is not possible to avoid systematic risk through diversification * Diversifiable risk: Risk that arises from an individual component of a financial market or system. An investor is unlikely to be rewarded for taking on diversifiable risk since, by definition, it can be eliminated by diversification

Answer 103

* High level preliminary analysis to confirm that there are no big risks that mean it is not worth continuing * Brainstorming with project experts and senior internal / external people to identify likely / unlikely, upside / downside risks, discuss these risks and their interdependency, broadly evaluate the frequency and severity of each risk, generate and discuss initial mitigation options * Desktop analysis to supplement brainstorming which involves looking at similar projects undertaken by the sponsor and others * Consult with experts who are familiar with the details of the project and the plans for financing it * Risk register or risk matrix setting out risks and other interdependencies

Answer 104

* There may not be a wide enough range of assets available, in particular it may not be possible to find assets in sufficiently long duration * Liabilities may be uncertain in amount and timing * Liabilities may include options and hence have uncertain cashflows after the option date * Liabilities may include discretionary benefits * The cost of maintenance a full-matched portfolio is likely to be prohibitive

Answer 105

When benefits are known in advance: * Risk of inadequate funds * Risk of illiquid assets * Risk of benefit changes * Risk of failing to meet the beneficiaries’ needs When benefits are not known in advance: * Lower than expected benefits due to lower than expected investment returns or higher than expected expense returns * Lower than expected benefits due to worse than expected purchase terms for any investment vehicle * Not meeting beneficiaries’ needs * Higher than expected claim payments on non-life insurance policies (e.g. due to high property or court-award inflation) = risk to provider

Answer 106

* Complicated products * Incompetent advisor * Advisor lack integrity * Unsuitable model parameters * Errors in the data relating to beneficiaries * State-encourages but inappropriate actions

Answer 107

* Uncertainty over the level of timing of investment returns * Mismatching of assets and liabilities * Reinvestment risk * Default risk * Investment returns being lower than expected increasing provider costs * Lack of appreciation of benefits by recipients due to poor returns * Higher than expected investment expenses * Liquidity risk * Lack of diversification * Changes in taxation of investment income and gains

Answer 108

* Mortality and longevity * Morbidity * Pandemics * Expenses * Withdrawals * New business volumes * New business mix * Reinsurance * Anti-selection and moral hazard * Loose policy wording * Lack of data * Poor underwriting

Answer 109

* Claim amounts, including claim inflation / court awards * Claim frequencies * Accumulations and catastrophes * Expenses * Renewals and lapses * New business mix * Anti-selection and moral hazard * Loose policy wording * Lack of data * Poor underwriting * Changes in the cover provided or in the characteristics of policyholders * Reinsurance, e.g. inappropriate reinsurance chosen

Answer 110

* Risk profile is a complete description of the risk exposures of an organization, including risks that might emerge in the future and that will affect the current business of the organization * Risk limits is a group of guidelines that set limits on acceptable actions that might be taken today. If risk limits are adhered to, then each individual unit of the business should be deemed to be working within its permitted risk tolerances * Risk capacity is the volume of risk that an organization can take as measured by some consistent measure. If there is spare capacity, then it might be possible to take positive actions that add economic value to the organization without breaching existing risk tolerances or risk limits.

Answer 111

* Existing exposure to a particular risk * Culture of the company * Size of the company * Period of time for which it has operated * Level of available capital * Existence of a parent company * Level of regulatory control to which it is exposed * Institutional structure * Previous experience of board members * Attitude to risk of owners and other providers of capital

Answer 112

* The policyholder must have an interest in the risk being insured, to distinguish between insurance and a wager * A risk must be of a financial and reasonably quantifiable nature * The amount payable in the event of a claim must bear some relationship to the financial loss incurred

Answer 113

MUD PIS * Moral hazard eliminated as far as possible * Ultimate limit on liability undertaken * Data exists with which to price risk * Pooling a large number of similar risks * Independent risk events * Small probability of occurrence

Answer 114

* Scenario analysis * Stress testing * Combined stress and scenario testing * Reverse stress testing * Stochastic modelling

Answer 115

**Advantages:** * The simplicity of its expression * The intelligibility of its units, i.e. money * Its applicability to all types of risks * Its applicability over all sources of risk – facilitating easy comparisons between products and across businesses its inherent allowance for the way in which different risks interact to cause losses * The ease of its translation into a risk benchmark **Disadvantages:** * It gives no indication of the distribution of losses greater than the VaR * It can under-estimate asymmetric and fat-tail risks as it does not quantify the size of the “tail” * It can be very sensitive to the choices of data, parameters and assumptions * VaR is not always sub-additive (Subadditivity means that a merger of risk situations does not increase the overall level of risk) * If used in regulation it may encourage “herding” thereby increasing systemic risk

Answer 116

* Deviation: Can be measured as standard deviation or tracking error * Value at Risk: generalizes the likelihood of underperforming by providing a statistical measure of downside risk. VaR represents the maximum potential loss on a portfolio over a given future period with a given degree of confidence * Probability of ruin: is the probability that the net financial position of an organisation or line of business falls below zero over a defined time horizon * Tail Value at Risk: is the expected loss given that a loss over the specified VaR has occurred. The ratio of TVaR and VaR can be used as an indication of the skewness of a distribution. A higher ratio can indicate that the loss distribution is asymmetric with a fatter tail

Answer 117

* To identify any new risks faced by the business * Obtain a better understanding of the risks faced by the business in terms of quantifying the materiality and financial impact of individual risks * Determine the appropriate risk and control systems to manage specific risks * Proactively monitor and manage the effectiveness of risk and control systems within its business * Assess whether the risks faced by a business are changing over time * Assess the interaction between individual risks * Appropriately price, reserve and determine any capital requirements for its business * Give shareholders or potential shareholders in a business a greater understanding of the attractiveness of that business for investment * Help credit rating agencies determine an appropriate rating for the business * Give a regulator a greater understanding of the areas within a business which could require more scrutiny

Answer 118

* Avoid the risk altogether * Reduce the risk, i.e. by either reducing the probability of occurrence or the consequences of both * Reject the need for financial coverage of that risk because it is either trivial or largely diversified * Retain all the risk * Transfer all the risk * Transfer part of the risk

Answer 119

* The likely effect on frequency, consequences and expected value * Any feasibility and cost of implementing the option * Any “secondary risks” resulting from the option * Further mitigating actions to respond to secondary risks * The overall impact of each option on the distribution of NPV

Answer 120

* How likely the stakeholder believes the risk event is to happen * The stakeholder’s risk appetite * The resources that the stakeholder has to finance the cost of the risk event should it happen * The amount required by another party to take on the risk * The willingness of another party to take on the risk

Answer 121

**Advantages:** * QS is useful for small, new or expanding cedants who want to diversify their risk, write more risks or who would like reciprocal business * Administration is relatively simple since it is written by treaty and a constant proportion is ceded for all risks **Disadvantages:** * It is inflexible in that the same proportion of each risk is ceded, irrespective of the size or potential volatility * A share of profits will also be passed to the reinsurer * It does not cap large claims

Answer 122

* Profit is passed from cedant to reinsurer * Reinsurance premium is likely to exceed cost of benefits (in the long run) as it will contain loadings for expenses, profit and contingencies * Liability may not be fully matched by reinsurance * Possible liquidity issues * Reinsurer may default * Reinsurer may not be available on terms saught

Answer 123

**Advantages:** * The proportion of each risk passed to the reinsurer can vary from risk to risk, allowing the cedant the opportunity to “fine-tune” its exposure. It is therefore useful where risks are heterogeneous in nature * Surplus is useful for cedants who want to diversify their risk, write more risks or who would like to be able to write larger risks **Disadvantages:** * Surplus treaties are more complex and expensive relative to quota share due to the extra administration in particular of assessing and recording each risk separately. Therefore, surplus is generally more appropriate for larger more heterogeneous risks such as commercial property. * It does not cap large claims

Answer 124

* Risk XL covers losses from a single claim from one insured risk * Aggregate XL covers the aggregate losses from several insured risks, sustained from a defined peril (or perils) over a defined period, usually one year * Catastrophe XL is a form of aggregate XL reinsurance that pays out if a “catastrophe” as defined in the reinsurance contract, occurs * Stop loss is a form of aggregate XL that provides cover based on aggregate losses, from all perils, arising on a company’s whole account (or major class of business) over a specified period, usually one year.

Answer 125

**Advantages:** * Caps losses, hence allows the cedant to take on risks that could produce very large claims * Protects the cedant against individual or aggregate large claims * Helps stabilize profits from year to year * Helps make more efficient use of capital by reducing the variance of the claim payments **Disadvantages:** * The ceding provider will pay a premium to the reinsurer which, in the long run, will be greater than the expected recoveries under the treaty as it must include loadings for the reinsurer’s expenses and profit * From time to time, excess of loss premiums may be considerably greater than the pure risk premium for the cover (due to for example, poor experience over the last few years)

Answer 126

* Integrated risk covers: Reinsurance arrangements that typically cover several lines of general insurance business for several years. This is cost savings as there is no need for yearly negotiations. * Securitisation: Transfer of insurance risk to the banking and capital markets. Securitisation involves turning a risk into a financial security, such as catastrophe bonds. * Post loss funding: a way of raising capital to cover losses from a risk after the risk event has happened. * Insurance derivatives: Works like normal derivatives but for insurance * Swaps: Organisations with matching, but negatively correlated risks can swap packages of risk so that each organization has a greater risk diversification.

Answer 127

* Provision of cover that might otherwise be unavailable * Stabilitsation of results * Cheaper cover * Tax advantages * Greater security of payment * Management of solvency margins * More effective provision of risk management * As a source of capital

Answer 128

* It can protect against anti-selection * Enables risk classification into homogeneous groups for which a standard premium can be charged * Identify risks for which special terms need to be quoted * Identify the most suitable approach and level for the special terms to be offered * Helps to ensure that claims experience is close to assumed experience * Reduce the risk of over-insurance

Answer 129

BAD MEDICS * Benefit improvements for a benefit scheme * Accountants and reports – published and internal * Discontinuance / surrender benefits * Mergers and acquisitions * Excess of assets over liabilities and so whether any discretionary benefits can be awarded * Disclosure of information for beneficiaries * Investment strategy * Contribution / premium setting * Statutory solvency reports * Can also be used by a bank to provide for expected credit losses

Answer 130

* Best estimate basis: Set of assumptions that have an equal probability of overstating and understating the value of the assets and the liabilities * Optimistic (or weak) basis: Assumptions are chosen which collectively result in a high value of assets and/or a low value of liabilities * Cautious (or prudent / strong) basis: Assumptions are chosen which collectively result in a low value of assets and/or a high value of liabilities

Answer 131

* Consider accounting principles and legislation in the country concerned * Consider whether the accounts are to be prepared on a going concern basis (or is discontinuance happening?) * Consider whether they are required to show a true and fair view * Consider whether the basis required is the best estimate or some other basis and how this is to be interpreted * Shareholders and potential shareholders make decisions using information in a company’s accounts. It is therefore, preferable for values to be included in the accounts that represent an actuary’s best estimate of future experience

Answer 132

* Consider the regulation and legislation in the territory concerned * Consider whether the accounts are to be prepared on a going concern basis or a discontinuance basis * Consider whether the basis is prescribed or left to actuarial judgement * Consider whether there are any relevant rules and actuarial guidance * Regulators may wish to consider values that present a realistic picture of the provider’s finances. Alternatively, they may wish to consider values that intentionally understate the financial strength of the provider

Answer 133

* The transferring company will prefer optimistic assumptions * The receiving company will prefer cautious assumptions * A best estimate basis is fair, and the need to agree may result in a best estimate basis being used * However, the basis will depend on the relative bargaining powers of both sides and relative supply and demand for liability transfers * It is possible that the 2 sides agree that the transfer should not reflect a best estimate of future costs, for example, if they recognize a need to hold a margin to protect the security of the benefits

Answer 134

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

Answer 135

* In general, a cautious approach is taken * However, unless all guarantees are in the money, assuming the worst case scenario in every case will build in too much caution * A stochastic model should be used for valuing guarantees (taking the class of business as a whole), to show the likelihood of the guarantees biting and the associated cost. Parameter values should reflect the purpose for which the results are required * Guarantees may become more or less onerous over time * The value of guarantees and their influences on consumer behaviour will vary widely according to the economic scenarios and the sophistication of the market

Answer 136

* In general, a cautious approach is taken * However, this can build in too much caution. * For example, a policyholder may not exercise the highest cost option despite it being financially better for them to do so * It is necessary to allow for anti-selection risk when valuing options, or to mitigate this risk using eligibility criteria for exercising the option * Options and guarantees are not necessarily independent; some guarantees may make options more valuable in certain circumstances * Deterministic and closed-form methods could be used

Answer 137

* Best estimate + margin: a margin is explicitly built into each assumption. The size of the margin reflects the amount of risk involved and its materiality to the final result * Contingency loading: The liabilities are increased by a certain percentage. The size of the margin reflects the uncertainty involved. This method is very arbitrary * Discount rate: The discount rate is adjusted by a risk premium that reflects the overall risk of the liability. Usually defined by governing bodies

Answer 138

* The strength of the bases used * The impact of business growth * The statutory and accounting rules that apply in the country concerned * Usually prepared on a going concern basis and gives a true and fair view * Whether there have been any changes in accounting practice over the last year and what the effects of these changes are * The reports accompanying the accounts (including occurrence of exceptional events) * The effects of the underwriting cycle on insurance companies – should compare only against accounts of provider with similar business

Answer 139

* Chairperson’s / CEO’s statement * Investment report * Remuneration report * Corporate governance report * Uncertainty (risk) report * Strategic report These reports might disclose information such as commentary on: * The performance of the company against key objectives * The company’s investment strategy and investment performance * The progress of the company against its long-term and short-term strategic objectives * The company’s attitude to risk, the key risks it faces and how it manages to mitigate those risks * The company’s governance arrangements and how the board assures itself to independence

Answer 140

* Sponsor is aware of financial significance of benefits * Informed decisions can be made * Mis-selling (or misleading beneficiaries) is avoided * Manages the expectations of members * Encourages take up * Regulatory requirement * Security of scheme improved as sponsor / trustees are made more accountable

Answer 141

* Assumptions used * Actuarial method used * Value of liabilities accruing over the year * Increase in the past service liabilities over the year * Investment return achieved on the assets over the year * Surplus / deficit * Change in the surplus / deficit over the year * Benefit cost over the year in respect of any directors * Membership movements

Answer 142

* Continuation as a closed scheme, paying the accrued benefits as they fall due from the existing fund * Transfer of the liabilities to another scheme with the same sponsor * Transfer of the funds to the beneficiary as cash (if permitted by legislation) or to place with an insurance company or in the scheme of any new employer * Transfer of the funds to an insurance company to invest and provide a group policy or an individual policy in the beneficiary’s name * Transfer the liabilities to an insurance company to guarantee the benefits * Transfer of the liabilities to a central discontinuance fund, operated on a nation / industry-wide basis

Answer 143

* Who takes on the future risks of experience not being as expected * What expenses / costs will be incurred? * Does the method give members a choice? * Do the members need expertise to execute the option? * Do investments need to be realized, generating associate costs? * What security and / or guarantees does the method offer? * Will any surplus or deficit be crystallised?

Answer 144

* To provide a cushion against fluctuating trading volumes * To build up funds for a planned expansion * To fund the cashflow strain arising from the need to apy suppliers, fund work in progress and finance stock before the finished good is sold * To provide start-up capital * Need to cover development costs * Setting up of systems for administering the liabilities and admin costs * Costs w.r.t. collecting premiums * Need to pay commissions * Investment expenses * Costs of setting up initial reserves * Need to meet minimum capital requirements

Answer 145

* Regulatory requirement to demonstrate solvency * Expenses of launching a new product / starting a new operation * Guarantees can be offered (higher solvency capital requirement) * Cashflow timing management (mismatch benefits vs premiums / contributions) * Unexpected events cushion * Smooth profit * Helps demonstrate financial strength / attract new business / obtain a good credit rating * Investment freedom to mismatch in pursuit of higher returns * Opportunities * New business strain financing * Demonstrate strength (high credit rating) * Growth and acquisitions * Invest more aggressively

Answer 146

* Reinsurance * Financial resources * Securitisation * Subordinated debt * Banking products * Derivatives (helps mostly solvency, does not affect liquidity much) * Equity * Internal sources of capital

Answer 147

Solvency II is a solvency regime for insurance companies. It is a regulatory requirement for all EU states The 3 pillars are: * Quantification of risk exposures and capital requirements * A supervisory regime * Disclosure requirements

Answer 148

* The MCR (minimum capital requirement) is the threshold at which companies will no longer be permitted to trade * The SCR (solvency capital requirement) is the target level of capital below which companies may need to discuss remedies with their regulators.

Answer 149

* Regulatory capital is capital required by the regulator to protect against the risk of statutory insolvency * Economic capital is the amount of capital the provider determines it is appropriate to hold given its assets, liabilities and business objectives.

Answer 150

To provide the board and senior management of an insurance company with an assessment of: * The adequacy of its risk management and * Its current, and likely future, solvency position The ORSA requires each insurer: * To identify the risks to which it is exposed * To identify the risk management processes and controls in place * To quantify its ongoing liability to continue to meet its solvency capital requirements * To analyse quantitative and qualitative elements of its business strategy * To identify the relationship between risk management and the level of quality of financial resources needed and available

Answer 151

DIVERGENCE * Divergence of actual vs expected (show financial effect / significance of) * Information to management and for accounts * Variance as a whole is equal to the sum of the variances from the individual levers * Experience monitoring to feedback into ACC * Reconcile values for successive years * Group into one-off / recurring sources of capital * Executive remuneration schemes (data for) * New business strain (show effects of) * Check on valuation assumptions and calculations * Extra check on valuation data and process

Answer 152

* Mortality / morbidity * Withdrawals * New business volumes / new business mix * Premiums received * Expenses, including commission * Inflation * Investment income and gains * Tax

Answer 153

* To update the methods and assumptions adopted so they reflect expected future experience more closely * Monitor any trends in experience, particularly adverse trends, so as to take corrective actions * Provide information to management and other key stakeholders

Answer 154

* The banking book consists of everything not in the trading book * The trading book is a portfolio of financial instruments held by a bank, which are actively traded and which are to facilitate trading for the customers

Answer 155

* Corporate banks * Retail banks * Investment banks * Community banks * Traditional deposit taking banks * Reserve (or central) banks * Development banks

Answer 156

* Transactional accounts * Savings accounts * Credit cards * Overdrafts * Mortgage loans * Vehicle finance loans * Unsecured personal loans: revolving and term

Answer 157

* Transactional accounts * Overdrafts * Asset based finance * Unsecured loans * Merchant services * Foreign exchange and trade solution services * Cash solutions * Savings and investment products * Portfolio management

Answer 158

Credit risk Market risk: * Volatility risk * Currency risk * Basis risk * Interest rate risk * Liquidity risk * Commodity price risk Operational risk: * Internal processes * People * Systems * External events Liquidity risk Business strategic risk Pre-payment risk Model risk

Things to know (Summary) Flashcards

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