2012 PART III EXAMINATIONS

Subject Title: C2A Life Insurance

Date: Tuesday 24 April 2012

Time: 9:15 am – 12:30 pm

Time allowed: Three (3) hours plus fifteen (15) minutes of

reading time

Instructions: Each new question (but not each section of a

question) must be commenced in a new
answer book.

Number of Questions: Five (5)

Question Marks
1 20
2 23
3 23
4 14
5 20
Total 100

Candidates are required to answer ALL questions.

This paper has five (5) pages (excluding this page).
COURSE 2A LIFE INSURANCE APRIL 2012 EXAMINATIONS

Answer all 5 questions

QUESTION 1 (20 Marks)

As a newly qualified actuary you have recently been given responsibility for the pricing of
group life insurance for an Australian life insurance company. The group life business offers
a death benefit to which additional TPD benefits can be added. No death benefit is
payable once a TPD benefit has been paid and the TPD benefit is equal to the death
benefit. TPD is defined as “unable to perform at least one of the major duties of your job”.
The underwriting policy includes automatic acceptance and underwriting for benefits in
excess of the automatic acceptance limit.

After reviewing the numbers provided by the finance department, the Head of Group
Business (who has a sales background and is not an actuary) has written to you noting that
the following numbers suggest pricing problems for TPD business. The Head of Group
Business is concerned that Death insurance is subsidising TPD insurance and has suggested
that premiums for TPD be increased and those for Death be reduced.

Group Life Portfolio Premiums Claims Ratio

Death 2,000,000 1,400,000 70%
TPD 1,000,000 1,150,000 115%
Total 3,000,000 2,550,000 85%
Note: In the above table, premiums are on an “earned” basis, claims are on an “incurred”
basis and there is no reinsurance. You can assume that there are no problems with the
calculation of earned premiums or incurred claims.

a) Draft a reply to the Head of Group Business. (7 Marks)

b) The Head of Group business has been negotiating with a newly established mining
company which is interested in providing group insurance benefits for its workforce.
The Head of Group Benefits is proposing to offer a small amount of TPD as
compulsory cover for all members in the base product, and allowing individual
members the option to increase their TPD cover for an extra premium. Discuss the
issues you need to consider for this proposal, including (but not limited to) automatic
acceptance, underwriting and the TPD definition. (7 Marks)

c) Outline how you would implement an Enterprise Risk Management (ERM) framework
for managing the risks of the current group life portfolio. (6 Marks)

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 COURSE 2A LIFE INSURANCE APRIL 2012 EXAMINATIONS

QUESTION 2 (23 Marks)

You have been provided with the following profit test results for a single premium term
insurance contract which covers risk for a period of three years. There is no tax payable,
transfers are made at the end of each year and are equal to the value of assets in excess
of the valuation liability.

Year Policies Premium Reserve Initial Renewal Claims Reserve Transfer Interest Transfer
at Start BOY Expenses Expenses EOY EOY before
BOY EOY Interest

1 1,000 2,400,000 2,160,000 120,000 49,950 300,000 1,438,560 491,490

2 999 1,438,560 49,850 600,000 717,840 70,870
3 997 717,840 49,700 900,000 0 -231,860
994
Note: “BOY” means beginning of year and “EOY” means end of year

a)

i) Calculate the transfer for each year, assuming investments earn a 5% per
annum return. (3 Marks)

ii) Calculate the Profit Margin as a percentage of premium. (2 Marks)

iii) Calculate the Value of New Business transfers at issue using a 15% discount rate.
(1 Mark)

iv) Comment on the internal rate of return. (2 Marks)

b) What adjustments would you make to the valuation liability and how would this
impact the transfers, profit margin and the present value of transfers at issue?
Confirm your comments by giving an alternative basis and calculating the profit
margin on the alternative basis. (7 Marks)

c) Discuss the suitability of using the profit margin, internal rate of return and the present
value of transfers at issue for determining the appropriate premium rate for this
policy. (4 Marks)

d) Describe how you would determine a risk neutral price for this product. (4 Marks)

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COURSE 2A LIFE INSURANCE APRIL 2012 EXAMINATIONS

QUESTION 3 (23 Marks)

For a number of years you have been working in the retail pricing area of an Australian
bank, pricing home loans and banking deposit products. The bank you work for has
recently purchased a smaller Australian bank which has an Australian life insurance
company which only writes non superannuation risk insurance related to credit life and
mortgages. Premiums are charged on a monthly basis according to the amount of loan
outstanding at the start of the month.

The “One Bank” project team is looking at how to integrate the acquisition into the new
structure. In particular the project team has asked for your opinion on the restructure
proposals as you have previous experience working in an Australian life insurance
company.

a) The “One Bank” project team has asked you to identify three advantages and three
disadvantages for each of the following two proposals

Option 1 – Product Actuary: The Appointed Actuary works for the CFO, with the
pricing of life insurance products being delegated to a Product Actuary in the
Product Division.

Option 2 – No Product Actuary: The Appointed Actuary works in the product area
and is responsible for pricing life insurance products as well as the statutory
responsibilities. There is no Product Actuary role.

Draft your response and give, with reasons, your preferred approach. (8 Marks)

b) The life insurance company has previously paid a commission to the bank but the
bank is adopting a relationship manager role. The bank has suggested that the
insurance company should pay a share of the salary for each relationship manager
in addition to the usual commission. Commission rates will remain the same at 40% of
first year premium as there are significant sales volumes expected from the new
model. Projections using these sales volumes show that the overall commission plus
expense ratio as a percentage of premiums is forecast to remain steady over the 3
year projection period. Discuss this proposal and its financial impact on the life
insurance company as well as any further investigations you would like to make. You
can ignore any taxation issues. (8 Marks)

c) The “One Bank” project team has asked you to briefly outline the product
development process assuming Option 1 was selected. The outline should identify
each step, give a brief description of what is involved in each step and indicate
whether the bank or the life insurance company is responsible for the delivery of
each step. You can ignore the existing product development process for bank
products and you can assume that marketing and product design will be handled in
the Product Division of the bank and that distribution will be handled in the Retail
Network division of the bank. You can also assume that administration and actuarial
work will be carried out in the life insurance company. (7 Marks)

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COURSE 2A LIFE INSURANCE APRIL 2012 EXAMINATIONS

QUESTION 4 (14 Marks)

You are a Product Actuary who is calculating the Value of New Business for the non-
participating product portfolio of an Australian life insurance company.

a) Describe how you would determine the gross best estimate investment return
assumption to be used for the profit testing of non-participating products. (3 Marks)

b) Give a set of individual asset return assumptions which you believe are currently
appropriate. Return assumptions are needed for inflation, cash, government fixed
interest, commercial fixed interest, commercial property and listed equity asset
classes. (3 Marks)

c) One of the products you are reviewing is directly linked to the All Ords accumulation
index of the ASX (Australian Stock Exchange) and the unit price is determined as the
index value divided by 1000. In the normal course of events, premiums and claims
notified today have units allocated using the price calculated from the index value
for the close of business today, but funds are not invested until the following business
day. Transaction costs are 0.1% of actual trades. Daily unit fees (paid by deducting
units) are .005% of the number of units multiplied by the unit price. Units deducted for
fees are held in the shareholders account and redeemed at the end of the month at
which time they are transferred out of the unit fund.

Discuss the risks for this product and unit price design. (5 Marks)

d) The Marketing Department has suggested extending this index concept to overseas
markets and the Appointed Actuary has asked for your advice on this proposal.
Discuss the extra risks for overseas markets. Give, with reasons, your advice to the
Appointed Actuary on whether or not you would accept or reject the
recommendation. (3 Marks)

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COURSE 2A LIFE INSURANCE APRIL 2012 EXAMINATIONS

QUESTION 5 (20 Marks)

You are a qualified Actuary working for an overseas life insurance company which
commenced writing regular premium participating whole of life policies 10 years ago. The
participating fund is open to new business. For many years the company has been paying
bonuses which are the same as included in policy illustrations and which assumed a 6%
return on investment.

Under local regulations, participating business is written in a separate fund and premiums
are calculated using a traditional formula approach. The interest rate used in the
formulae must be 3% per annum and companies must use the same interest rate for
premiums and cash values, both of which are guaranteed. Bonuses are all declared as
cash payments. Shareholders receive a distribution of 25% of the cash bonus declared.

Regulations also state that policy funds for participating policies must be invested in
special government bonds which are only available to financial institutions. The special
government bonds are only sold for a ten year term and historically have been issued at
par with a coupon of 6% per annum. The special bonds can be sold in an active listed
market but only to other financial institutions. However, in the past year new special
government bonds have been issued at par with a 2.5% coupon per annum and future
issues seem likely to stay at this level.

The regulator is still considering lowering the rate of interest used to calculate the premium
rate but regulations are expected to take some time to finalise.

The Chief Actuary has asked you to prepare some written comments on some specific
areas that they need addressed for a report they are preparing. Your comments should
include recommendations for further investigations and cover the following areas:

a) The impact that the current investment climate has on the ability of the invested
assets to cover the product guarantees, both now and in the future. (Note: You do
not need to discuss valuation regulations) (7 Marks)

b) Ceasing to write new participating business until the regulations are changed.
(4 Marks)

c) The factors you would consider when determining a suitable basis for offering
conversion from a regular premium participating whole life product to the
company’s existing regular premium unit linked product. These factors should
include, but not be limited to, consideration of the impact on the customer, the
participating fund and the shareholders (2 marks for each of these factors). The
existing unit linked product has a premium charge of 5% of all premiums and a
management charge of 2% of assets. There are no other charges or penalties and
the full value of units is payable on surrender or maturity. (9 Marks)

END OF PAPER

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