2011 PART III EXAMINATIONS

Subject Title: C2A

Life Insurance

Date: Thursday 28th April 2011

Time: 9:15 pm – 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 18
2 22
3 25
4 17
5 18
Total 100

Candidates are required to answer ALL questions.

This paper has eight (8) pages (excluding this page).

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COURSE 2A LIFE INSURANCE APRIL 2011 EXAMINATIONS

Answer all 5 questions

QUESTION 1 (18 Marks)

An Australian financial services group offers single premium superannuation products

through both a wholly owned life insurance company and a unit trust company. A range of
different investment options is offered within the various products. Many of these options
have a property component but, because of the varying size of the funds, it is not practical
for them to hold their own property investments. Consequently, the funds invest in a
wholesale property trust run by the group. The wholesale property trust operates using a
single unit price.

A unit pricing error has recently been discovered. Due to a linkage problem with the
spreadsheets used in calculating the unit price for the superannuation products, the unit
price for the wholesale property fund has not been updated for the last 6 months. Over the
last 6 months the wholesale property unit trust price has declined by 10%, reflecting the
impact of recent revaluations. However, the strong performance of the retail funds over
this period (in part because of this error) has resulted in a large inflow of funds with the
result that the wholesale fund now has a significant volume of funds available for direct
investment.

As a consulting actuary, you have been asked for your recommendations on the error
correction process.

a) Outline the issues you would consider in determining your recommended

compensation for unit holders in both the life insurance company and the unit trust
company. (3 Marks)

b) Describe the checks and controls that you would recommend when calculating unit
prices and comment on their effectiveness in detecting the error.
(8 Marks)

c) What extra steps would you undertake to minimise the risk of errors occurring in
addition to the checks and controls recommended in b)? (3 Marks)

d) Discuss the advantages and disadvantages of using a single unit price for the
wholesale fund rather than separate prices for buying and selling units. Give your
recommendation. (4 Marks)

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COURSE 2A LIFE INSURANCE APRIL 2011 EXAMINATIONS

QUESTION 2 (22 Marks)

As the pricing actuary for an overseas life company, you have been provided with the
following profit test and pricing results (see next page) for a single premium insurance
contract covering an interest only mortgage sold through mortgage providers. This
insurance is compulsory for mortgages in this market and the insurance will cover the
amount of the mortgage outstanding on the date of death. Policies are issued on the basis
of simplified underwriting assessed on 4 health questions. The life insured in this profit test
is a male aged 55.

a) Comment on the results including the following:

- factors affecting profitability
- sufficiency for future expenses
- pattern of claims
- earnings pattern
- use of an internal rate of return profitability measure for this product
- other relevant factors you would have investigated

(7 Marks)

b) What sensitivity tests would you ask for and why? Indicate the most important
sensitivities and why you consider these to be important. (5 Marks)

c) Following consumer pressure, banks have launched mortgages that can be transferred
from one property to another, and to change insurance from being payable by a single
premium, to monthly premiums. What issues arise for the mortgage provider and
your company? (5 Marks)

d) It has been suggested that the new monthly premium product should include
unemployment insurance. What are the policy design considerations you need to
assess before determining a price? (5 Marks)

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COURSE 2A LIFE INSURANCE APRIL 2011 EXAMINATIONS

PROFIT TESTING AND PRICING RESULTS

Profit Test Assumptions

60% of IA64/70 ultimate

Reserve Reserve at
Year Age qx lx dx wx lx+1
at Start End

1 55 0.00000 1.00000 0.00000 0.00000 1.00000 7,200.00 6,480.00

2 56 0.00000 1.00000 0.00000 0.10000 0.90000 6,480.00 5,760.00
3 57 0.00640 0.90000 0.00576 0.08942 0.80481 5,760.00 5,040.00
4 58 0.00714 0.80481 0.00575 0.07991 0.71916 5,040.00 4,320.00
5 59 0.00796 0.71916 0.00573 0.07134 0.64209 4,320.00 3,600.00
6 60 0.00886 0.64209 0.00569 0.06364 0.57276 3,600.00 2,880.00
7 61 0.00986 0.57276 0.00565 0.05671 0.51040 2,880.00 2,160.00
8 62 0.01096 0.51040 0.00559 0.05048 0.45433 2,160.00 1,440.00
9 63 0.01216 0.45433 0.00553 0.04488 0.40392 1,440.00 720.00
10 64 0.01349 0.40392 0.00545 0.03985 0.35863 720.00 0.00

Best Estimate Cash flow model using Statutory

Reserves

Increase Statutory Invested Interest Interest

Expenses and Investment
Year Premium Claims in Earnings Reserve at Assets at on Assets on Cash
Commission Income
Reserves Start Start at Start Flows

1 7,200.00 -2,304.00 0.00 -6,480.00 604.80 -979.20 7,200.00 7,200.00 360.00 244.80
2 0.00 0.00 0.00 1,296.00 324.00 1,620.00 6,480.00 6,480.00 324.00 0.00
3 0.00 0.00 -576.18 1,127.74 259.20 810.76 5,184.00 5,184.00 259.20 0.00
4 0.00 0.00 -574.64 949.49 202.81 577.66 4,056.26 4,056.26 202.81 0.00
5 0.00 0.00 -572.60 795.25 155.34 377.99 3,106.78 3,106.78 155.34 0.00
6 0.00 0.00 -569.02 661.98 115.58 208.53 2,311.53 2,311.53 115.58 0.00
7 0.00 0.00 -564.63 547.08 82.48 64.93 1,649.55 1,649.55 82.48 0.00
8 0.00 0.00 -559.20 448.24 55.12 -55.84 1,102.47 1,102.47 55.12 0.00
9 0.00 0.00 -552.56 363.41 32.71 -156.43 654.24 654.24 32.71 0.00
10 0.00 0.00 -545.06 290.83 14.54 -239.69 290.83 290.83 14.54 0.00
Total 0.00 2,228.71 0.00 0.00
NPV
5.0% 7,200.00 -2,304.00 3,314.30 -1,018.53 1,594.53 2,157.70 1,361.39 233.14
15% 7,200.00 -2,304.00 1,924.95 -2,161.49 1,246.41 2,055.97
Profit Margin as % of premium @ 5% 30.0%

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COURSE 2A LIFE INSURANCE APRIL 2011 EXAMINATIONS

QUESTION 3 (25 Marks)

You are the Pricing Actuary for a medium sized Australian Life Office distributing through
independent financial advisers. The Life Office has a market share of 5% of the total life
insurance market. Your guaranteed renewable disability income product has had low sales
(less than 1% market share) and you have recently completed a pricing review for the
product. However the new pricing, which is based on the most recent overall company
experience and target yield on transfers, is still not competitive. An actuarial student in the
marketing department has suggested that you split the aggregate morbidity assumption
using a higher percentage of smokers and a higher smoker claim ratio in order to achieve a
more competitive non-smoker rate. The Head of Marketing has suggested that you review
all assumptions in order to get a more competitive product.

a) List the assumptions needed to price a typical disability income product.

(3 marks)

b) Identify the sources of information you would consult before reviewing your
incidence and termination rate assumptions and relate why each is important to your
review. You should note that sources should include internal departments and
external parties.
(6 Marks)
c) Discuss the issues you would consider in responding to the actuarial student in the
Marketing Department, and outline the implications for the company if the
suggestion is implemented. Consider the impact on new business and on repricing
the in-force block.
(5 Marks)

d) The same actuarial student has pointed out that “our top occupational category
experience has been impacted by the inclusion in that category of the bad claims
experience from policies covering disability for the company’s tied agency force.
We could get a more competitive premium rate in the top occupation category by
giving a lower occupation rating to policies covering the company’s tied agents.”
Discuss the issues you consider in your reply, including the impact on new business
and on repricing the in-force block.
(5 Marks)

e) A reinsurer has offered to take 85% of the risk for the contract using a standard 90
day waiting period for all contracts. Most of your business is for a 30 day waiting
period. Your initial calculations show that this will make your premium rates
competitive and meet your profitability criteria. Discuss the items you would
consider in assessing this offer for this product, mentioning any further analysis you
would require. (6 Marks)

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COURSE 2A LIFE INSURANCE APRIL 2011 EXAMINATIONS

QUESTION 4 (17 Marks)

You are the Appointed Actuary for a listed Australian life insurance company which
distributes business through three different channels – independent financial advisers,
banks and direct marketing. The Channel sales mix has been stable for a number of years.
Actual sales last year were 40m/30m/30m for independent financial advisers, banks and
direct marketing respectively. The bank channel operates in an arrangement with a single
bank.

The distribution agreement with the bank is now due for renewal. The initial tender has
indicated that your company is likely to lose this business unless commission rates can be
increased.

Until now pricing has been done on an average basis with the same unit expense
allowances used for each channel. Some products are sold in more than one channel but
when this happens, the same premiums and charges apply in each channel.

The CEO has said that it would be disastrous for the company to lose its long established
relationship with the bank and this would need to be disclosed in the soon to be released
annual results which include the embedded value, sales results and sales forecast. The
CEO has therefore asked you to use lower expense allowances for the bank channel when
determining the maximum commission payable to the bank. Premiums and charges for
products offered in the bank channel will remain unchanged.

a) Discuss the issues you would consider for using different expense allowances for
each distribution channel when determining the expense allowances for overhead
costs and IT costs. (5 Marks)

b) Evaluate the impact of using different expense allowances for each distribution
channel from the perspectives of each of the following direct reports to the CEO

- CFO (Chief Financial Officer)

- Head of Products
- Channel Sales Heads (Head of Agency Sales, Head of Bank Sales, Head of
Direct Sales)

Assume that your investigations have shown that the acquisition expense
assumptions should be calculated in the ratio of 120/80/100 for independent financial
advisers, bancassurance and direct marketing respectively. No change is required for
maintenance expense assumptions. (8 Marks)

c) The bank business has been retained by increasing commissions in the bank channel
whilst leaving prices unchanged. Your CEO has asked for your initial thoughts on
how to determine the annual bonus for the channel heads now that different expense
allowances have been introduced. Outline your reply. (4 Marks)

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COURSE 2A LIFE INSURANCE APRIL 2011 EXAMINATIONS

QUESTION 5 (18 Marks)

You are the Appointed Actuary of an Australian Life Insurance company which has
recently acquired Pacifica Life, a life insurance company in Pacifica, a developing Pacific
island nation. The Pacifican government is financially sound due to the strong demand for
its natural mineral resources and manages the Pacifican dollar so it is linked to the
Australian dollar (P$2 = A$1), and financial contracts may be written in either A$ or P$.

Investments in P$ are limited to Pacifican bank deposits, 5 year government bonds (current
yield 2%) and 2 year corporate bonds (current yield 3%) so most insurance contracts are
written in A$ and invested in A$. Where Pacifican life companies invest in A$
investments they are only permitted to invest in securities issued by Australian banks and
Australian government bonds. There is no corporate or income tax in Pacifica as the
government earns sufficient income from resource royalties.

Individuals can only invest in insurance contracts or bank deposits and cannot invest
overseas. Bank deposits are currently paying 0.1%.

The only insurance contract available in Pacifica is 10 year non-participating endowment

insurance with premiums of $1,000 pa payable annually in advance for 4 years. The Sum
Insured for the policy is equal to 104% of total premiums due under the policy and is
payable on death or maturity.

All insurance is sold through banks. The banks receive a total commission payment of
20% of the first year’s premium. Although Pacifica Life has only been established for five
years, it has a stable expense structure and expenses approximately equal to 20% of the
first premium and $50 p.a. in the second and subsequent years. The mortality of insured
lives is equal to 70% of IA90/92 ultimate. The maximum issue age is 55.

You can assume that:

- the current A$ bond yield is 5.7% for 10 year, 5.6% for 9 year, 5.5% for 8 year and
5.4% for 7 year
- the average duration of net cash flows is 8 years
- the sum of net cash flows is $3,150 without interest or discounting.

a) Describe the issues you would consider in determining the investment return
assumption used in pricing this contract. Do not calculate any returns.
(3 Marks)

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COURSE 2A LIFE INSURANCE APRIL 2011 EXAMINATIONS

b) A student has provided the following tables. Use these numbers to derive an
appropriate surrender value basis for this product and provide an initial estimate of
the surrender value to be published in the policy document for the end of policy year
1, 3, 5 and 8. As the policies are sold through the bank the basis needs to be as
simple as possible.
Expense
and Net Accumulation of Net Cash Flow at end of Policy Year using
Policy Commis Cash
Year Premium sion Flow
5.00 4.50 4.00 3.75 3.50 3.25 3.00 2.75
% % % % % % % %
1 1000 -400 600 630 627 624 623 621 620 618 617

2 1000 -50 950 1,659 1,648 1,637 1,631 1,626 1,621 1,615 1,610

3 1000 -50 950 2,739 2,715 2,690 2,678 2,666 2,654 2,642 2,630

4 1000 -50 950 3,874 3,830 3,786 3,764 3,743 3,721 3,700 3,678

5 -50 -50 4,015 3,950 3,885 3,854 3,822 3,790 3,759 3,728

6 -50 -50 4,163 4,075 3,989 3,946 3,904 3,862 3,821 3,779

7 -50 -50 4,319 4,207 4,096 4,042 3,989 3,936 3,884 3,832

8 -50 -50 4,482 4,344 4,208 4,142 4,077 4,012 3,949 3,886

9 -50 -50 4,654 4,487 4,325 4,246 4,168 4,091 4,016 3,941

10 -50 -50 4,834 4,636 4,446 4,353 4,262 4,172 4,085 3,998

Policy Accumulation of Premiums paid at the end of the Policy Year using
Year Premium
2.00 1.50 1.00 0.75 0.50 0.40 0.25 0.10
% % % % % % % %

1 1000 1,020 1,015 1,010 1,008 1,005 1,004 1,003 1,001

2 1000 2,060 2,045 2,030 2,023 2,015 2,012 2,008 2,003

3 1000 3,122 3,091 3,060 3,045 3,030 3,024 3,015 3,006

4 1000 4,204 4,152 4,101 4,076 4,050 4,040 4,025 4,010

5 4,288 4,215 4,142 4,106 4,071 4,056 4,035 4,014

6 4,374 4,278 4,183 4,137 4,091 4,073 4,045 4,018

7 4,461 4,342 4,225 4,168 4,111 4,089 4,055 4,022

8 4,551 4,407 4,268 4,199 4,132 4,105 4,065 4,026

9 4,642 4,473 4,310 4,231 4,153 4,122 4,076 4,030

10 4,734 4,540 4,353 4,262 4,173 4,138 4,086 4,034

(7 Marks)

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COURSE 2A LIFE INSURANCE APRIL 2011 EXAMINATIONS

c) It has been suggested that a terminal bonus, paid as a percentage of the maturity
value, should be added to improve the marketability of the policy. Participating
products, profits are distributed 80% to policyowners and
20% to shareholders respectively. Evaluate this suggestion.
(4 Marks)

d) A board member of your company has asked whether or not the Pacifican product
has potential as a non superannuation life product in the Australian market as your
company is looking to drive revenue growth next year. Draft your reply to the
director covering the issue of the attractiveness of the Pacifican product for the
customer in the current Australian market (consider tax and distribution costs).

(4 Marks)
END OF PAPER

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