(Papers) ACET Paper May 2010 "ST2 – Life Insurance "

(Papers) ACET Paper May 2010 "ST2 – Life Insurance "

Q. 1) A company sells only non participating term insurance business. The company reinsures the policies on its books on a risk premium constant retention basis whereby death benefit at risk above a specified retention limit is ceded to the reinsurers.

i) The company has calculated the reinsurance premium due for the recent quarter. Mention the checks you might apply in order to ensure consistency, accuracy and completeness of the reinsurance premium calculations.

ii) The company plans to launch a new non participating term product targeting lower socio-economic segments of the society for the first time. Death benefits are likely to be much lower than the current retention limits of the company. Explain the reinsurance arrangement the company might use to reduce its risks under this product

Q. 2) A life insurance company promotes a limited payment unit-linked contract with the following features:

  • A death benefit of 105% of fund value of units

  • Surrender benefit of 100% of fund value of units

  • Initial commission of 15% of the first year’s premium; renewal commission of 1% in years 2 and 3

  • Policy term of 10 years with a premium payment term of 3 years

  • Maximum entry age 65

  • No medical underwriting

The charges under the contract are:

  • Initial charge of 10% of one year’s premium

  • Fund management charge at the rate of 1% per annum of the value of units, charged by deduction of units at the beginning of each month

i) Discuss the risks to the company of selling this product

To improve the competitive position of this product in the current economic downturn, the company proposes to introduce a ‘watermark’ guarantee in which the unit price at maturity is guaranteed to be not less than the highest unit price recorded on any day during the 10-year term of the policy. The fund will be close-ended and will be invested  in a mixture of equities and bonds. This guarantee is available only on maturity and not on earlier death or surrender.

ii) Discuss the additional risks to the company of this proposal.

The company operates in a country where insurance companies are prohibited from using derivatives. Further, the company is very risk averse and wants to keep the risks to a minimum without compromising the competitiveness of the proposal.

iii) Explain the investment strategy that the company would adopt in such an environment to manage the additional risks arising from this proposal.

Q. 3) In the context of the supervisory valuation of a life insurance company

i) State the principles of setting supervisory reserves for solvency purposes.

Realistic reserves i.e. reserves without any prudential margins are sometimes used by management for measuring company’s financial performance and rewarding key staff.
ii) State the main reasons why these realistic reserves might be negative at the start of a contract
iii) Explain why a premium pricing basis can sometimes be stronger than the reserving basis

Q. 4) The insurance regulator of a developing country has recently published a report on the persistency experience in the industry. A life insurance company, which has been writing predominantly unit-linked business ever since it commenced operations four years ago, has found that its persistency experience is the worst in the industry and is also much worse than that assumed in its pricing basis.

i) Discuss the possible reasons for the poor persistency experience of the company.
ii) Discuss why poor persistency may be taken seriously by the management of the company.

Q. 5) Regulations surrounding unit pricing and allocation in a certain Asian country have recently been changed requiring a company selling unit linked contracts to allocate/de-allocate units to policyholders on the same day’s unit price as the cash/cheque for renewal or request for surrender/cancellation is received. A company operates sales offices all around this geographically diverse country where such requests are received but processing takes place at a single central location in batches

i) State the basic equity principle in unit pricing for internally linked funds As a result of compliance with the new regulations, the company is experiencing gains and losses in shareholder account in order to maintain existing policyholder’s equity.
ii) Explain why such a gains and losses might occur

The stock markets have become more volatile as a result of the recent financial crises. The Board of Directors has asked for a plan to minimize these gains and losses on the shareholders’ account.

iii) The Chief Operating Officer has in turn approached you to come up with a range of steps that might be taken to overcome this situation. Mention the steps you would outline in your advise to the COO

The company has been using appropriation price for unit pricing. Recent financial crises have reduced Unit Linked Insurance Plans (“ULIP”) sales to a minimum and a significant proportion of existing policyholders have started surrendering their policies.

iv) Explain the changes that need to be incorporated in the unit pricing bases to maintain policyholder equity

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