ACTL40006/90010 Actuarial Practice & Control I 2022

Question 1

You have been invited to an international panel discussion on superannuation trends globally.

Provide brief explanations to the following questions from audience members           interested in the trends experienced in Australia and how they might apply in their    own countries where Defined Contribution arrangements have been introduced more recently.

(a) “In our country, we have a large number of corporate standalone                   superannuation funds.  What has been the recent experience in Australia for corporate standalone funds (number of funds and number of members) and what are the key drivers for this trend?”

(4 marks)

(b) “I have heard that the Australian market divides large funds available to the public into two groups.  What are these groups and what are the key            differences between them?”

(4 marks)

(c) “Elsewhere in the world, Defined Benefits are very popular.  What are the key reasons why Defined Contribution arrangements are more popular for              employers in Australia?”

(4 marks)

Total marks for question 1 = 12

Sample solution to Question 1

(a) (1 mark per point or similar; 4 marks maximum)

.    Trend is for reducing number of funds and reducing members

.    Corporate funds have insufficient economic scale

.    Increased regulatory cost

.    Increased market competition

.    Pressure from regulator to increase scale/efficiency by merging/outsourcing

.    Lower interest in running standalone fund from employer-sponsor

.    Better features and lower cost in large industry/retail fund

(b) ( 1 mark per point or similar; 4 marks maximum)

.    Two groups are retail funds (or master trusts) and industry funds

.    Retail has capital from shareholders whereas industry funds have limited capital and typically hold reserves funded by members

.    Industry funds are“profit-for-members”whereas retail funds need to generate profit for shareholders

.    Industry funds typically have lower fees and features vs retail funds with higher fees/more features

(c) (1 mark per point or similar; 4 marks maximum)

.    DC funds are consistent with legislation/Super Guarantee

.    Investment risk and inflation risk transferred to employees

.    Able to make own investment choices 一 aim for long term returns greater than salary inflation

.    More flexibility of insurance benefits than defined benefits

.    More flexibility of member contributions 一 no compulsory contributions required

.    Easy to stay with the same fund if you change jobs

Question 2

The following question considers the environment, product features, and risks of Lenders Mortgage Insurance (LMI).

(a) In your own words, describe the operation of LMI, including the circumstances in which an LMI policy is required, and the circumstances in which a claim would be made.

4 marks

(b) In your own words, provide two reasons (including clear explanations)

why LMI is different than most other General Insurance products.

2 marks

(c) From the policyholder,s point of view, provide a relevant example of how an inherent risk is mitigated by the purchase of LMI.

2 marks

(d) In your example from part (c), explain the residual risk that remains to the policyholder.

1 mark

(e) Do you regard LMI as a short tailed or long tailed product? Give reasons for your answer.

1 mark

(f) An executive at a major LMI provider makes the following comment: “Over the past four years, we have made claim payments less than 1 per cent of the premiums we have collected over the same period. That period has included the pandemic where we might have expected higher claims. The LMI portfolio is extremely profitable; even if we cut our premiums significantly, we could gain market share and boost our overall profits”.

Provide an assessment of the executive,s comments.

5 marks

(g) You have been asked to develop a model of claims costs of the LMI portfolio. Identify with reasons three variables that you would expect to be material in your model.

3 marks Total Marks for Question 2 = 18

Question 2 - sample solution

(a) LMI will be required by a lender if the borrower is seeking a home loan but   requires a loan to value ratio above a certain threshold (say 80%). Students     may flip this around and say that their deposit is insufficient. In these              circumstances lenders (such as banks) will require the borrower to take out an LMI policy, so it is effectively compulsory.

A claim will be made in the circumstances where the borrower defaults on the loan. The lender, as mortgage holder, is then able to force the sale of the         house. It is only if the amount of proceeds is lower than the amount of the       remaining loan that the LMI claim will then occur. The claim amount will      cover any shortfall in the loan. If the sale proceeds are higher than the             outstanding loan amount, the excess will go to the homeowner, and no claim  under LMI will be necessary.

(b) Main two differences are:

The premium is paid by the borrower but they are effectively protecting the lender/bank, so the stakeholder paying the premium is not getting the main “benefit” .

Multi-year exposure paid by a single premium, although this may be then “financed” as part of the overall repayments.

Other relevant ones may be:

It,s my understanding that if you received some windfall such as an               inheritance and paid down the loan to well under the threshold you wouldn,t get any refund of the LMI premium.

Typically individual policies are bundled by the lender, so if insured by an external insurer, the policy covers a whole lot of individual policies.

Reflecting material provided in lectures, students may refer to the pattern of   exposure reducing over time as loan paid down and house values increase, but intended these are dealt with in part (f).

(c) Looking for a reasonable risk. E.g. Inherent risk of financial distress leading to inability to pay homeloan and eventual default, so lender exercises mortgage.  This risk could/should be specifically covering that risk that the sale value       won,t meet the outstanding loan.

(d) Should be linked to the inherent risk from part (c). e.g. Residual risk of         financial distress from other areas of life. The reduction in risk from inherent to residual only covers this one small part of financial exposure. Also could  say that the hassle of getting a claim processed etc is part of the residual

(e) Long tailed, as would likely be several years after issuance that a claim could potentially occur. Also likely to be significant delays for bank to impose        mortgage, force sale etc.

(f) Expectation that students will address all aspects of the statement to get full marks.

Expect discussion that the last four years have been a period of increasing    house prices, relatively low unemployment, and relatively low interest rates. So would expect very few claims over this period.

Would hope that better students would identify that payments over last few years aren’t necessarily related to the policies written over that same period. Given the natural delays between policy and claim and processing delays,    these payments would relate to earlier periods. Consistent with this, need to allow for the claims associated with the last four years’ policies to be paid   sometime in the future.

Probably wouldn’t expect students to comment that policies are grouped, but would award bonus marks if they did.

With respect to the pandemic, while unemployment is now low, presumably significant financial distress for a cohort, particularly small business owners? Banks and lenders allowed repayment “holidays”, and this may have delayed the emergence of potential claims. Also a factor that following royal              commission, banks may be reluctant to foreclose on mortgages.

Premiums should be set on the basis of a long term cycle i.e. in the full            knowledge that many years of benign experience could then be followed by    very significant claim payments. This reflects the circumstances that could      lead to widespread financial distress and inability to make home loan               repayments; these could coincide with falling residential property prices. In    terms of cutting premiums to gain market share, this would presumably ignore the professional cycle of the CC by failing to consider what competitors are    doing, and the reasons they are charging that premium.

(g) Claims cost will be primarily driven by value of properties and distress in        home loans. Accordingly would we looking for some variable reflecting house prices, and some variable reflecting loan paying ability. Not expecting             students to come up with anything sophisticated, so something like                   unemployment rate would suffice.

Other relevant variables would be amount of loan, or loan to value ratio,     policy or premium volume (for future periods), age of loan, original loan to value, income of policyholders.

Hard to justify own recent claims experience would be a relevant material variable. Fine if students mention CC, esp analytic cycle, provided they    identify appropriate variables.

Question 3

You are working for a global HR consulting firm and one of your clients,                 CrownTwenty Australia, has appointed a new HR director.  His previous roles have mostly been in Europe and so he has asked for a meeting to discuss aspects of         CrownTwenty Australia,s superannuation arrangements.

A large majority of the Australian employees are in the defined contribution employer sub-plan, CTASP.  The sub-plan is part of a large master trust with tailored                  investment and insurance arrangements specifically for CTASP members.                   CrownTwenty is responsible for the design of the tailored investment and insurance    design, but fees and insurance premiums are deducted from members, accounts.

He has sent an email outlining some of the areas he would like the discussion to  cover.  Prepare your notes for the meeting in response to the following questions. Your answers should include particular focus on the objectives and nature of       Australian superannuation arrangements.

(a)  “I note that the default investment option has a 75% allocation to growth

assets.  Why is there not a greater allocation to cash and other defensive assets to protect employees, retirement benefits?” (4 marks)

(b) “The default investment option has an allocation of 10% to unlisted assets,   including direct property, private equity and infrastructure.  I have heard that some other funds have unlisted allocations of over 20%.  What are the          advantages and disadvantages of a higher allocation to unlisted assets?” (4    marks)

(c) “The Australian default death insurance benefits are calculated as 15% x     Salary x Years of Future Service to age 65.  What are the advantages of this formula compared to our global death benefits of 3 x Salary?” (4 marks)

(d) “I can see the advantages of offering insurance benefits to all employees at a  default level with no underwriting.  Why is underwriting required if                employees want to increase the factor in the death benefit to 20% or 25%?” (4 marks)

Total Marks for Question 3 = 16

Sample solution to Question 3

(a) (1 mark per point or similar; 4 marks maximum)

.    Long investment timeframe to retirement age and afterwards

.    Greater expected long term investment returns of growth assets

.    Returns need to be considered relative to inflation risk 一 defensive assets do not provide as large a premium above inflation risk

.    Consistent with other default allocations in the market 一 lower returns relative to competitors will result in unhappy employees or employees choosing other funds

(b) (1 mark per point or similar; 4 marks maximum)

.    Advantage 一 More diversification of assets reduces concentration risk, offsets some volatility of total returns

.    Advantage 一 Unlisted assets are not priced regularly, so the value is not as volatile in the very short term

.    Disadvantage - Increased liquidity risk becomes more of an issue as allocation is higher

.    Disadvantage 一 Allocation to unlisted assets can increase even further    during economic downturns as listed assets have large drops in value and are sold off to cover immediate liquidity needs. This can exacerbate the liquidity issue

(c) (1 mark per point or similar; 4 marks maximum)

.    In Australia, superannuation death benefits are equal to the account balance plus the insurance cover.

.    So as a member ages, the account balance increases, the insurance cover can reduce to provide the same benefit.

.    Death premiums increase with age, so reducing cover with age keeps premiums relatively stable.

.    Since members pay premiums, it would be an advantage to offer reducing levels of insurance cover to keep premiums consistent across all ages.

(d) (1-2 marks per point or similar; 4 marks maximum)

.    Group insurance can provide automatic acceptance levels because there is a large pool of relatively healthy members (2 marks)

.    As all members receive the default cover, there is negligible selection risk, unless large numbers of (healthy) members opt-out of cover

.    An option to increase the factor to 20% or 25% without underwriting      would attract the least healthy members to increase insurance in response to their increased chance of death or disability, particularly if there is no restriction on when members can change their cover level.

Question 4

You are the Appointed Actuary of Oh My Life, a life insurance company operating in the Australian market. Oh My Life offers three core products - a yearly renewable life insurance product, a major trauma product and an investment account savings product which is guaranteed to not reduce in value.

Oh My Life has 3 key strategic objectives:

(1) to become the largest insurer in Australia

(2) to become a household name in Australia

(3) to deliver a return on investment of 12% to its shareholders

You have been asked by the Board of Oh My Life to present your ideas on how the    company could respond in the event of a severe pandemic. You are to assume that the pandemic has the potential to spread to up to 60% of the population, and that it           increases the mortality rate of those infected in each age group by the following

amounts:

They have specifically asked you to address these 2 questions:

a)   For each of our major product lines, what are the specific risks that could  emerge in the event of a pandemic? You should consider both existing and new business

(6 marks)

b)   What are the key assumptions you need to consider and data you require in quantifying the potential effect of these risks on Oh My Life?

(4 marks)

Total Marks for Question 4 = 10

Solution 4

Yearly renewable term product:

Sales

一 impacted by potentially higher unemployment / lower cash reserves 一 may be some panic buying of life insurance

Existing business

一 claim rates increase quite dramatically with age; massive rise in risk

for older lives insured 一 impact on profit

一 likely higher terminations; can administration processes cope? Impact

on product profitability and on value

一 higher claims 一 can claims team cope with increased volumes?

Investment account

Sales

-      likely to be heavily impacted by cash flow needs

-     guarantee likely to be attractive to risk averse people

Existing business

一 assets backing product likely to have reduced in value; possible impact

on capital position

一 -potential terminations by people needing to access capital; possible

impact on profit, value and

Assumptions and data required (half mark per point):

Need to identify: internal data and assumptions, external / market data and

assumptions 一 link back to specific qualities of the two products

Internal (max 2 marks)

.    portfolio data by age (for yearly renewable term)

.    mortality assumptions for yrt

.    mortality experience for yrt

.    asset mix (including min and max allocations) of portfolio backing the investment account product

.    crediting rate policy and history .

External (max 2 marks)

.    rate of spread of virus

.    historic  population mortality

.    mortality rate increases - understand how they increase across each age band (get further breakdown)

.    re-infection rates and whether mortality changes on re-infection

.    economic affects - impacts on terminations, new business sales

.    economic assumptions - impact on investment portfolios, impact on guaranteed product and impact on capital position

Question 5

You have been invited to meet with a visiting executive from a global life insurance   company who is interested in entering the life insurance market in Australia. The        executive is keen to understand more about the life insurance market in Australia, and in particular what kinds of business can be sold through a life insurance business in

Australia.

Provide a response to the executive,s request for the following information

(a) Describe the key features of an investment linked and a income protection   product. Describe the needs that each of these products meets for the            policyholder. Describe the limitations of these products from a policyholder perspective.

(4 marks)

(b) More than half of life companies in Australia have been sold in recent years, many to overseas companies. What may be some reasons behind this? What may make the Australian market attractive to overseas insurers?

(4 marks)

Total Marks for Question 5 = 8

Solution 5

Investment linked product:

Features - provides returns to policyholder based on market returns (both upside and downside); many choices of product with varying degree of growth or          stability

Policyholder needs - get the full, benefit of market gains, transparency, select product that matches risk appetite

Limitations - no guarantee of return 一 downside risk and volatility Income protection product:

Features: provides income stream to policyholder on event of being unable to    work due to illness. Income streams continues while policyholder unable to work, up to a designated time. Income stream capped in Aust at 75% of income

Policyholder needs - provides income replacement during period of sickness. Can determine period of benefit, waiting period etc. (within limits)

Limitations - subjective definition , policy limits may mean benefit ceases while person still not able to work

Possible reasons for sale activity:

.    Broader environment 一 Royal Commission into Banking and Finance, robo advice changing market competition / profitability

.    LI Environment 一 losses in product lines such as income protection

.    Industry re-shaping -> for example, banks returning to core business and selling off non core activities

Why might Aust be more attractive to overseas insurers?

.    ROI differential;

.    Risk appetite of different entities / countries

.    Diversification of risk by geography

.    Scale opportunities for global players

Question 6

You have been asked by the Chairman of My Insurance to advise on how his organisation should set their risk appetite.

(a) Define risk appetite and outline the key considerations and roles and

responsibilities for setting and communicating risk appetite across an organization

(4 marks)

(b) Explain why the chairman of the Board is interested in discussing this with you rather than the CEO or the CRO or Chief Actuary of the organisation. What does this suggest or imply about the role of the Board?

(3 marks)

(c) If the inherent risks of an organisation exceed its risk appetite, what actions can an insurer take to reduce its inherent risk?

(3 marks)

Total Marks for Question 6 = 10

Solution 6

(a) Risk Appetite

一 Aggregate amount of risk entity willing to accept

一 Related to entity’s risk capacity as well as its culture, desired level of

risk, risk management capability and business strategy

.    The CRO will typically be involved in partnering with the executive team to allocate the risk appetite broadly across business lines (top down approach)

.    Each business line the considers what this means for various teams and processes and what risk limits are appropriate

.    The risk limits are aggregated up and compared to the top down amount

.    CRO and risk team have central process in aggregating and communicating and ensuring shared understanding and appropriate responsibility

(b) Why Board is interested

.     Setting the risk appetite is the responsibility of the Board

.    The risk appetite must be set in relation to the organisation’s strategy and the level of risk appropriate to achieve its strategic objectives 一 the Board is       responsible for the org’s strategy

.    The amount of risk an organisation can take will be limited by its current  capital resources and its capacity to access other capital resources; this is a core Board consideration

(c) Inherent risks can be reduced by:

.    Transfer of risk (for example, reinsurance)

.     Stop taking particular risks (for example product risk or currency risk)

.    Limit some risks (for example cap maximum policy size for new business)

.    Put in place actions that reduce probability of risk occurring (for example tighter underwriting or claims standards)

Question 7

(a) Noems is a general insurer writing a variety of different products.

For its commercial property portfolio, Noems had the following reinsurance programme for 2021.

Surplus Insurance 一 9 lines of $2m in excess of $2m (75% of this surplus treaty is taken by ELC, and 25% of this treaty is taken by YPS)

Dever Pty Ltd insures its factory and offices with Noems. There is an excess of $50,000 per claim, and a sum insured of $14m.

In September 2021, Dever,s factory was damaged by a storm. The total repair bill was $4,250,000.

For the $4,250,000 loss to Dever, calculate the amounts attributable to Dever, Noems and ELC.

5 marks

(b) The use of reinsurance may lower the risk of high claims cost, however the use of reinsurance may introduce other risks to Noems. Explain the nature of these other risks.

3 marks

(c) What measures may Noems take to mitigate these other risks?

2 marks

Total Marks for Question 7 = 10

Sample solution - question 7

(a) Remembering that in this subject considering RI at a broad level; not getting into fine detail. Similar examples have been discussed in lectures.

Excess is 50k, so Dever must pay this. The remaining amount of $4.2m will be met by Noems, ELC and YPS.

9 lines of $2m in excess of $2m, so with a sum insured of $14m, Noems will take 1/7 of this amount and the rest (6/7) is subject to reinsurance. ELC and YPS will each take half.

So amounts are

Dever

Noems

ELC

YPS

$0.050m

$0.600m

$2.625m

$0.875m

(b) Main point is that reinsurance is not without its own set of risks. I would      expect students to mention the risk of reinsurer failure or default, but would  hope that better answers could consider some other risks such as a risk of     mismatch between reinsurance terms and direct policy terms, risk of delay in payments, potential operational risks etc.

Students may also mention that if a reinsurer default, there are two possible     broad effects (i) if a layer breached, won,t get recoveries as expected under    treaty, (ii) even if no breach, existing reinsurance will need to be“replaced”,   or else the company will be“exposed”. This second one mentioned in lectures but wouldn,t expect students to make the distinction, nor is it required at all in the answer.

(c) Would expect students to say:

Don,t over rely on one/few reinsurers 一 this was covered in lectures; i.e. diversification

Go for“safer”reinsurers 一 Could refer to ratings, or more generic reasoning such as reference to say large international insurers.

Others should be given credit where appropriate 一 linked back to the risks identified in (b) above.