ACTL40006 / ACTL90010 Actuarial Practice & Control I PRACTICE EXAM 2022

Question 1

You are an actuary at a consulting firm employed by the FWH Company to design a new Defined Contribution superannuation fund for their employees. Your task is to design the basic death and total and permanent disablement (TPD) benefits that will be paid for by the employer (basic benefit). Members will also be able to purchase additional voluntary death and TPD cover.

The client wants the basic benefit to be higher at younger ages and lower at older

ages.

(a) Why is this an appropriate design for a basic death & TPD benefit?

(4 Marks)

(b) State two benefit formulae that would achieve the client,s aim.

(2 Marks)

(c) What data would you request to determine an appropriate level of benefit under the formulae in (b)?

(4 Marks)

Total marks for question 1 = 10

Solutions for question one:

(a) It is appropriate because in general, younger members have a greater need for death & TPD protection, due to larger mortgages and younger children.

As mortality/disability risk increases with age, it makes the cost of providing the benefit more even across the membership, making it a more equitable for the      employer to provide.

(b)

1.   Unit-based formula provides a reducing sum insured for a fixed premium at all ages.

2.   Percentage of salary times years between current age and retirement age.

Other formulae that achieve a relatively smooth reduction in sum insured as age increases are also acceptable.

(c)

-     Age distribution of membership

-     Salary distribution of membership

-     Mortality/disability rates (e.g. Claims history of membership, industry average decrement rates, etc.)

-     Premium rates charged by insurer for this membership

Question 2

The CEO of a general insurer makes the following remark _ “This industry has excessive regulation. We should let the market decide. Consumers know the better insurance brands, and they,ll pay higher premiums for greater service and security”

Prepare a reply to the CEO, supporting your case with reference to existing legislation, and their underlying principles.

Total marks for question 2 = 12

EXAMPLE SOLUTION:

Dear CEO,

I understand where you are coming from. It is true that consumers have a sense of   insurance brands, and often take out policies with these established brands, even     though the premiums may be a bit higher than for lesser known insurers. Obviously better service and security are ways that an insurer can differentiate itself.

However, we shouldn’t confuse this phenomenon with the need for regulation. I don’t believe we can just let the market decide 一 in the past regulation has helped to keep    insurer collapses, and resulting policyholder losses to a minimum. Since the last        significant failure (HIH) the prudential regulation has been strengthened.

There are several pieces of legislation that are relevant for General Insurers. These include:

.    Prudential regulation, administered by APRA. Under the Insurance Act, and  supporting regulations, APRA is attempting to protect consumers. It does this by the imposition of qualitative and quantitative requirements. The qualitative requirements include that relevant officers must pass a fit and proper test,       imposition of risk management standards etc. Quantitative tests include          minimum capital requirements (including liability valuation).

We can’t expect consumers to be able to be able to assess the financial           strength of each insurer, so the government steps in with legislation to           overcome the“information asymmetry”. While the standards can’t eliminate   the possibility of failure they can reduce it to what is seen as an“acceptable” level.

The regulations do impose additional costs, which must be passed onto policy  holders or reduce our overall return, however I believe these costs are justified as they help to protect our consumers.

When you buy a car you,ll expect minimum safety standards. We wouldn,t expect every person that is buying a car to be able to gain sufficient            engineering knowledge to assess its safety. Obviously the imposition of the safety measures and the administration of government protection (i.e.         checking standards are met) both impose costs that are passed onto the       consumer. Insurance prudential regulation works in the same way.

.    We,ve also seen an increased focus on consumer needs in recent times             following the Royal Commission and ASIC investigations. It,s no longer good enough to earn very large profits at the expense of consumers. This is              particularly relevant for non-competitive markets.

In addition ASIC found poor sales practices for some products such as

Consumer Credit Insurance.

.    There is other legislation that is relevant such as the Insurance Contracts Act. This legislation could be argued to protect both consumers and insurers as it  sets out a fair balance between the two parties. It may be argued that               disclosure requirements (plain English policy documents etc) impose              excessive costs, but they also provide a structure to protect our interests by    clearly stating up-front what policies do or do not cover.

.    There is also other relevant legislation including Brokers and Agents               legislation, competition legislation (ACCC), as well as specific legislation for some lines of business that we write (e.g. NSW CTP, Builders, Warranty).     Again, a major objective is to protect consumers

Remember, our competitors also must meet these legislative requirements. While   consumers don,t explicitly think about the costs of regulation, they probably realise they are paying for some protection in the end.

We could use marketing that emphasises our financial strength, but I reckon we are better off emphasising our service as a point of differentiation.

Yours sincerely,

A.N. Actuary

Question 3

You are a Chartered Enterprise Risk Actuary (CERA) working for a risk management consultancy. You have been asked by the CEO of Gung Ho 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 a business entity

(6 marks)

(b) How will risk appetite support Gung Ho Insurance in effectively managing its business operations?

(3 marks)

(c) If the inherent risks exceed Gung Ho,s risk appetite, what actions can the insurer take to reduce its inherent risk?

(3 marks) Total marks for question 3 = 12

Sample Solution - Question 3:

(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

.    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

.    The amount of risk an organisation can take will be limited by its current capital resources and its capacity to access other capital resources

.    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) How does risk appetite support effective management:

.    By identifying risk an organisation is willing to accept, this improves clarity on what risks are appropriate (and should be taken ) and what risks are        inappropriate and should be avoided, transferred or limited

.    By cascading down risk limits, it increases individual ownership and responsibility for risk

.    The act of measuring risk relative to risk appetite increases the awareness and understanding of risk at all levels in an organisation

(c) Residual risk is the amount of risk remaining after taking action to reduce inherent risk. The residual risk should be less than the risk limits for a     particular kind of risk.

Ways to reduce inherent risk include (expect students to use :

Avoid risk 一 policy exclusions, underwriting discretion to refuse insurance

Reduce the size of the risk taken 一 policy limits, limits of insurance based on underwriting,

Transfer the risk (all or part) to a third party. Reinsurance, proportional or non proportional.

Question 4

LSG Insurance is an Australian General Insurer which writes a variety of products.

(a)  For its liability portfolio, LSG had the following reinsurance programme for 2019. The stop loss policy operates after the excess of loss policies.

Individual claims

Excess of loss policy of $3m excess of $1m with Nancy Reinsurance

Excess of loss policy of $6m excess of $4m with Jojo Reinsurance

Aggregate claims

Stop loss policy $40m excess of $60m; for this layer, 20% written by Unper Reinsurance, 40% by Dwad Reinsurance, 30% by Nancy Reinsurance.

The claims for 2019 for LSG are as follows:

Individual large claims (defined as greater than $1m) $2m, $3m, $6.5m, $8m   Small claims (defined as less than $1m) 一 total across all small claims of $66m.

For LSG,s total direct claims for 2019 (both large and small) calculate the amounts

assumed by LSG and each reinsurer after operation of the reinsurance programme.     (6 marks)

(b) LSG,s new financial controller doesn,t know a lot about reinsurance. With respect to the two types of reinsurance programs:

1.   Per claim Excess of loss treaties

2.  Aggregate stop loss treaties

Explain the differences between the two reinsurance programs, and explain the risks that each program is designed to protect against.

(4 marks)

(c) LSG has analysed its expected recoveries for each of the two proposed          reinsurance programs (1 and 2 in part (b) above). The expected recoveries are the same for each program. Explain, with reasons, which program would you expect to have a higher reinsurance premium.

(2 marks)

(d) Outline the specific risks faced by a reinsurer in writing a treaty for long tailed business such as public liability policies.

(3 marks) Total Marks for Question 4:  15

Question 4: Sample Solution

(a) (a) Remembering that in this subject considering RI at a broad level; not getting into fine detail. While this example may seem unrealistic, similar

examples have been discussed in lectures.

For the individual large claims:

$2m:

$3m:

$6.5m:

$8m:

$1m Carben $1m Nancy

$1m Carben $2m Nancy

$1m Carben $3m Nancy $2.5m Jojo

$1m Carben $3m Nancy $4m Jojo

For aggregate stop loss:

Small claims are a total of $66m, but must also include the $4m for Carben,s lower layer on the large claims, so a total of $70m

Carben retains $60m

Of remaining $10m:   $4m Dwad $3m Nancy $2m Unper; Note the layer isn,t fully filled, so presumably the remaining $1m shall go back to Carben

So totals are

Carben

Nancy

Jojo

Dwad

Unper

$61m

$12m

$6.5m

$4m

$2m

(b) Difference is that per claim XOL operates on individual claims whereas aggregate operates  on  aggregate  claims within  a period, usually  a year. Per  claim XOL  is designed to protect against large claims. Aggregate protects against large claims or a large number of claims leading to a large claim costs.

(c)  In general, would expect the aggregate to have a higher premium as it has greater potential to lead to a claim (via large claims or via a large number of moderate claims). Note that while this is the “normal” answer, it is indeed possible to make an argument that since the expected claims are the same under each, you would have to look at the distribution of relative outcomes, and they may be the same or different. This is getting to a level of nuance not expected in this subject. Potential bonus marks if identified

(d) There are the usual risks of writing a long tailed product which are faced by both the direct  insurer  and  the  reinsurer  i.e.  pricing  risk,  liability  risk,  expense  risk, superimposed inflation, judicial precedent, increasing claim propensity etc

In  addition  there  are  particular  risk  for  the  reinsurer  such  as  lack  of timeliness  of information, having to rely on the direct insurer’s underwriting and claim administration policies etc.

Question 5

You are a consulting actuary. One of your clients, PBM Pty Ltd has a defined benefit superannuation plan. The plan was established many years ago, and has not been open to new members since 1998. There are no more remaining active members, only pensioners. You are the Plan Actuary, reporting to (i) PBM as the employer, and (ii) to the Trustee on managing the longevity risk.

Using each of the five categories,

. Avoid

. Retain

. Reduce

. Transfer

. Exploit

explain if each category is suitable to manage the longevity risk.

For each strategy which you believe is suitable, explain how it would be applied in practice.

(10 marks) Total marks for question 5 = 10

Sample solution

1.(2 marks for each one with adequate explanation = 10 marks total)

1 Avoid - offer voluntary commutation to pensioners

1 Retain 一 retain pensioners in plan

1 Reduce 一 not appropriate

1 Transfer 一 purchase annuities from insurer

1 Exploit 一 not appropriate

Question 6

You are an analyst for Nancy Insurance, which is a general insurer. You are working with your boss, Fred Wana to develop a new product.

The new product is insurance for pets.

(a) What sort of benefits do you suggest the pet insurance would provide? (2 marks)

(b) Apart from Nancy Insurance and the policyholder, describe two other

relevant stakeholders, and their interests in this new product.

(3 marks)

(c) Provide, with reasons, the proposed investment strategy or strategies for this product

(3 marks)

(d) Provide, with reasons, two feasible methods for the marketing of this product

(3 marks)

Total marks for question 6 = 11

Sample solution for question 6:

Broad material for product design (Aim 8) covered in lectures - in this semester while the students are expected to realise adverse selection etc, we cover topics such as a      rating structure more in APC2.

Some examples of “newish” products covered in lectures (from a product design point of view). Rich covered the investment side.

a)   Would expect it to cover veterinary bills, but also to cover potential third party costs, such as a dog biting someone.

Note not expecting answers to cover specific issues such as deductibles, limits, fine definitions etc.

b)  Put this in as a specific sub-aim within Aim 8, and have tried to stress that students think of the range of stakeholders. Mainly looking for sensible    answers given these circumstances. Only half marks for vague marginal   stakeholders not related to this situation (e.g. reinsurers, tax office etc)

Possible answers are Vets (interested as may make their services more  affordable); Regulators (as with any GI product); Local Government (as they register dogs and cats)

c)  Main points are to realise that expect it to be a fairly short-tailed insurance, so investment should be liquid. Students may point out that given it’s a      new product, there is even more uncertainty, so perhaps even more            important to be liquid.

Expect answers such as cash deposits, bank account, perhaps some other liquid fixed interest investment.

Important they give reasons as well as an actual strategy; not just one or the other

If students made a point regarding the whole portfolio of Nancy Insurance  and how this new product fits into their overall investment strategy, then ½ - 1 bonus marks.

d)  Again, looking for sensible answers which recognize the particular circumstances.

Possible answers are:

Via veterinary association or vets (e.g. pamphlets in their office) 一 don’t need to mention commission structure or similar

As add-on to a household policy 一 similar to actual marketing of this type of product

Via dog clubs, cat clubs etc

e)  Flexibility required in marking, as many possible answers. Markers would take a sensible approach, looking for sensible and relevant answers.

e.g. risk that very ill pets will join scheme thus incurring significant claims costs. Mitigation would be to exclude pre-existing conditions, or place a   limit on annual veterinary reimbursements, or have a high deductible

e.g. risks that vets will over-service or over-charge if they know the animal is covered by some form of pet insurance. Mitigation would be to have a   list of scheduled fees. May also have the ability for audits of the vets’      services

Question 7

You are the Chief Actuary of XYZ Aussie Insurers, a listed Australian insurance

company.

The CEO has recently read a government report on the aging Australian population. The report suggests that lifetime annuity products will be an important product to meet the retirement needs of Australians. It also comments that sales are poor compared to lump sum retirement products.

She asks you to provide her a briefing note on lifetime annuities. Draft a briefing note for the CEO, outlining the following:

(a) What are the features and benefits of an immediate annuity product?

(4 marks)

(b) What are the risks inherent in the product for the life office?

(4 marks)

(c) What are the risks to the consumer? How may design mitigate some of these risks?

(4 marks) Total Marks for Question 7: 12

Question 7 - sample solution

1.

.    A deferral period - benefit payments start at a particular age (age chosen will determine the benefit amount)

.    Regular payment made from time of commencement throughout remainder of policyholder life

.    Indexation provided, typically at CPI

.    Typically have a guaranteed  minimum benefit payment period to mitigate the risk of early death

.    Option of reversionary benefit to spouse

.    As payments are stable and reasonably known (only uncertainty is inflation), helps consumer to plan effectively

.    Tax effective

2. The possible risks to the life office are:

.    Longevity risk - that life expectancy continues to improve across the broader population of annuitants  and the life office pays  benefits for longer than       priced into the portfolio

.    Reinvestment risk - the duration of liabilities may exceed the duration of available assets. Hence company will need to reinvest at unknown future interest rate

.    Inflation risk - may not have assets available that can back the potential inflation in the liabilities

.    Asset risk - risks of default on assets (exacerbated by long term nature of liabilities), or assets underperforming longer term expectations.

3. Risks to the consumer:

.    Dies before very long (can be offset by minimum benefit payment period and by spouse reversion)

.    Cannot access lump sum (and there may be unanticipated needs that come up)

.    Amount may not be sufficient to fund future lifetstyle. Some costs of aging may increase faster than inflation (example healthcare costs)

Question 8

You have recently taken the role as Appointed Actuary for LifeCo in an established life insurance market.

LifeCo sells a trauma product that was recently re-designed; cover was expanded to include several additional illnesses. Before this expansion, LifeCo received advice from its reinsurer on these additional illnesses, based on the reinsurer,s experience in another market. As these illnesses have not previously been covered in your market, they have been priced based on the other market,s experience.

LifeCo sells this product via intermediaries and distributors. The re-designed trauma product was released to market immediately after the product design was approved by the previous Appointed Actuary. There was no additional training of internal staff or distributors. Despite this, the product has sold extremely well.

In the three months following the launch of the re-designed trauma product, distributors of the product received a one-off sales bonus of 80% of the first year premium. This is in addition to the standard remuneration to distributors which is 50% of first year premium.

All LifeCo,s administrative systems and processes, from point of sale to point of claim, are currently manual. The new illnesses covered have been added to the policy document. Otherwise, no other changes to policy documentation, underwriting or claims processes have been made.

LifeCo is expecting formal regulatory approval soon. In this market, products are able to be released prior to regulatory approval, but regulatory approval must be received within six months of product launch.

(a) Using the control cycle framework, identify and explain the potential risks that emerge from the design and launch of the re-designed trauma product.

14 marks

Question 8 (continued)

It is now 12 months since the product launch. You have been informed that there have been several adverse audit findings in relation to the trauma product. These include:

. The claims assessors have declined over 90% of claims relating to the new included illnesses.

. Many policies have been issued where the client already had trauma cover with LifeCo, so is ineligible to claim under the new policy.

(b) Describe how these issues may have emerged since the product launch, and provide recommendations to deal with these adverse audit findings.

4 marks

Total marks for question 8 = 18