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Fundamentals of Actuarial Practice: Interim Assessment Questions Interim Assessment Questions Overview Assessment Structure This assessment comprises 16 questions you are to answer. All questions are listed in this document. Questions are grouped into the following sections: Questions 1-6 relate to a group term life insurance scenario. Questions 7-11 relate to an individual disability insurance scenario. Questions 12-14 relate to an ERM scenario. Questions 15-16 are independent of each other and are not linked to a shared scenario. Your answers to the questions are to be contained in one Microsoft Word document that you will submit when completed with the Interim Assessment. You must use the template document IA_template.doc that you downloaded when obtaining this document and the spreadsheets. You will also submit spreadsheets containing the work you complete for the first scenario. (Further information about the process for completing the Interim Assessment can be found by clicking the Interim Assessment FAQ or Interim Assessment Instructions links on the Download Page.) Important Notes All information you want to convey to graders must be in your Microsoft Word document. Your answers should be presented with an 11-point (minimum) font and single-spaced (with double spacing between paragraphs). You should not assume that graders will examine the Microsoft Excel spreadsheet you upload. While graders will have access to your Excel file, they will only review your spreadsheet if they would like to check your work. Considerations in Preparing Your Answers For the most part, your answers are not expected to be in memo form and do not need to be in structured paragraphs. It is acceptable to use outlines and lists where you believe it is appropriate. However, if the question calls for you to write a memo or document that is intended for an audience other than the grader, then the communication should be appropriate for that audience. Your goal should be to answer each question completely and appropriately. You should effectively and efficiently convey the information that answers each question. Your answers should average approximately one page (single-spaced). Your name should not appear anywhere in your submission or in any way identify you as the author. If you believe you should refer to yourself in the context of an answer, use FAP Candidate instead of your actual name. Questions 16 Scenario You work for Sensible Insurance Company, a mid-sized insurance company whose core product is group term life. Sensible aims to grow and is trying to gain Mammoth Mart as a client. Mammoth Mart is a large employer in the U.S., and its addition will almost double the number of insured lives Sensible covers. Sensible operates in all states in the U.S., but focuses on small to medium sized businesses THIS MATERIAL IS STRICTLY CONFIDENTIAL. DO NOT DISTRIBUTE TO ANY OTHER PERSON. © 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 1 of 10concentrated in the Eastern U.S. Its current book of business has an average occupation mix of 20% blue-collar/80% white-collar. The average case size is 81 lives with no single group comprising more than 2% of the insured lives. The CFO of Sensible is concerned that it may be growing too fast and has asked you to analyze the effect of adding Mammoth Mart as a client. Your student actuary has sent you the following information about Mammoth Mart: 1. It has offices nationwide with over 500,000 employees. 2. Approximately 60% of the employees are blue-collar, with the remainder being white-collar. 3. As of today, all of its locations are in the U.S., but it is considering opening some Canadian locations in the next year or two. 4. It is using a broker to negotiate prices and benefits with insurers. Mammoth Mart wants a simple plan for its employeesall of them will be covered, and the face amount will equal the employees annual salary. However, instead of a typical one-year rate guarantee contract with premiums paid monthly, Mammoth Mart would like a three-year rate guarantee on the premium. It will pay the entire three years premium up-front based on its current workforce and salaries, with monthly adjustments based on increases or decreases to the covered salary amount. Ideally, for such a large group we would want to use Mammoth Marts own experience to develop a rate, but this is the first time it has sought life insurance coverage. Therefore Sensibles rate manual needs to be used. A spreadsheet, which can be downloaded by clicking the Excel File Group Term link on the Download Page, has been prepared to assist you with the questions. Further description of the spreadsheet will be provided in the questions. Question 1 (A) Using the existing ratemaking information provided in , determine the monthly premium per $1000 of covered salary for Mammoth Mart. Show your work in your answer. (B) Due to Mammoth Marts request for an unusual payment arrangement you decide a monthly cash flow model should be built to better understand the financial implications. Your student actuary provides a model that you agree is sufficient for your immediate needs, located in . You notice that using the assumed premium from (1A), the profit is greater than 3% of the claims. Briefly explain why this is and recommend a premium that matches the profit goal. Premiums for both (A) and (B) (monthly cost / $1000 covered payroll) should be rounded to the nearest tenth of a cent. For Questions 2-5, if a premium is needed in your calculations use the premium from 1(B). Question 2 What are the key external factors that Sensible should consider when determining whether or not to pursue the Mammoth Mart account? How do these factors apply to this specific situation? Question 3 Up until this point management has wanted you to use a 3.0% investment income rate. However, because investment income plays an important role in the case of Mammoth Mart you want to explore it in more depth. Using the historic data for different asset classes located in recommend an investment strategy and investment income rate assumption. Question 4 THIS MATERIAL IS STRICTLY CONFIDENTIAL. DO NOT DISTRIBUTE TO ANY OTHER PERSON. © 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 2 of 10Mammoth Mart has been considering purchasing one of its rivals, Pacific Pro Shopper, and company officials are estimating the purchase would be effective at the start of month 30 in the current contract. This purchase would result in an additional $5B of monthly payroll covered for each of the remaining 7 months. Assume that the premium rate cannot be renegotiated for the additional payroll. Using the monthly cash flow model located in , briefly describe the impact the purchase would have on the premium that is collected by Sensible and the ending cash position compared to the original assumptions. As a baseline scenario, assume that the average claims rate remains level throughout the contract period. Question 5 Before you give your final recommendation to the CFO regarding the Mammoth Mart contract, you decide it would be best to perform some sensitivity testing. Discuss the assumptions that you should consider when performing a sensitivity analysis. Explain why each of these assumptions is important to analyze. Do not perform the sensitivity analysis. Question 6 Three years have passed and you have been asked to evaluate the Mammoth Mart deal. Mammoth Mart has expressed interest in a renewal quote. Mammoth Marts experience has been summarized by your actuarial student in . Note that the Canadian expansion has not yet occurred and talks with Pacific Pro Shopper have been delayed past the 30-month mark initially anticipated. Actual expenses for Sensible have been equal to those in the original assumptions. (A) Evaluate Mammoth Marts results and profitability for Sensible. Are there any concerns about the results? Briefly discuss how well the rate guarantee worked for Sensible. (B) In a memo written to an actuarial student who will be working with this contract going forward summarize your approach to the renewal using the control cycle as a framework. Include all five components of the control cycle as they relate specifically to this situation (Professionalism, External Forces, Define the Problem, Design the Solution, and Monitor the Results) as well as key renewal rating considerations, recommendations, or concerns you have. Note: Be sure to save your spreadsheet calculations showing your work for the group term scenario. You will be prompted to upload this saved spreadsheet when you have completed the Interim Assessment. Questions 711 Scenario Your company, Awesome Benefits Company, sells the following individual disability insurance product. Level annual premiums are paid while healthy and under age 65. Premium rates are guaranteed and premiums are due at the beginning of the year Upon disability, a level monthly benefit is paid while the policyholder is unable to work (a status that is defined in the policy) Benefit payments commence after a 90 day waiting period (also called an elimination period) Benefit payments are 60% of salary and cease when the policyholder turns age 65, dies, or recovers The target market is highly paid professionals (such as doctors and lawyers) and corporate executives. The product is sold through insurance agents. You have assigned your actuarial student, Joe, to build a pricing model. Joe has built the model in THIS MATERIAL IS STRICTLY CONFIDENTIAL. DO NOT DISTRIBUTE TO ANY OTHER PERSON. © 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 3 of 10Asset Annual* Coupon Rate Maturity Price / Face T-bill N/A 1 Year 990 / 1000 T-Note 2.9% 10 Year 1000 / 1000 Corporate Bond 3.2% 10 Year 1000 / 1000 Corporate Bond 4.1% 30 Year 1000 / 1000 the Excel spreadsheet . Joe has made all of the baseline assumptions and selected initial premiums. The per-unit premium for each policy is set equal to the issue age for example, a 42-year old with a $100,000 salary would pay $4,200 annually while a 30-year old with a $50,000 salary would pay $1,500 annually. Joe thinks this pricing scheme will help with marketing the product, because each year a customer delays buying this policy will lead to an increase in the level premium. Given the recent economic volatility, Awesome Benefits Company has a conservative investment strategy. The investment strategy has three priorities; first it is required to hold at least a certain percent of its portfolio in liquid, short-term assets. The value can be found on the Documentation tab of the spreadsheet . Next, it wants to duration match assets and liabilities. Finally, it prefers to invest in United States government securities. Awesome Benefit Company uses profit as a percent of premium as its primary profit measure. Using a discount rate of 5%, the required present value of distributable earnings as a percentage of premium is 10%. Management also desires an IRR greater than 10%. For this assessment, you can ignore the claims paying ability of the company and any other plan design features not mentioned in this assessment. You do not have to audit the model. Question 7 Now that the pricing model is built in , Awesome Benefit Companys investment managers have asked you what type of assets should be purchased to back reserves and capital. You have been asked to assess and comment on its investment strategy. (A) Using an interest rate of 5.0%, and the cash flows in the Model Income Statement tab, calculate the modified duration using paid claims as the liability cash flows. (B) Given the available assets below, build an asset portfolio that best meets the requirements and preferences of the companys investment strategy. Discuss the characteristics and implications of the choice of assets. * Assume coupons are paid once per year, at the end of the year (C) Senior management has determined that Awesome Benefit Companys investment strategy should be even more conservative. You are now required to invest 100% of assets in government securities. Build a second asset portfolio, which is as close to duration matched as possible. Discuss the characteristics and implications of the choice of assets and compare it to the first portfolio. Question 8 You need to review Joes pricing work (recall though that you do not have to audit the model). Use the model to run the entire population. (A) Using Joes initial assumptions in the cell info tab, discuss the results of the pricing model in light of the desired profit measures. Recommend changes to the premium schedule if necessary. (B) Assuming Joes premiums are maintained, assess Joes premium selection in light of the model results by age and gender, which are summarized on the Output Summary tab of . Is setting the per-unit premium proportional to the issue age THIS MATERIAL IS STRICTLY CONFIDENTIAL. DO NOT DISTRIBUTE TO ANY OTHER PERSON. © 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 4 of 10appropriate? Justify your answer. Recommend changes if necessary. (C) All of Joes pricing work has focused on one deterministic scenario. Assuming Joes premiums are maintained, perform a sensitivity analysis by changing key assumptions in the cell info tab and re-running the entire model. Key assumptions to include in the analysis are incidence, maintenance expenses, and interest rates. Which assumptions are most/least critical? Question 9 The new CFO doesnt understand regulatory reserves and gross premium reserves. You created the following graph of regulatory reserves and gross premiums reserves by duration for the IDI projection. Reserve Projection GPV Total Regulatory Reserves Duration (A) Explain the difference between these two reserves, including the how those differences produce this pattern of reserves by duration. (B) Using the model output, calculate the gross premium reserve at the end of year 1 using a discount rate of 5% and the cash flows in the Model Income Statement tab. (C) Awesome Benefit Companys current regulatory reserves are rules-based. Discuss the differences when compared to a Principles-based valuation. Question 10 In response to perceived abuse of disability income benefits by insureds, Awesome Benefit Company decides to offer a new product with a more restrictive definition of disability. This new definition of disability requires policyholders to be more severely disabled in order to qualify for benefits. Briefly describe the general impact on claim costs / claim administration expenses, litigation costs, and reinsurance needs. Similarly, briefly list what data you would seek to quantify those effects. Note: You will not upload the spreadsheet you used for this scenario. Question 11 Awesome Benefits Company has completed the Failure Modes and Effects Analysis (FMEA) process. For the individual benefit product the subject matter experts (SME) have identified the assumptions for each of the 5 scenarios shown below and the likelihood of the scenario occurring. THIS MATERIAL IS STRICTLY CONFIDENTIAL. DO NOT DISTRIBUTE TO ANY OTHER PERSON. © 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 5 of 10Risk Scenario Likelihood(%) Credible worst-case 5 Pessimistic 15 Baseline 60 Optimistic 15 Credible best-case 5 The assumptions for the 5 scenarios were run through the model. After completing the step of estimating the quantitative impacts, the SMEs were concerned about the results from the moderately pessimistic and credible worst-case scenarios. Reinsurance was suggested as a risk mitigation strategy. The ERM team wanted to include the option of reinsurance prior to presenting results to senior management. An offer for reinsurance was received. The model was adjusted for reinsurance and re-run. Risk Scenario No Reinsurance Reinsurance Credible best-case 1 6 Optimistic 2 7 Baseline 3 8 Pessimistic 4 9 Credible worst-case 5 10 The model income statements have been provided to you in to prepare for the senior management report. The table above indicates the scenario in the spreadsheet for the described situation. Generate an executive summary of the data that is easy to understand and present. Make a recommendation as to whether the reinsurance offer should be chosen. Justify your recommendation. Note: You will not upload the spreadsheet used with this question. Questions 12-14 Scenario Warren Peace (WP) winery is a family-owned company which manufactures, markets, and distributes fine wine. The winery is located on a 60 acre vineyard in Northern California, USA which is where WP grows grapes and manufactures its products. WP has a history and heritage of fine winemaking for over 30 years. WP sells several types of wine produced from its own locally grown grapes. Generally, WP produces two vintages of wine, a high quality vintage wine which sells at a premium, and a lower quality brand name wine. From time to time, WP purchases grapes from other vineyards in Northern California and imports grapes from France, Italy, Argentina, and Canada. The current Chief Executive Officer is Warren Peace III and the Board of Directors consists of 5 members of the Peace family. The company has 10 total permanent employees. WPs company objectives include: Produce quality wines at a reasonable price Conduct business with integrity and honesty Have a passion for wine Maximize company value through increasing profit margins Distributable profits provided by WP over the past few years have ranged from $0 to $1,000,000. As a result of this volatility, WP is in the process of adjusting the company objectives to include an increased risk management focus. To help with this task, WP has hired Al Nino to develop a risk management framework for WP. You are part of a team of actuarial students working for Al. THIS MATERIAL IS STRICTLY CONFIDENTIAL. DO NOT DISTRIBUTE TO ANY OTHER PERSON. © 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 6 of 10Question 12 Warren Peace has asked your team to make a presentation to the Board of Directors to describe the ERM process. You will hand out a summary of the benefits of ERM. Al has asked you to draft the handout and to include the following: Why should WP implement an ERM process? What are the benefits to WPs major stakeholders (The Peace family, WPs other employees, wholesale distributors, business partners, creditors, and customers)? Who will be responsible for the ERM process? How will a Corporate Value ERM framework assist in WPs business decision making process? How will an ERM framework address the Boards concerns? The handout should be written in bullet point form summarizing the main ideas of your presentation. Question 13 Warren has asked Al to recommend an ERM framework for WP winery. One of your fellow actuarial students has drafted the following memo and has asked you to review it before sending it to Al. Suggest five ways to improve the document. Do not include any grammar, style or punctuation improvements. Do not submit an entire revision of the document; rather just provide a description of the suggested improvements. TO: Warren Peace III FROM: Al Nino, Risk Consultant RE: WP Winery Enterprise Risk Management (ERM) Framework Introduction This memo will lay out considerations for the development of an enterprise risk management strategy for Warren Peace Winery (WP). The risk management philosophy of WP should: Identify and successfully manage risks that present good risk/reward opportunities Balance demands of various stakeholders Encourage a risk management culture throughout the company Quantify risks and strictly manage to an indentified risk tolerance An understanding of enterprise risk management should be embedded throughout the organization. The CEO is ultimately responsible for the key risks, but responsibilities will be delegated to the Chief Risk Officer (CRO) and the ERM committee. CRO: responsible for providing the CEO with a written risk report on a quarterly basis, which includes a status report on risk tolerances and risk appetite. Currently there is no CRO on staff at WP. ERM Committee, which is a subset of the work force and includes equal representation from manufacturing, marketing, and distribution. This committee is responsible for reviewing and recommending risk tolerance and risk appetite. Risks Identified We have done a comprehensive review of WPs business processes and global wine market conditions and have identified the following risks: THIS MATERIAL IS STRICTLY CONFIDENTIAL. DO NOT DISTRIBUTE TO ANY OTHER PERSON. © 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 7 of 10 Competitor risk / loss of key customer This is the loss of a primary distribution partner to competing wineries. Production risk This is the loss resulting from unexpected equipment repairs or replacement. Counterparty credit risk WP sells its products to various wholesalers throughout the world. This is the risk of financial loss resulting from counterparty default or delay of payment. Market risk Unexpected changes in external markets impacting the cost of producing wine. Product / pricing risk Unexpected changes in external markets impacting the price of wine. Interest rate risk WP has variable rate loans. This is the risk of increasing interest rates affecting the financing costs. Labor expense risk This is the risk of adverse changes in the cost of labor. Business risk This is the risk of losses resulting from general business practices and from political, regulatory, and legislative issues. Reputation risk This is the risk of losses due to negative publicity or failure to uphold a good reputation. Operational risk This is the risk of losses arising from failures in people, process, technology. Weather / suboptimal growing condition risk This is the risk of losses due to poor growing conditions leading to poor wine quality and low yields. Risk Quantification We are proposing the following framework to manage and monitor the above identified risks. WP should develop well-defined risk limits and metrics that are regularly and consistently monitored and enforced. They should also be reviewed regularly for needed updates. The CRO will be responsible for developing and maintaining appropriate models to manage and monitor risk. One of the key modeling outputs is distributable cash flow under both deterministic risk scenarios and more advanced scenario testing such as stochastic simulations. The baseline company value is the present value of distributable cash flows over a 10-year time horizon, discounted at the hurdle rate. When assessing the various risks, multiple scenarios are combined using correlation matrices. A summary of the key metrics is included in the table below. Enterprise Risk Metric Definition Frequency of Review Company Value (CV) Average Present Value of Distributable Cash Flows Annually Company Value at Risk (CVR) from all risks CV at the 5th Percentile Annually CVR from Standalone Risk (SCVR) CV at 10th Percentile Annually Risk Tolerance In defining WPs risk appetite, there should be a target risk metric and a maximum risk metric. Target risk metric this is where WP is most comfortable with overall risk/reward relationship. Maximum risk metric this is the maximum amount of risk WP is willing to take. If the risk metric reaches the maximum, then there needs to be action to reduce the exposure. THIS MATERIAL IS STRICTLY CONFIDENTIAL. DO NOT DISTRIBUTE TO ANY OTHER PERSON. © 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 8 of 10Risk Metric Target Maximum CV Increase Company Value while managing to other risk tolerances N/A CVR 15-25% of Baseline CV 35% of Baseline CV SCVR 5-10% of Baseline CV 20% of Baseline CV One of the objectives of WP is to maximize company value through increasing profit margins. This is accomplished through increasing Company Value while managing to the specified risk tolerances. Conclusions and Recommendations This memo has outlined an enterprise risk management strategy for Warren Peace Winery. This memo should be updated and reviewed on an annual basis. Currently, WP has no CRO. In order to embed a risk management culture throughout the organization, this position needs to be filled as soon as possible. The CRO will be responsible for organizing the ERM committee. The company objectives for WP should be adjusted to specifically cite risk management. It is recommended that an additional objective be added. Question 14 Several months have passed and WP has adopted a risk management framework based on your recommendations. Melissa Peace, a member of the Board, is the new Chief Risk Officer (CRO) and an ERM Committee has been created. The members of the ERM Committee include the CRO, the General Manager, and the head winemaker. The ERM Committee has identified the following as the key risks to WPs CV: Competitor risk / loss of key customer Weather / suboptimal growing condition risk Production risk The ERM Committee has asked for your assistance in evaluating several proposed risk mitigation strategies. These have been suggested to align WPs risks within the limits proposed by the adopted risk document. To assist in determining the effectiveness of the suggested strategies, your team constructed a stochastic model. It was used to identify and quantify the key risks for the Board and incorporates all aspects of income and expenses. The risk mitigation strategies include: Sales Contracts: Enter into a sales contract with your primary distributor. The sales contract will ensure purchase of a fixed amount of wine in exchange for a discounted price over the next 10 years. Diversification: Lease out a portion of WPs vineyard and use the funds to rent space in vineyards in other locations. There will be additional costs to transport grapes from the new vineyards to the main winery in Northern California. Update Equipment: Invest in new equipment and maintenance workers to reduce the likelihood of expensive repairs to equipment. 1000 scenarios of the stochastic model were run to determine the risk metrics. The results of the stochastic model are summarized in the excel worksheet THIS MATERIAL IS STRICTLY CONFIDENTIAL. DO NOT DISTRIBUTE TO ANY OTHER PERSON. © 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 9 of 10Considering the Risk Document adopted by the ERM Committee, evaluate the effectiveness and appropriateness of each of the above risk mitigation strategies. Note: You will not upload the spreadsheet used with this question. Questions 1516 Questions 1516 are independent of each other and are not linked to a shared scenario. Question 15 Due to your stellar actuarial work and superior management skills at Great Health Insurance (GHI), you have just been promoted to Sr. Vice President and have been put in charge of the new Economic Capital/Risk Management area. You will report directly to the CEO and are expected to work closely with the Chief Actuary and actuaries from the Pricing and Valuation areas. Your department has been staffed with several actuarial students from your former team, but you still have an Actuarial Associate position open. (A) Write an internal job posting for the Actuarial Associate position. Describe what your area will do. Your firm has an actuarial student rotation program, so you will need to distinguish your area from other actuarial areas to attract an internal applicant. Your Human Resources representative will attach specifics such as educational background, exam level, and years of experience. Your focus should be describing in general terms what your area will do and how it will interact with other key areas of the company. (B) As a public relations initiative, the CEO wants to highlight GHIs commitment to emerging risk management strategies. She would like to showcase your department on the companys external Web site. Write a description of how your department will benefit GHIs stakeholders. Question 16 You are an actuary with Mayhem Consulting. Quality Insurance, a small insurance company that is a new client, has provided you with detailed policyholder data for a block of universal life insurance policies and asked you to prepare a reserve estimate using that data. You begin reviewing the data and notice some irregularities. A sample of the data provided is shown in . (A) According to ASOP 23, what should you consider prior to using the data? Discuss problems that you see with the data and how the considerations apply. You discuss the irregularities with Qualitys Chief Financial Officer (CFO) and he is able to provide you with an updated data set. However, the CFO says that the policy administration system automatically assumes all policyholders are male and they havent been able to fix the system to correctly track gender. You continue with your reserve estimate assuming all policyholders are male because you know that assumption does not conflict with any laws or regulations. You believe that reserves may be overstated by as much as $2,000,000 due to that assumption. (B) Prepare a disclosure statement regarding data quality that you would include in your documentation. (C) After you have prepared your reserve estimate and disclosure statement, Qualitys CFO asks you to change some of the data in order to reduce the reserve amount. How does the Code of Professional Conduct apply in this situation? Note: You will not upload the spreadsheet used with this question. THIS MATERIAL IS STRICTLY CONFIDENTIAL. DO NOT DISTRIBUTE TO ANY OTHER PERS
