CT5

1. Force of mortality
The force of mortality is the instantaneous rate of mortality at age x.

2. UDD and CFM

UDD is an assumption about how mortality varies within a year of age. It
assumes that lives die regularly through the year.
CFM assumes that the force of mortality takes a constant value between
consecutive integer ages.

3. Select mortality and ultimate mortality

The mortality which varies by age only is called ultimate mortality

whereas the select mortality is the mortality which depends on age as
well as the duration of the policy. The mortality of recently joined
policyholders (select mortality) is expected to be lower than that of the
policyholders who have a longer duration (ultimate mortality).

4. Difference between insurance and assurance contracts

Assurance contracts provide cover for a definite event i.e. whose
happening is certain like- Death. An Insurance contract provides cover
on the happening of an anticipated event i.e. which may or may not
happen like- theft, fire, flood etc.

5. Types of Assurance contracts

i- whole life assurance- The benefit under such a contract is an
amount, called the sum assured, which will be paid on the
policyholder's
death.
ii- term assurance – It is a contract to pay a sum assured on or after
death, provided death occurs during a specified period, called the
term of the contract.
iii- A pure endowment contract provides a sum assured at the end of
a fixed term, provided the policyholder is alive.
 iv- An endowment assurance is a combination of:
(i) a term assurance, and
(ii) a pure endowment.
That is, a sum assured is payable either on death during the term
or on survival to the end of the term. The sums assured payable
on death or survival need not be the same, although they often
are.

6. Types of Annuity contracts

i- Annuities under which payments are made for the whole of life,
with level payments, called a whole life level annuity or, more
usually, an immediate annuity.
ii- Annuities under which level payments are made only during a
limited term, called a temporary level annuity or, more usually,
just a temporary annuity.
iii- Annuities under which the start of payment is deferred for a given
term, called a deferred annuity.
iv- Annuities under which payments are made for the whole of life,
or for a given term if longer, called a guaranteed annuity

7. Difference between assurance and annuity

Assurance contracts provide a lump sum amount at the time of claim.
Annuity contracts represent a series of regular income to the
policyholder or the nominee.

8. Types of bonus

Bonus is an additional benefit is given to the policyholders to increase

the basic sum assured in respect of any emerging surplus of assets over
liabilities in valuation. Types of bonuses are:

Reversionary bonus – which is paid at the time of maturity of the

policy, but is declared every year during the term of the policy, when
the company makes a profit.

Terminal bonus– which is paid on the termination of the policy, but

may not be declared every year.
 Interim Bonus– which is paid in case of a policy claim is made
between two bonus declaration dates. In such a case, the bonuses which
have to be accrued to date is paid and called an interim bonus.

9. Methods of allocating bonus

i- Simple – the rate of bonus each year is a percentage of the initial
(basic) sum
assured under the policy. The sum assured will increase linearly
over the term of the policy.
ii- Compound – the rate of bonus each year is a percentage of the
basic sum assured and the bonuses added in the past. The sum
assured increases exponentially over the term of the policy.
iii- Super compound – two compound bonus rates are declared each
year. The first rate is applied to the basic sum assured. The second
rate is applied to the bonuses added to the policy in the past. The
sum assured increases exponentially over the term of the policy.

10. Gross premium and net premium

The gross premium is the premium required to meet all the costs under
an insurance contract, and is the premium that the policyholder pays. It
takes into account the expenses and the bonuses.

11. Why insurance companies hold reserve

In many life insurance contracts, the expected cost of paying benefits
increases over the term of the contract. the premiums which pay for
these benefits are usually level. This means that premiums received in
the early years of a contract are more than enough to pay the expected
benefits that fall due in those early years, but in the later years the
premiums are too small to pay for the expected benefits.
It is, therefore, prudent for the premiums which are not required in the
early years of a contract to be set aside. So The company sets up
reserves to ensure that they remain solvent.

12. Methods of calculating reserves

i- Prospective Reserve
ii- Retrospective reserve
13. Conditions of equality
If:
1- the retrospective and prospective reserves are calculated on the
same basis, and
2- this basis is the same as the basis used to calculate the premiums
used in the reserve calculation,
then the retrospective reserve will be equal to the prospective reserve

14. How the life insurance products are priced?

The price of life insurance contracts are the premiums. Premiums
are calculated using the principle of equivalence i.e. by equating the
expected present value of incomes to the expected present value of
outgoes, on the basis of some suitable set of assumptions like-

· Mortality experience
· Investment returns
· Future expenses
· Bonus rates
· Interest rates ( constant, deterministic, stochastic )

We must consider-
Time value of money
The uncertainty attached to payments to be made in the future ,
depending on the death or survival of a given life.

15. Differentiate between Surrender and lapse of a policy?

When policyholders want to receive the benefit before the expiration,
they can terminate the policy; this is called surrendering the policy. In
such cases, the insurance company cut a certain fixed proportion and
pays the remaining amount.

When due to some reasons, the policyholder stops paying the premium
due to the policy, the company lapses/terminates the policy and no
premium or claim payments are made in these scenarios.

16. What is DSAR?

Death strain at risk (DSAR) is the extra amount that the company may
have to pay to the policyholder if the policy becomes a claim during the
year, with some given probability.

17. Differentiate between multiple state model and multiple

decrement model?
Multiple state model is a model where more than one decrement is
available and returns to the same state is possible. Multiple decrement
model is the one which has one active state and one or more absorbing
 exit states. Only one-way decrement is possible i.e. return to the same
state is not possible.

18. Differentiate between defined benefit and defined

contribution schemes?
Defined benefit plans are where the employer guarantees a
specific retirement benefit amount for the employee, which can be
based on the employee’s salary, years of service or a no. of other
factors. Employees have a little control over the fund. Defined benefit
plans require the complex actuarial projections.

Defined contribution, on the other hand, is contribution-based rather

than benefit-based. These plans are funded by the employee, with the
employer matching contributions to a certain amount. The accumulating
value of each member’s fund may be used to pay for scheme benefits
required for the member from time to time and the rest is used for post-
retirement benefits.

19. What are unit-linked contracts/ULIPs?

Unit Linked Insurance Policies (ULIPs) are the contracts in which the
benefits are directly linked to the value of some underlying investment
fund, chosen by the policyholders.

A specified proportion of the premiums received are invested in the

fund. The investment fund is divided into units which are priced
continuously, each policyholder then receives the value of the
units allocated to the policy.

To avoid the risk of poor investment performance, sometimes a

minimum guaranteed sum assured is specified in the terms of the
contract.

20. What are some unit fund charges?

Unit fund charges comprise:

· Fund management charges, basically a percentage of the unit fund.

· Policy Fee.
· Charge to cover the cost of providing any additional non-unit benefits.

21. What is the significance of Profit testing?

Profit testing is the process of projecting the income and outgo
emerging from a policy and discounting the results.
 Profit testing is a useful tool that can be used for various different
purposes, such as setting the premium for a life policy that will give us
our required level of profitability, setting reserves and various other
applications.

22. Health insurance contracts

i- Critical illness insurance, which normally pays a lump sum on
diagnosis of a defined “critical illness”
ii- Long term care insurance, which pays an income contingent upon
the policyholder requiring long term care and hence supports the
costs of receiving that care.

23. Types of expense

i- Overhead expense: This expenses in the short run do not vary with the
amount of business written. Eg- rent of building
iii-Direct expense: This expenses vary with the amount of business
written.
· Initial expense
· Renewal expense
· Terminal expense

COMPANY
PREMISES

PREMIUM
UNALLOCATED NON UNIT FUND
PREMIUM

ALLOCATED BID OFFER

PREMIUM SPREAD

COST OF
ALLOCATION UNIT FUND NON UNIT
MANAGEMENT BENEFIT TO
CHARGES POLICYHOLDER

UNIT FUND
UNIT BENEFIT TO POLICYHOLDER
24. Non unit fund
The non unit fund is the insurance company’s money, held in an account
that the policyholder does not see.
The money in the non unit fund is not invested in units and reflects the
insurance company’s cashflows from having sold the contract. These
cash flow include any premiums not allocated to units, charges levied on
the unit fund, less the insurance company’s expenses and any benefits
paid to the policyholder.

25. Why to have non unit reserves

It is a principle of prudent financial management that, once sold and
funded at the outset, a product should be self-supporting. This implies
that the profit signature has a single negative value (funds are provided
by the insurance company) at policy duration zero. This is often termed
‘a single financing phase at the outset’.

Many unit-linked products naturally produce profit signatures which

have a single financing phase but not all of them.

If we expect future negative cash flows, we need to set up a non unit

reserve to fund these future negative cashflows.

These reserves are funded by reducing earlier positive non-unit

cashflows. Good financial management dictates that these reserves
should be established as late as possible during the term of the
contract. So we find the latest negative cashflow, set up a reserve the
year before to fund for that negative, and if necessary carry on working
back until we have no negative cashflows.

26. On what factors the size of the margin depends

· The level of risk that the insurer is underwriting. The higher the
risk the bigger the margin.
· The purpose of the investigation.

27. Two reasons for an element of caution in the basis

· To allow for contingency margin , to ensure a high probability that
the premiums plus interest income meet the cost of benefits ,
 allowing for random variation . In other words , to ensure a high
probability of making a profit.
· To allow for uncertainty in the estimates themselves

28. Net Premium

The net premium is the amount of premium required to meet the

expected cost of the assurance or annuity benefits under a
contract , given mortality and interest assumptions.

29. Why the prospective reserve is important

If the company holds funds equal to the reserve and the future
experience follows the reserve basis, then , averaging over many
policies , the combination of reserve and future income will be
sufficient to pay the future liabilities.

30. Net Premium Reserve

The net premium reserve is the prospective reserve , where we
make no allowance for future expenses and where the premium
used in the calculation is a notional premium, calculated using
the reserving basis.

31. Give the circumstances where mortality profit or loss arises

· If the interest earned is greater than that assumed in the reserve,
then the premium and reserve at the start of the year will
accumulate to more than the sum required to cover the cost of the
benefits and the year-end reserve, giving an interest surplus.
· If the policyholder decides to surrender his or her policy (that is, to
cease paying premiums, and take some lump sum in respect of the
future benefits already paid for) then the year end outgo is not as
assumed. The lump sum will be required in place of the year end
reserve and there will be a surrender profit (positive if the lump sum
is less than the reserve).
· If the experienced mortality is heavier than that assumed in the
basis, then there will be a profit or loss from mortality.
 32. Expected Death Strain at Risk
The expected amount of the death strain for a single policy is called
the expected death strain (EDS) for that policy. This is the amount
that the life insurance company expects to pay extra to the year-
end reserve for the policy.

33. Bonus explanation

We see from the graph that:

● the sum assured under a simple bonus arrangement is a straight line
● under a compound bonus arrangement, the sum assured increases slowly at first
and more quickly later in the policy
● under a super compound arrangement, this feature becomes more pronounced,
with lower increases earlier on being compensated for by greater increases later
on in the policy.
For a given total amount of reversionary bonus at the maturity date of an endowment
assurance, the super-compound approach defers the distribution of surplus – as bonus – more
than does the compound approach. The compound approach in turn defers it more than does
the simple approach. In the first few years of the contract, the initial guaranteed sum assured
is much larger than the attaching bonuses. Therefore super-compound bonus methods, which
give a lower percentage bonus to the initial guaranteed sum assured, produce lower amounts
of bonus in the early years. Once significant bonuses have built up under the contract (towards
maturity), the higher figure on bonuses becomes more significant. The bonuses given late in
the contract will be higher than under a simple or compound system, all other things being
equal

34. Comparison of super compound bonus with other methods

35. Net premium reserve for conventional with-profits contracts
When calculating a net premium prospective reserve for a conventional with-profits
policy, remember that:
 the premium used in the reserve calculation:
– is calculated using mortality and interest given in the reserving basis
– makes no allowance for any expenses or bonuses
 the EPV of the future benefits used in the reserve calculation takes account of
bonuses added so far, but makes no allowance for any future bonuses
 expenses are ignored.

36. Net premium reserve for conventional without-profits

contracts
In this case:
 the premium used in the reserve calculation:
– is calculated using mortality and interest given in the reserving basis
– includes all future guaranteed benefit payments, including future
increases or decreases in those benefits
– makes no allowance for expenses
 the EPV of the future benefits used in the reserve calculation takes account of all
benefit increases or decreases, both those that have already occurred and those
that are contracted to occur in the future.
 expenses are ignored.
Where future benefit increases are of uncertain amount, but still non-discretionary
(such as index-linked benefits), then a suitable assumption for the future rate of change
in benefits would need to be made (eg an inflation assumption).

37. The influence of inflation on expenses

Inflation affects underlying costs, which in turn influence the level of expenses
allocated to policies.
The main categories of costs are:
-> salaries and salary-related expenses,
 ->buildings and other property costs,
 ->computing and associated costs, and
 ->costs associated with the investment of funds.

38. Conditions for equality of gross premium prospective and retrospective

reserve
If:
 the mortality and interest rate basis used is the same as that used to
determine the gross premium at the date of issue of the policy, and
 the expenses valued are the same as those used to determine the original
 gross premium, and
 the gross premium is that determined on the original basis (mortality,
interest, expenses) using the equivalence principle
then the retrospective and prospective gross premium reserves are equal.

39. Expenses
In order to price contracts profitably, life insurance companies need to determine the
expenses that will be incurred by the contracts and adjust the premiums accordingly.
To determine the expenses per policy, we conduct an expense investigation. In this
investigation, expenses are broken down into overheads and direct expenses. We then
apportion overheads to policies on a per-policy basis, and apportion direct expenses to
policies according to the relevant drivers (per policy, per £ premium, or per £ sum
assured).
These per-policy expenses then need to be broken down into initial expenses, renewal
expenses and termination expenses. We can then allow for them when calculating the
premium.
Care needs to be taken to allow for inflation of renewal expenses.

40. Contingent Assurances

These are payable on the death of one life , contingent upon another life being in a
specified state (alive or dead).

41. Reversionary Annuities

These are payable to one life from the moment of death of another life.

42. Competing Risks

When a life is subject to more than one transition , then the transitions are referred to
as a set of competing risks.

43. Profit Vector

The profit vector gives the expected profit at the end of each policy year per policy in
force at the beginning of that policy year.

44. Profit Signature

The vector of expected profits per policy issued is called the profit signature

Summarising the above, we have the very important distinction:

 profit vector = profits per policy in force at the start of each year
 profit signature = profits per policy in force at inception

45. NetPresentValue
This is the present value of the profit signature determined using the risk
discount rate.

46. ProfitMargin
 This is the NPV expressed as a percentage of the EPV of the premium income

47. ProfitCriterion
The objective specified for expected level of profit is termed the “profit
criterion”.
Careful choice of a profit criterion is central to the actuarial management of the
company selling the products. It is common for those marketing and selling the
products to receive part of their salary in the form of a “productivity” bonus eg
commission which is a percentage of the total premiums for the policies sold. If
the profit criterion chosen is directly related to this “productivity” bonus, then
the company’s profits will be maximised if the salesforce maximises its income.
Such considerations are important in choosing the profit criterion to be used

48. UnitLinkedContracts
With unit-linked contracts the policyholder’s basic entitlement is expressed in terms of
units, which represent a portion of a fund or funds run by the life insurer. The value of
these units moves in line with the performance of the fund. Given this basic concept,
the unit-linked idea can be used to provide many different types of product, for
instance:
● a regular premium product offering a guaranteed sum assured on death, to give
an endowment assurance;
● a single premium product offering a return of premium on death to give a pure
savings bond;
● a regular premium contract offering an annuity payment during periods of
disability or unemployment; or,
● a single premium product offering an annuity payment until death.

49. Whatwillhappenifthereservingbasisistoooptimistic
A company whose reserving basis is too optimistic runs a significant risk of
paying out too much profit to its capital providers. The result could be
insufficient assets in future to meet liabilities, and the company would become
insolvent.

50. What will happen if the reserving basis is too pessimistic

A company whose reserving basis is too pessimistic will be holding extremely
large reserves. Large reserves require large amounts of capital from the
shareholders (or with profit policyholders). The profits from the business then
have to be that much higher in order to provide the required rate of return on that
capital, which will mean greater cost to the customer through having to pay
higher premiums or charges

51. Selection
Selection is the process by which lives are divided into separate groups so that
 the mortality (or morbidity) within each group is homogeneous. That is, the
experience of all lives within a particular group can be satisfactorily modelled by the
same stochastic model of mortality (or morbidity).

52. DifferentPensioners
(i) activemembe rsofthes cheme,ie thosen otinreceiptofanybenefit s
and
forwhomcontribu tionsareb eingpaid,
(ii) deferredpe nsioners,ie thoseforwhomnocontributionsarecurrent ly
beingpaidandwh oareentit ledtoapen sionatsomefutured ate,and
(iii) pensionerswhoretire datthenor malretirementageandarenow
receivingapensi on,
(iv) pensionerswhoretiredunderthei ll-h
ealthretirementrulesofth e
scheme
andarenowrecei vingapens ionbenefit,
(v) pensionersw horetiredundertheea rly(beforenormalpensionage)
retirementrulesofthesche meandaren owreceivingapensionbenefit.

53. Why it is necessary to have different mortality tables

for different classes of lives

When a life table is constructed it is assumed to reflect the mortality experience

of a homogeneous group of lives ie all the lives to whom the table applies follow
the same stochastic model of mortality represented by the rates in the table.
This means that the table can be used to model the mortality experience of a
homogeneous group of lives which is suspected to have a similar experience.
If a life table is constructed for a heterogeneous group then the mortality
experience will depend on the exact mixture of lives with different experiences
that has been used to construct the table. Such a table could only be used to
model mortality in a group with the same mixture. It would have very restricted
uses.
For this reason separate mortality tables are usually constructed for groups
which are expected to be heterogeneous, eg separate tables for males and
females.
Sometimes only parts of the mortality experience are heterogeneous, eg the
experience during the initial select period for life assurance policyholders, and
the remainder are homogeneous, eg the experience after the end of the select
period for life assurance policyholders. In such cases the tables are separate
(different) during the select period, but combined after the end of the select
period. In fact there are separate (homogeneous) mortality tables for each age
at selection, but they are tabulated in an efficient (space saving) way.

54. Pensionable Salary

(i) annual rate of salary at retirement, termed final salary
(ii) average annual salary in the last few years (usually 3 to 5 years) before retirement,
termed final average salary
(iii) average annual salary during scheme membership, termed career-average
salary or lifetime earnings
55. Benefits on Withdrawal
Members who leave service before NPA may be entitled to:
-> a refund of their own contributions, or
-> a deferred pension payable from NPA based on service to the date of leaving
56. Classification of Benefits
· An accrued benefit (sometimes referred to as past service benefit) is a benefit
that has been earned as a result of pensionable service (or credited service)
prior to the valuation date
· A future service benefit is a benefit that is expected to be earned as a result of
pensionable service after the valuation date
· A prospective service benefit does not depend on either past or future service,
although it may depend on total expected pensionable service