I and FC A 11201204 Exam Final

INSTITUTE AND FACULTY OF ACTUARIES
EXAMINATION
16 April 2012 (am)
Subject CA1 Actuarial Risk Management

Paper One
Time allowed: Three hours
INSTRUCTIONS TO THE CANDIDATE
1.
Enter all the candidate and examination details as requested on the front of your answer
booklet.
2.
You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
3.
You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4.
Mark allocations are shown in brackets.
5.
Attempt all seven questions, beginning your answer to each question on a separate
sheet.
6.
Candidates should show calculations where this is appropriate.
AT THE END OF THE EXAMINATION

Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.
In addition to this paper you should have available the 2002 edition of the Formulae
and Tables and your own electronic calculator from the approved list.
CA11 A2012
Institute and Faculty of Actuaries
An insurance company offers two related life assurance policies.

The first policy is a standard five-year term assurance.
The second is a special five-year term assurance with an option at the end of the five
year term for the policyholder to renew for a further five years without further
underwriting. The premium rate at renewal will be set at the start of the special
policy.
Discuss how the special initial and renewal premium rates applying under the second
policy might differ from each other and from the standard premium rate for the first
policy.
[6]
(i)
Discuss why a pension scheme would carry out a review of its investment
strategy.
[4]
The investment strategy for the equity portfolio of a large pension scheme for the last
three years has been to invest 50% in a passively managed equity fund and 50% in an
actively managed equity fund. The funds are run by different investment
management companies and over the last three years have achieved the following
annual returns, which have been calculated consistently.
Year
Active benchmark
Active fund return
Passive benchmark
Passive fund return
(ii)
1
8%
7%
5%
5%
2
20%
15%
10%
9%
3
7%
7%
5%
6%
(a)
Comment on the performance of the investment funds; and,
(b)
Suggest the main reasons why actual returns may have differed from
the respective benchmark returns.
[4]
The pension scheme carries out due diligence of the investment managers.
(iii)
Outline the features of an investment management companys practices, which

the pension scheme should consider as part of this assessment.
[3]
[Total 11]
CA11 A20122
(i)
Discuss the characteristics which will influence the credit rating of a new bond
issue.
[5]
An investor is evaluating fixed interest bonds to add to their bond portfolio. The
bonds being evaluated are:
a bond issued by the national government.
a corporate bond issued in the local currency by a large multi-national firm, which
has extensive overseas operations.
a corporate bond issued by a small firm, which only has local operations.
(ii)
Explain why the redemption yield on the bond issued by the small firm may be
higher than the redemption yields on the other two bonds.
[3]
(iii)
Outline the main factors which may influence the investors decision as to
which of the three bonds above to invest in.
[3]
[Total 11]
(i)
Outline why companies in the financial services sector have moved to using
more complex models when designing and monitoring products.
[3]
A large financial institution is about to launch an investment fund designed for

experienced investors. The fund will invest directly in a large number of markets and
investment classes.
The institution also intends to offer an insurance policy linked to the new fund. The
insurance policy will provide protection against large falls in the value of an
investors holding in the new fund.
The institution will know what assets the fund will invest in. Hence the team
responsible for designing and managing the fund believe that the insurance policy
premiums can be invested in derivatives so as to hedge the risks faced by investors in
the fund.
Therefore, by charging an appropriate premium, the design team says that there
should be little risk to the institution in offering the insurance policy and guaranteed
profits could be made.
The specific investments for the insurance policy will need to be determined by the
design team using a complex model.
(ii)
Explain why the need to use a complex model may make it difficult for the
directors of the institution to understand the actual financial risks associated
with the investment of the insurance policy premium.
[5]
(iii)
Discuss why the proposed hedging arrangement may not result in guaranteed
profits for the institution.
[4]
[Total 12]
CA11 A20123
PLEASE TURN OVER
A country has a large horseracing industry. Horses generally start racing between the
ages of two and five. Most horses are retired from racing when they reach the age of
thirteen. A very small number of horses are retired at younger ages for breeding.
Revenues from breeding fees can be very high but are very volatile.
It has been proposed that a proportion of all breeding fees should be used to provide
contributions to a general fund that will be invested in order to provide benefits to
look after horses in retirement.
All horses actively involved in racing would be covered by the fund.
Benefits would normally only be payable when horses retire from racing aged
thirteen.
Benefits would only be available in respect of retirement before age thirteen if the
horse is certified as injured by a registered vet.
No benefits would be payable on the death of the horse either before or after
retirement.
(i)
Outline the demographic information that would need to be considered when

determining the cost of any retirement benefits.
[5]
Two possible forms of benefits have been proposed:

(a)
Benefits for each horse will be paid out of the general, overall resources of the
fund
Benefits will be calculated as a cash amount for each year of a horses racing career to
be paid as an annual income from retirement until the horse dies. This amount will be
the same for all horses and will be increased each year, both before and after
retirement, in some way to allow for inflation.
(b)
Benefits for each horse will be provided from individual accounts held within the
overall fund
A proportion of each years contributions will be allocated to each horse. These
contributions will form individual accounts for each horse. The value of these
accounts will grow in line with investment returns earned by the general fund. On
retirement, the accumulated individual accounts will be used to provide appropriate
benefits.
In both cases, any proceeds would be payable to the horses owner who would use
them on behalf of the horse. Measures would be taken to ensure that any payments
are actually used to provide care for horses and not taken by their owners.
CA11 A20124
(ii)
Discuss the relative attractions of each proposal in terms of providing suitable

benefits for horses retiring at age thirteen or on earlier certified retirement.
[10]
As an alternative to proposal (a), it has been suggested that instead of paying income
until the horse dies, the fund will reimburse the cost of housing the horse at a
retirement farm approved by the fund.
(iii)
Describe the additional risks that the fund may face if this alternative were
adopted.
[4]
[Total 19]
High Power is a domestic construction firm specialising in the energy sector. Over
the last ten years it has built a number of traditional power plants (which rely on fossil
fuels). With increased consumer demand for green energy High Power is currently
bidding for a contract to construct a dam and hydro-electric plant project for the
government.
Under the terms of the project contract one quarter of the project fee will be payable
to High Power upon exchange of contracts. The balance of the fee will be paid as a
lump sum on completion and handover of the dam and hydro-electric plant. It is
expected that the project will be completed within three years.
As part of the bidding process High Power will prepare a written strategy document.
(i)
List the particular items, which should normally be included in such a strategy
document.
[6]
(ii)
Describe four distinct non-financial risks that High Power could be exposed to
under this project. Your description should include of a way of mitigating
each risk.
[8]
Most of the fee will be paid on completion of the project. Hence High Power believes
that a key financial risk will be maintaining company cash flows for the three-year
term of the contract.
(iii)
Discuss options for managing the cash flow problems arising from the
staggered project payments.
[5]
[Total 19]
CA11 A20125
PLEASE TURN OVER
The Wetsock music festival has been running for 25 years. The festival is open air
and based in a remote location. Popularity has increased in the last five years with a
large number of visitors choosing to camp at the site over the weekend. Although the
acts at the festival are known in advance, late changes to scheduled performances are
common.
There are two kinds of ticket and both require wristbands to be worn for the duration
of the festival:
Silver band
Provides access to the festival and campsite.
Gold band
Provides access to the festival, campsite and VIP areas. In addition mobile text
message alerts are provided when scheduled performances are confirmed or altered.
Next year, an insurance company will sponsor the festival. The insurance company
has negotiated with the organisers to provide free insurance to gold band ticket
holders. The insurance company will receive a share of the gold band ticket price in
return for providing the insurance.
(i)
List the perils a visitor may wish to insure against during the festival weekend.
[4]
The cover the insurance company decides to offer to gold band holders includes two
key benefits:
Mobile phone cover: a compensation payment if a visitor has their mobile phone
stolen or damaged at the festival; and
Cancellation cover: a full refund of the ticket price if the entire festival is
cancelled due to poor weather.
(ii)
Discuss the factors that would need to be considered when determining the
cost of providing the mobile phone cover at this particular festival. Your
description should include possible sources of data.
[8]
(iii)
Explain why the claims experience for the cancellation cover is likely to be
markedly different and more difficult to predict compared to that for the
mobile phone cover.
[4]
(iv)
Outline the factors, which could lead to the price the insurance company
would charge the organisers being different to the expected cost of claims. [6]
[Total 22]
END OF PAPER
CA11 A20126

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INSTITUTE AND FACULTY OF ACTUARIES

Subject CA1 Actuarial Risk Management

Mark allocations are shown in brackets.

Candidates should show calculations where this is appropriate.

AT THE END OF THE EXAMINATION

Institute and Faculty of Actuaries

An insurance company offers two related life assurance policies.

Comment on the performance of the investment funds; and,

Outline the features of an investment management companys practices, which

a bond issued by the national government.

A large financial institution is about to launch an investment fund designed for

PLEASE TURN OVER

Outline the demographic information that would need to be considered when

Two possible forms of benefits have been proposed:

Discuss the relative attractions of each proposal in terms of providing suitable

PLEASE TURN OVER

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