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Subject ST2
CMP Upgrade 2013/14
CMP Upgrade This CMP Upgrade lists the most significant changes to the Core Reading and the ActEd material since last year so that you can manually amend your 2013 study material to make it suitable for study for the 2014 exams. Alternatively, you can buy a full replacement set of up-to-date Course Notes at a significantly reduced price if you have previously bought the full price Course Notes in this subject. Please see our 2014 Student Brochure for more details.
This CMP Upgrade contains: all changes to the Syllabus objectives and the most significant changes to Core Reading. significant changes to the ActEd Course Notes, Series X Assignments and Question and Answer Bank that will make them suitable for study for the 2014 exams.
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The products under this syllabus objective may provide benefits of the following types: single, or periodic, payments from the date of death single, or periodic, payments on survival to a specified point in time periodic payments on continued survival
and the products may be written on the following bases: single or regular premium without-profits non-linked unit-linked index-linked with-profits single, joint, or group life basis with or without options and guarantees.
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The last three bullet points of Syllabus Objective (e) have been updated so that it now reads: (e) Describe the effect of the general business environment, including the impact on level of risk to the insurer, in terms of: propensity of consumers to purchase products methods of sale remuneration of sales channels types of expenses and commissions including influence of inflation economic environment legal environment regulatory environment taxation regime professional guidance.
The fourteenth bullet point of Syllabus Objective (f) has been updated so that it now reads: (f) Discuss how the following can be a source of risk to a life insurance company: policy and other data mortality rates investment performance expenses, including the effect of inflation withdrawals mix of new business volume of new business guarantees and options competition actions of the board of directors actions of distributors failure of appropriate management systems and controls counterparties legal, regulatory and tax developments fraud aggregation and concentration of risk.
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Syllabus Objective (i) has been updated (eg the sub bullet points on the use of models have been deleted) so that it now reads: (i) Describe the use of actuarial models, including stochastic models and Monte Carlo simulation, for decision making purposes in life insurance in terms of: the objectives and basic features of a life insurance model choosing between formula and cashflow approaches choosing between stochastic and deterministic approaches the differences between traditional and financial economic approaches the use of sensitivity analysis or the assessment of variances the uses of models
The fourth bullet point of Syllabus Objective (o) has been updated so that it now reads: (o) Describe how supervisory reserves may be determined for a life insurance company in terms of: the principles of setting supervisory reserves the reasons why the assumptions used may be different from those used in pricing the calculation of non-unit reserves allowing for future bonuses on conventional with-profits contracts the use of sensitivity analysis the interplay between the strength of the supervisory reserves and the level of solvency capital required.
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The first paragraph of ActEd text has been deleted. Page 10 The last six words have been deleted from the first paragraph of ActEd text so that it now reads: A without-profits endowment assurance offers a guaranteed amount of money (the sum assured) at the end of the contract in exchange for a single premium at the start of the contract or a series of regular premiums throughout the contract. If the policyholder dies before the contract term ends then usually the same sum assured is paid on death. However, the contract could be structured with a sum assured paid on death different from that paid at maturity. Page 13 The last bullet point of Core Reading has been updated to read:
No death benefit (ie a pure endowment contract). Here there will be a longevity risk, the significance of which will increase with duration in force.
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Chapter 2 Page 6 The first paragraph of Core Reading has been amended to read:
A decreasing term assurance (ie the benefit amount reduces periodically during the policy term) can be used to meet two specific such needs. First, it can be used to repay the balance outstanding under a repayment loan and, secondly, it can be used to provide an income for a family with children until such time as the children can fend for themselves.
Page 9 A new paragraph of Core Reading has been added after the examples box as follows:
Initial capital strain can also arise for regular premium policies due to high initial expenses, such as underwriting costs and initial commission.
Chapter 4 Page 20 The second paragraph of Core Reading has been amended to read:
Unit-linked contracts tend to be designed in a flexible manner so as to allow the policyholder to vary premiums and benefits over his or her lifetime. However, increases in minimum guaranteed death benefits are likely to be made subject to satisfactory evidence of health, so there is a risk to the policyholder that such increases are declined or made subject to special terms.
The following paragraph of Core Reading and paragraph of ActEd text have been added at the bottom of the page:
Unit-linked contract charges may be variable at the discretion of the insurance company, so there is a risk to the policyholder that these are increased.
As we saw in Section 1.3, the insurer is exposed to the risk of high inflation on its expenses and possibly mortality risk too. It may be able to pass these risks on to the policyholders through higher charges.
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Chapter 5 Page 3 The first word has been deleted from the first bullet point so that it now reads:
expenses incurred and any commissions paid
The first heading and following paragraph have been amended to read:
Chapter 7 Page 2 The following question has been added immediately after Question 7.1: Question 7.1A A policyholder has made the following comment: My premium has gone up by 2%, so of course my sum assured should go up by 2% too. I dont see how this is a bonus. How would you respond? The solution to this question is: If the policyholder had paid 2% more from outset then the sum assured would have been 2% higher. So one way of thinking about the bonus is that the policyholder gets 2% more in benefits without having paid 2% more on his or her past premiums.
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Chapter 8 Page 4 The first bullet point has been amended to read:
persistency risk, and consequent financial losses including the possibility of compensation
So the persistency risk mentioned in the Core Reading above is the risk that the policyholder lapses or surrenders early, ie it is the same as withdrawal risk. The final two paragraphs have been amended to read:
Changes in the propensity of consumers to purchase particular products (for a variety of reasons) lead to new business risk for the insurer as they can result in new business volume or mix being different from that assumed.
These risks are fully discussed in Chapter 11. Page 5 The first paragraph has been amended to read:
Insurance intermediaries are salespeople who must act independently of any particular life insurance company (although they can be owned by one). Their aim is to find the contract that best meets, in terms of benefits and premiums, the needs and situation of their clients. They may be remunerated, via commission payments, by the companies whose products they sell, or they may alternatively receive a fee from their clients.
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The last paragraph has been amended to read: Of course, lists of clients have to be acquired in the first place. This might be achieved, for example, through press advertising, personal contacts, or by purchasing a list from a marketing company (who might, for example, provide a list of, say, 5,000 people who have moved house in the last 12 months). Page 8 The following paragraph has been added at the end of the page:
Some direct marketing is now being performed using other forms of social media, such as Twitter and Facebook.
Page 11 The first paragraph after the question has been amended to read:
Different products will suit different methods of sale. For example, the dynamics of selling via the telephone, press advertisements or the internet mean that the products sold in this way will almost inevitably be quite simple. This confirms the
answer to the previous question, but we wanted you to think about it for yourself first. The following paragraph has been added at the end of the page:
An insurance company using more than one distribution channel may therefore sell different versions of the same product, varying by channel.
Page 12 The last paragraph of Core Reading has been amended (by deleting the reference to withdrawals) to read:
The level of underwriting will then be reflected in the demographic assumptions used for pricing. The class selection mentioned above will also affect these assumptions.
Chapter 9
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Page 12 The first paragraph of Core Reading has been amended to read:
The regulatory environment can also affect the choice of assets through their relationship with the investment assumptions used to value the liabilities. A particular asset selection may allow a company to use a higher investment assumption and thereby reduce the value of the liabilities and increase the free assets. Typically, however, such distributions will not enable the company to maximise the expected investment return.
Page 21 The second paragraph of Core Reading has been amended to read:
As such, professional guidance should not unduly restrict the actions of actuaries and may even provide protection against pressure from proprietors to agree to courses of action that may not be in the best interests of policyholders.
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Page 24 The final bullet point has been amended to read: tax payable on investment income / gains less some or all of the operating expenses of the company.
Chapter 11 Page 8 The following two paragraphs have been added at the end of the page:
Equally, the actions of competitors can have adverse implications for new business volumes.
So a companys new business volumes are likely to fall if it does not follow any of the decisions in the list above but its competitors do. Page 13 The paragraph of Core Reading has been amended to read:
As discussed in Chapter 9, the legal, regulatory and taxation regimes can pose risks to the extent that such environments and rules are changed adversely, whether as they apply to policyholders, or insurers, or both.
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Chapter 21 Page 2 The first paragraph of Core Reading has been amended to read:
In 1990 the Groupe Consultatif des Associations dActuaires des Pays des Communauts Europennes proposed the following set of principles.
Page 8 The final paragraph of Core Reading has been replaced by the following two paragraphs:
The implementation of such principles within a country will depend on the requirements of its insurance supervisory authority and possibly also professional guidance from its actuarial association. Indeed, in some countries (including those in the European Union) there has been movement towards a supervisory regime under which the basic reserves are calculated on a best estimate basis, with additional risk margins held. However, the majority of the above principles remain relevant. Knowledge of how the principles are implemented in practice in any particular country is not required for this subject, but will be covered (from the UK perspective) in the related Specialist Applications subject.
Page 13 The first paragraph of Core Reading has been amended to read:
A net premium valuation does not result in the capitalisation of basis differences mentioned above for the gross premium method.
Page 15 The last paragraph of Core Reading has been amended to read:
In other countries, it is standard practice to calculate premiums using assumptions that broadly reflect expected future experience, with the risks to the company being allowed for mainly through the risk discount rate. If the supervisory regime in that country requires prudence in reserving assumptions then it would not, in that case, be appropriate for the same assumptions to be used both for pricing and for reserving.
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The following paragraph of Core Reading has been added at the bottom of the page:
However, as noted in Section 1, some regimes have been moving towards the use of best estimate assumptions in reserves. In that case, the underlying basis could be the same for both pricing and reserving, but additional allowances for risk would be needed for each.
Page 16 The first paragraph of Core Reading has been amended to read:
If the assumptions used for reserving need to be prudent estimates of future experience, ie expected values but with margins for adverse future experience, then sensitivity analysis can be used to determine these margins.
Chapter22 Page 5 The sixth bullet point has been amended to read:
take account of surrender values offered by competitors (and possibly also auction values, where available)
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Chapter22 Section 4.5 The headings Prudent basis and Realistic basis have been deleted. The first paragraph has been amended to read:
The assumptions used would likely be those implicit in the pricing of a new contract issued at the alteration date to provide the benefits before alteration and the benefits after alteration. The basis may be prudent (with margins) or realistic (without margins).
The two paragraphs of Core Reading under the heading Realistic basis have been deleted.
Chapter 24 Page 5 The last paragraph of Core Reading has been amended to read:
A guaranteed annuity rate corresponds to a call option on the bonds that would be necessary to ensure the guarantee was met, ie at an exercise price which generates the required fixed rate of return. Alternatively it can be mirrored by an option to swap floating rate returns at the option date for fixed rate returns sufficient to meet the guaranteed annuity option (a swaption).
Page 9 The second paragraph of Core Reading and the ActEd paragraph that follows it have been amended to read:
The company will need to make assumptions about future rates of exercising options, which would take into account expected policyholder behaviour and the size of the guaranteed amount relative to the alternative benefit (eg asset share).
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So, for example, a guaranteed surrender value on a unit-linked policy is more likely to be taken when the guaranteed amount is greater than the alternative benefit based on the value of the units. Similarly, a with-profits policy is more likely to be surrendered if the guaranteed amount is greater than an alternative benefit based on the asset share. However, it would be quite simplistic to assume a policy would always be surrendered in these situations. Policyholders might value the maturity benefits more highly or expect the guarantee to become even more valuable at a later date. Chapter 26 Page 2 The second paragraph has been deleted. Page 12 Point (b) has been updated as follows:
(b) the cost of obtaining reinsurance the reinsurer naturally incorporates an expense and profit loading in its reinsurance terms, and the ceding company incurs administrative expenses.
The first paragraph of ActEd text has been deleted. Section 3.2 The heading has been amended to read:
A large, established and financially strong mutual life insurance company mainly transacting with-profits business
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The last paragraph of ActEd text has been deleted. Section 3.3 The last paragraph of Core Reading has been amended to read (in particular the reference to assumption swaps has been deleted):
Proprietary companies will face scrutiny from the stock market on measures such as return on capital employed. Reinsurance can be used to reduce the capital employed, creating leverage, and so increasing the firms own return on capital. This can be achieved by stop loss reinsurance or the different types of financial reinsurance. Reinsurance can also help to smooth profit emergence.
Chapter 27 Page 10 The second bullet point has been amended to read:
underwriting manuals prepared internally or by the major reinsurance companies.
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The final two paragraphs have been amended to read: This states the fundamental approach towards balancing risk and return. The aim is to maximise return subject to an acceptable level of risk. The level of risk a company can take on, given its risk appetite, will depend on the financial resources of the company ie its free assets. We consider below how holding more free assets enables a life company to pursue a riskier strategy.
Although the insurer may decide to mismatch deliberately as a means of seeking a higher expected investment return, the actuary should still make an assessment of the asset-liability position in order to understand the risks being run, including assessment of the adequacy of free assets to support the mismatch.
Page 8 The second, third and fourth bullet points have been amended to read:
Guaranteed in terms of an index of prices, earnings or similar this consists of benefits whose amount is directly linked to such an index. Discretionary this consists of any benefit payments that are at the discretion of the life insurance company, so in particular the future bonus payments under with-profits contracts, and surrender values where these are
not guaranteed. The level of discretion will depend upon the bonus distribution method used.
Investment-linked this consists of benefits where the amount is determined directly by the value of the investments underlying the contracts, so in particular the benefits under unit-linked contracts (or benefits linked directly to a specified investment index).
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Page 21 The following paragraph has been added immediately after Figure 2:
So, the projection of future solvency is an important component of this model. The assessment of the supervisory solvency position, including dynamic solvency testing, was also described in Section 3 of Chapter 16 and in Chapters 20 and 21.
Chapter 30 Page 11 The second paragraph of Core Reading has been replaced by the following two paragraphs:
The role of the actuary in managing a life insurers risks should therefore be a regular programme of advising the directors of the nature and size of the risks faced. Particular attention will need to be given to those risks that are the most material and/or the most sensitive to change. Risks should be controlled by analysing and explaining their nature, costing them as far as possible, and agreeing on management strategies for them.
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In the case of sensitive risks, the actuary should model a range of long-term scenarios to show the impact of variations to future experience, and management strategies should be designed to protect against those risks that the insurer is able to (and chooses to) control.
The following five paragraphs have been added at the end of this section: One approach to managing risks is Enterprise Risk Management. You may have come across this already in Subject CA1 or Subject ST9.
Enterprise Risk Management (ERM) is a risk management framework which considers the risks of the enterprise as a whole, rather than considering individual risks in isolation. This allows the concentration of risk arising from a variety of sources within an enterprise to be appreciated, and for the diversifying effects of risks to be allowed for. This is the holistic, integrated approach to risk management.
So, by looking at the insurer as a whole, the management will be able to see the overall level of risk that they are exposed to. The overall level of risk will be lower if the insurer is well diversified, eg by writing business in many different countries. One benefit of greater diversification is that the insurer will need to hold less capital against its risks.
Another element of ERM is the recognition that value can be added to a business through educated risk-taking, with a strong risk management framework that better allows companies to identify and assess strategic opportunities.
For example, the longevity risk on annuities offsets, to some extent, the mortality risk on term assurances. So it may be beneficial for an insurer writing lots of annuities to take on extra mortality risk by selling more term assurances.
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Page 15 The section under the heading of Systematic risk has been updated as follows: Actuaries advise the companys decision-making process. The key role is to analyse, explain and quantify the risks and rewards of various courses of action. It is important to model the potential variations in future experience caused by the most sensitive risks. Agreed risk management strategies should be documented, implemented, and their effectiveness monitored continually. ERM is an integrated approach to risk management that allows managers to understand concentrations of risk and the benefits of diversification.
Chapter 31 Page 3 The third and fourth bullet points have been replaced by:
monitor any trends in experience monitor actual compared to expected experience and take corrective actions as needed provide management information to aid business decisions make more informed decisions about pricing and about adequacy of reserves.
These changes are also made to the equivalent list in the Summary on page 31. Page 6 The first line of Core Reading has been updated as follows:
The data (both claims and exposed to risk) would ideally be analysed, where relevant, by
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Page 13 The first paragraph of Core Reading has been updated as follows:
Commission is normally excluded from the expenses being analysed on the basis that its format is known and can be added in later by a formula approach.
Page 18 The last paragraph of Core Reading has been updated as follows:
The expenses analysed elsewhere should exclude large one-off capital costs, which need to be amortised over the expected useful lifetime of the item purchased. The amortised cost may then simply be treated as part of the overheads.
Page 29 The first paragraph of Core Reading has been updated as follows:
The results of analysing the experience, the surplus arising and the change in the embedded value will be used by the actuary to reassess his or her view of the future with regard to the company. This may result in changes to the assumptions or models used for pricing or reserving, or changes to the ways in which the business and its risks are managed.
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Q&A Bank Part 6 The sixth and seventh points under the heading of Interest in the solution to Question 6.3 (i) have been changed to: The reduction will also be affected by the expectation for inflation. If inflation is expected to be very high then the company can price on the assumption that benefit escalation will be at 7.5%. The company will then invest mainly in fixed-interest stocks, but with a reduction in price compared with an ordinary annuity escalating at 7.5% pa. [1] Similarly, if inflation is expected to be very low then the company can price on the assumption that benefit inflation will equal national index inflation. The company will then invest mainly in index-linked stocks and a reduction in price may be afforded compared to an ordinary index-linked annuity. [1] The following point has been added to the first list in the solution to Question 6.5: 11. Regulatory changes such as a strengthening of supervisory solvency rules and capital requirements. []
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The following point has been added to the second list in the solution to Question 6.5: 11 Maintain close links with regulators and strengthen capital position in advance of any changes. []
The solution to Question 6.11 incorrectly showed the maximum number of marks as 8. This should have said a maximum of 7 marks.
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5.1
Study material
We offer the following study material in Subject ST2: Mock Exam Additional Mock Pack ASET (ActEd Solutions with Exam Technique) and Mini-ASET MyTest (coming soon) Sound Revision Revision Notes Flashcards Online Classroom (coming soon).
For further details on ActEds study materials, please refer to the 2014 Student Brochure, which is available from the ActEd website at www.ActEd.co.uk.
5.2
Tutorials
We offer the following tutorials in Subject ST2:
a set of Regular Tutorials (lasting three full days) a Block Tutorial (lasting three full days) a Revision Day (lasting one full day).
For further details on ActEds tutorials, please refer to our latest Tuition Bulletin, which is available from the ActEd website at www.ActEd.co.uk.
5.3
Marking
You can have your attempts at any of our assignments or mock exams marked by ActEd. When marking your scripts, we aim to provide specific advice to improve your chances of success in the exam and to return your scripts as quickly as possible. For further details on ActEds marking services, please refer to the 2014 Student Brochure, which is available from the ActEd website at www.ActEd.co.uk.
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