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INSTITUTE OF ACTUARIES OF INDIA

CA1 PAPER I (INDICATIVE SOLUTION)

MAY 2012 EXAMINATION

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Solution1:TheCompanymayhaveconcernsaboutconflictofinterestingettingthevaluation
donebyanactuarywhoisalsoanemployee.

Companys internal actuary in an employee of the organization and also a member of the
pensionscheme.

Asanemployeehehasaninterestinthebottomlineoftheorganizationashisvariablepaymay
be linked to the same. In fact if he is a senior member of the staff his variable pay can be
expectedtobesignificantlyhigh.Accountingprovisionsimpactbottomline.

Beingamemberoftheschemeontheotherhand,hecanbeexpectedtohaveconcernsabout
thesecurityofhisbenefitsanditmightbeperceivedtotoinfluencehisjudgment(especiallyif
hisnearretirement).

In some professional bodies, only an actuary holding certificate of practice and satisfying
Continuous Professional Development requirements in that specific area is eligible to provide
adviceonaccountingprovisionsforemployeebenefitschemes.Theremaybenoactuaryinthe
lifecompanywhosatisfiesthisrequirement.
Insomecountriestheremayexistlegislationorregulationtoensurethatthevaluationcanonly
couldbedonebyanindependentexternalactuary.

The external auditor of the company may have requested for report from an independent
actuary.

[4]

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Solution2:
(i)
Impactofclassselection
ThecurrentproductisbeingofferedthroughTiedagencychannel.Thetargetmarketof
thischannelcouldbebluecollaredworkers,personsbelongingtolowersocioeconomic
groupsetc.

The IT industry would have a predominance of professionals e.g. Software engineers,


Hardwareengineersetconlywhitecollaredemployees.(betterclassselection)

The employees of the IT company could likely be more health conscious due to their
educationalbackgroundandbeexpectedtotakebettercareoftheirownhealth.(better
classselection).

Employees would be financially well off and can be expected to easily avail quality
medicalfacilities.(betterclassselection).

In IT company more younger employees are likely to join and hence overall lower
averageagewithlowermortalityexperiencecanbeexpected.(betterclassselection).

Reducedantiselection
PurchaseofLifeInsurancebyindividualcustomersislikelytobevoluntarydecision.One
canexpectacertaindegreeofantiselectioninsuchpurchases.

Ontheotherhandtheinstanceofantiselectionisreducedinthegroupschemeas

Thecoveriscompulsoryforallemployees.(lessantiselection).

Employees do not join a firm for insurance. The insurance cover is incidental to the
employment.(lessantiselection).

Premiumispaidbytheemployeronlyasthescheme isnoncontributoryinnature(less
antiselection).

Lifeoverispredeterminedandbasedonanobjectiveformula(multipleofsalary).The
employee does not have any choice as to the level of cover. (less antiselection).
Although a life insurance company performs financial underwriting in resppct of
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individualpolicies,thisislikelytobedonewhenSumInsuredcrossescertainlimit[riskof
antiselection].

UnderwritingandScreening

Fulltime employees of reputed firms would typically go through health screenings at


time of recruitment. Individual customers of protection products also go through a
medicalunderwritingprocess,butthisislikelytohappenwhenthesumassuredcrosses
alimit.

Thoseinillhealthareunlikelytobeemployed.(betterselection).

Less healthy or ill employees havea greater tendency to leave employment since they
maynolongerbefitenoughtowork.

(ii)
Risksofquotingasingleunitrate

single rate would work well for a stable group where older employees leave at
retirementandnewemployeesjoinsothattheaverageageremainsunchanged

For a rapidly growing company in the IT sector it would be difficult to predict the
membership composition in terms of age, gender etc all of which would have an
impactonthesinglerate

Inparticular,thesingleratewouldbeveryriskytouseiftherearemajorchangesinthe
workforce(massretrenchments,mergersetc)

SinglerateonbenefitbasedonsalarywouldshowhighpremiumforhighCTCandlow
premiumforlowCTC,astherateissameirrespectiveofage.

IfthehigherCTCisfor ayoungeremployeeandlowerCTCforan olderemployee,the


absolute premium amount would be higher for younger than older in line with cover.
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Theincreaseinpremiumdirectlyinproportiontothecover,inspiteofdifferencesinage
might not be easily understood/justified to the younger employees leading them to
believe that the benefit provided by insurance company "does not provide good value
formoney"andcouldleadtolossofbusiness.

If the group is geographically spread, members of the same group are likely to be
exposed to differing risk factors. For eg., members resident in tropical regions, areas
morepronetoterroristattacksetc.ASingleratewouldnotappropriatelyreflecthigher
riskassociatedwithriskyregionsandtherewouldbecrosssubsidyamongmembers.If
thegroupcompositionchangesbygeographicallocationthenusingasingleratewould
beinappropriate.

[9]
Solution3:
(i)Assertionstobeexamined
thataliabilityorassetexistsonagivendate

thataliabilityisheldoranassetisownedonagivendate

that when an event is recorded, the time of the event and the associated income or
expenditureareallocatedtothecorrectaccountingperiod

thatdataiscomplete,ietherearenounrecordedliabilities,assetsorevents

that new entrants to the scheme since the last valuation have been included and that no
categoriesofmember(egseniormanagement)havebeenexcludedfromthedata

thattheappropriatevalueofanassetorliabilityhasbeenrecorded.

(ii)Thereareseveralpossiblechecksthatcouldbedone

Reconciliation of the total number of members and changes in membership, using previous
yearsdataandmovementdata.

The reconciliation of movements of members is useful in providing an early indicator of any


trendsoccurringwithinthebenefitarrangement.

Reconciliation of the total benefit amounts and changes in them, using previous data and
movementdata.

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Themovementdatashouldbecheckedagainstanyappropriateaccountingdata,especiallywith
regardtobenefitpayments.

DataintegrityChecksshouldbemadeforanyunusualvalues,forexample,impossibledatesof
birthorretirementagesorstartdates.

Thedatashouldbecheckedagainstpreviousvaluationrecordstoensuredatesthatshouldhave
remainedfixed(egdatesofbirth)havenotchanged.

Consistency between salaryrelated contributions and inpayment benefit levels indicated by


membershipdataandthecorrespondingfiguresintheaccounts.

Consistencybetweeninvestmentincomeimpliedbytheassetdataandthecorrespondingtotals
intheaccounts.

Whereassetsareheldbyathirdparty,reconciliationbetweenthebeneficialownersandthe
custodiansrecords.

Full deed audit for certain assets, for example checking the title deeds to large real property
assets.

Consistencybetweenholdingsofvarioussharesandsecuritiesatthestartandendoftheperiod,
adjustedforsalesandpurchases,andalsobonusissuesinrespectofshares,etc.

Randomspotchecksondataforindividualmembersdetailsorassets.

Itwillbeparticularlyimportanttocheckdataformemberswhohavesignificantliabilitiessince
errorsintheirdatarecordswillhaveasignificantimpactonthevaluationresult.

[9]

Solution4:
(i)
Sourcesofdata

National/populationstatistics

StandardMorbiditytablesbasedonindustrystatistics
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Reinsurancedata

StandardTableavailablefromothercountries(similarrace)

ExistingInsuredlivesdataifcauseofdeath/disabilityisrecordedanddataisstatistically
credible

DatamaintainedbyHospitals

(ii)
Anypublicallyavailablesourceofdataneedstobeadjustedforthefollowing

DefinitionofCriticalIllness

ItfirstneedstobeconfirmedthattheCIdefinitionusedintheunderlyingstatisticsisthesame
asthatusedinthepolicy.Ifnotsuitablechangesneedstobedone

First ever occurrence adjustments Publically available may include data for whom the CI
would not be the first occurrence. For eg. Many people may have two or more myocardial
infarctionsinthecourseoftheirlives.

CIinsurance,willhowever,coveronlythefirstinfarctionaftercommencementofthepolicyand
ceasesafterthatevent.

Hencesuchcasesshouldbeexcludedfromthepublicallyavailabledatabeforeuseforpricing.

Overlap of conditions Often one and the same health impairment causes the occurrence of
severalCIsoneaftertheother.

As the CI cover ceases after the first claim, such overlap effects must be considered in the
calculationofincidencerates.

For example, about every second patient undergoing a bypass operation would have had a
myocardialinfarctionbefore.

Theincidencerateofabypassoperationcanthereforebereducedaccordinglysinceasbenefits
arepaidonlyonce.
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Adjustment for selection the effects of medical selection, antiselection and moral hazard
needtobeestimated.

Mortality during survival period Most CI policies will have a survival period. The CI benefit
would normally be paid only to those who are still alive after that period. The probability of
dying during the survival period would need to be subtracted from the incidence rate of the
disease.

Trend The publically available statistics used will be based on historical data. However, in
order for them to be applicable for the pricing purpose, they must be investigated for
improvementordeterioration.

[9]

Solution5:
(i)

Theaimsofgoodcorporategovernanceisthatacompanyshouldbe

Managed in order to best meet appropriate requirements of its stakeholders the


shareholders, employees, pensioners, customers, suppliers and others who may be
affected by the companys operations whilst not having any contractual relationship
withthecompanyatanytime.
A particular concern of corporate governance is that managers do not make decisions
based more on their own personal interests rather than on the interests of the
shareholders.

(ii)

a) Agoodcorporategovernancestructurecanbeachievedby

Stating clear corporate aims and objectives in terms of financial, operational


andbusinessobjectives.

Theproductionofregularinternalmanagementreportstocompareactual

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performancewiththeaims,objectivesandtargetsofthecompanyforeg.
achievementagainstsales,productprofitabilityandProfit/losstargets,capital
adequacy,investmentperformance,TATonpolicyissuanceandclaimssettlement
etc.

Theestablishmentofclearoperatingproceduresforallcriticalprocessesforeg.
a welldocumented underwriting process, product development and pricing
process, investment management process, well controlled financial reporting
processetc.

Set up a system that checks that such procedures are being implemented
setting up of an internal audit team which conducts regular reviews of all key
processesandtesttheeffectivenessofcontrolsetc.

SettingupsubcommitteesoftheBoardliketheauditcommittee,remuneration
committee etc. which report directly to the Board in respect of financial/audit
matters,remunerationofkeymanagementpersonnel.

The appointment of independent nonexecutive directors to the Board to


provideamoreimpartialviewsinceitisprivatecompanyitmaynothavean
independent director/s on Board. The Independent Board member could also
head crucial board committees like the audit committee, remuneration
committeeetc.

Theregularpublishingofauditedinternalandpublishedaccounts.sinceitisa
private company currently there might be limited statutory requirement to
publishfinancialinformation.

Thedevelopmentandrecordingofjobdescriptionsformanagementwithkey
accountabilitiesandlimitsonauthorityforeg.forkeypersonnelliketheCEO,
CFO,COO,CIO,ChiefActuaryetc.

Theestablishmentofeffectiveperformancemeasurementpracticestoinclude
the setting of performance standards, regular monitoring and feedback with
the remuneration committee of the Board being responsible for setting
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performancestandardsandreviewespeciallyforthekeypersonnel.

Theimplementationofremunerationschemeslinkedtoindividualperformance
(eg profit/value generation related pay), and/or corporate performance (eg
shareoptionsschemes)especiallyforkeypersonnel.

[10]

Solution11:
(i)
Immunizationistheinvestmentoftheassetsinsuchawaythatthepresentvalueoftheassets
lessthepresentvalueoftheliabilitiesisimmunetoageneralsmallchangeintherateof
interest.

(ii) There are three conditions that must be satisfied, for Redingtons classical immunization
theorytoapply:
1.Thepresentvaluesoftheliabilityoutgoandassetproceedsmustbeequal.
2.The(discounted)meantermofthevalueoftheassetproceedsmustequalthemeantermof
thevalueoftheliabilityoutgo.
3.Thespread(orconvexity)aboutthemeantermofthevalueoftheassetproceedsshouldbe
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greaterthanthespreadofthevalueoftheliabilityoutgo.

(iii)Thereareanumberoftheoreticalandpracticalproblemswithimmunization:

Immunizationisgenerallyaimedatmeetingfixedmonetaryliabilities.

Immunizationremovesmismatchingprofitsapartfromasecondordereffect.

Thetheoryreliesuponsmallchangesininterestrates.

Thetheoryassumesaflatyieldcurveandlevelinterestratechangesatallterms.

Inpractice,theportfoliomustbeconstantlyrebalanced.

Thetheoryignoresdealingcosts.

Assetsofasuitablylongdiscountedmeantermmaynotexist.

Thetimingofassetproceedsandliabilityoutgomaynotbeknown.

(iv)
Purematchingisnotalwayspossibleforthelifeinsurancecompanywhen:
theliabilitiesarenotknownwithcertainty,ietheydependuponfactorswhichdonotaffect
the assets to the same degree eg mortality of policyholders, expenses of administering
policies.
net new money is to be invested in the future eg reinvestment of existing assets if
sufficientlongdatedassetsarenotavailable,
the initial income from the required assets is too large.This is possible if coupons are
receivable on fixed interest securities and zero coupon securities/strips are not available.
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Investmentincomeisgreaterthantheliabilityoutgo,thisislikelytobethecaseastheoutgo
fromdeathbenefits,expensesarelikelytolow.
Nonavailabilityofassetswithalltermsforeg.,assetswithonlyspecificdurationmaybe
availableeg.5,10,15yearbondsetc.

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Solution7:
(i)

(i)
Onlinechannelsalesmaydiversifythecustomerbase,butthereareseveralrisks
onsellingthroughonline

Thereisincreasedpotentialforantiselection.

Typically these types of products are aimed at mass market with low cover and easy
issuebasis.Fewerhealthquestionsareaskedsomortalitymaybeexpectedtobehigher
thanforotherchannels.

Internet usage is higher amongst younger people, hence average age may be lower.
Unfortunately,youngerpeoplemayhaveahigherpropensitytolapsetheirpolicydue
to lack of steady work/income, greater propensity to change providers if they find a
morecompetitiveproductoriftheyexperiencepoorservice.

Nosalesmanisinvolved,whichmayincreaselapsesforthischannel.

It may create angst among other distribution channels if internet channel eats into
theirnaturalmarket.

Therearelikelytobeconsiderabledevelopmentcostswhichwillneedtoberecouped
Thereisariskoflowersalesleadingtolowerexpenserecoveriesandhenceloss.

Without the existence of facetoface advice, there may be a tendency for people to
underinsure themselves by paying smaller premiums, thus reducing the average case
sizeandnofulfillmentofpropercustomerneed.

Premiumrateswillbecomparableoverthenetandhencepricehastobecompetitive
/frequentlyreviewedtoberelevantinthemarket.Otherwise,thiswillimpactbusiness
volumes,expenserecoveriesandhenceprofits.

There may be expectations of additional service facilities from policyholderseg, to


make simple administrative changes online, such as change of address, nominee etc
whichmayinvolveadditionalITcosts.

SincethisanewchannelforthecompanythereareadditionaloperationalandITrisks
like
IT down time/slow down load/up load/internet traffic impacting customer
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experienceandsales
Issues relating to data security and protection of customer details like credit
card/debitcarddetailsetcwhichwillrequireadditionalprotection.Anybreach
willleadtosignificantlossofreputation.

Solution(ii)
Disadvantagesoftheproposal:

By limiting its premium payment options, the company will be catering only to a
limited market of High income individuals who can afford a large initial outlay
requiredunderasinglepremiumpolicy

Singlepremiumwillinvolvealargerinitialinvestmentthanregularpremiumpolicy
from a customer perspective. Regular premium can make a policy appear more
affordable and hence increase sales volume for the company especially if its
distributionchannelscatertolowincomegroups.

Regular premium with monthly mode can help the customer to pay premiums by
wayofdeductionfromsalary,whichismoreconvenientforthecustomerandeasy
toadminister.

Incomparingthemarketshare,analystsmaynotgivefullvaluetosinglepremium
policies but instead give limited credit, significantly impacting market share by
Annualized Premium equivalent. This could in turn impact future potential
customersperceptionaboutthemarketstandingofthecompany.

Regular premium policies provide frequent opportunities for interaction with


customer. A satisfied customer is also a repeat customer. Regular premium
policies provide more opportunities for customer interface than single premium
policies.

Regularpremiumpoliciesmaybeperceivedbycustomersasprovidinghighervalue
astheSumAssuredwillbelargermultipleofannualregularpremiumthanasingle
premiumpolicy.

Purchasersofsinglepremiumpolicymightexpectsomesurrendervaluetobepaid
intheinitialyears.Anysurrendervaluethatcanbeofferedcouldappearsmalland
unattractiveandhencethereisariskofcustomerdissatisfaction.
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Advantagesoftheproposal:

Regularpremiumpoliciesareexposedtoriskoflapseandreentryespeciallyif
the term market is highly competitive and premiums rates are reduced
frequentlytocornermarketshare.Itisunlikelythatsinglepremiumpolicesoffer
surrenderbenefitsandhenceriskofselectivesurrenderandentryisreduced.

Risk of lapse isconsiderablyreduced ensuring thatcompany is able to recover


expenses.

NewBusinessStrainwillbelowerforasinglepremiumproduct.Thismaybea
beneficialtoacompanyinatightcapitalsituation.

Theoperationalcostofmanagingaregularpremiumpolicyishigherasrenewal
noticeshavetobesentregularlytothecustomers.Premiumscollected,records
updatedetc.Ofcourse,thesamecanbereflectedthroughahigherpremium,
butacompetitivemarketwillmakeitdifficult.

A single premium policy will be preferred by customers who are looking to


purchaseterminsurancetocovermortgageorotherloans.
The uncertainty over future premium taxes (eg. service tax) in regular pay
comparedtosinglepay

There is possibility of having high commission rate in regular premium than


singleandhencehigherpriceforcustomer.

Highinitialcommissionwithoutclawbackfromthedistributorinregularcould
reduceprofits.

Solution(iii)
Most customers find insurance contracts with its terms and conditions, options and
guarantees,exclusionclauses,benefitsetc.fairlydifficulttounderstand,moresoifitis
incomplexlegallanguage.

Communication is important in insurance sale process and in building a long term


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relationship with a customer. Using Simple English it is an easy and a simple way to
communicate policy terms and conditions without any technical jargon in very small
simplesentences.

UsingsimpleEnglishwillundoubtedlyhelpthecustomerstounderstandthetermsand
conditions of the products. This would help to understand product design and bring
greaterappreciationofbenefitsunderapolicy.

Given that such an initiative is being undertaken for the first time in the market this
wouldenhancethecustomerfriendlyimageofthecompany.

Some expertise will be required to do this. It may increase the cost to the company
initiallybutoverthelongtermbringbenefittothecompanythroughrepeatsalesfrom
existingcustomers.

Policywordinginthedocumentsreceivedbythecustomeristheprimaryreferencefor
any policy servicing issues and also hence will help to understand the service
related/claimsprocess.

This wording would bring more clarity in interpretation and hence there would be
limitedavoidabledelaysinclaimprocess.

There may be some cost saving as far as the claim underwriting is concerned, due to
moreclaritylessinterpretationdifferencesinclaimeligibility.

UsingsimpleEnglishcanputthecompanyasadifferentiatorintheindustry.

The simple wording will also help to reduce customer complaints as less ambiguity in
termsandconditions.Thiswillultimatelyreduceservicingcostsforthecompanyinthe
longrun

Thismaybeappreciatedbytheregulatorasthisseemstobefairtothecustomer.

[15]

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Solution8:
(i)
(a) The Insurer should select investments that are appropriate to the nature, term
andcurrencyoftheliabilitiesandtheinsurersriskappetite.

(b) Subject to (a) the investments should also be selected so as to maximize the
overall return on the assets, where overall return includes both income and
capital.

(ii)

Thesuggestedinvestmentapproachmaynotbeappropriatesinceitcould
leadtothefollowing:

General insurance liabilities are typically shortterm except for long tailed
liabilitybusiness.

The proposed investment strategy could lead to mismatch by term for short
tailedliabilities.

Even for longertail insurance there would be a poor match by nature since
liabilitieswouldbereal,typicallylinkedtoprice/wageinflation.

Following a mis matched strategy will require a company to have substantial


freeassets.Itcouldenhancereturnsbutthereverseisequallylikelytohappen
impacting solvency or tying up capital. Capital could be better utilized by
investinginthebusiness.

Theshareholdersandmanagementshouldalsohavetheriskappetitetofollow
suchamismatchedstrategy.

Fixedinterestsecuritiesofferhighersecuritybutlowerreturnsascomparedto
equities/propertyetcinthelongterm.Companycouldbemissingoutongood
opportunitytoenhancereturnsonitsfreeassetsbyfollowingthisapproach.

Market values of medium/long term assets are volatile especially in a volatile


interestrateenvironmentwhichcouldleadtoproblemswithstatutorysolvency
ifassetsaretakenatmarketvalue.

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Leads to too much concentration in a single asset class though diversification


canbeachievedbyinvestingincorporatebondsacrosssectors,thereisstilla
systemic risk associated with investing in one asset class. This can only be
reducedbyinvestingacrossvariousassetclasses.
Theassetsmaynotbemarketableparticularlyforcorporatebondstheremay
belossofvalueatthetimeofsaleduetodifficultyinfindingabuyer.

Some fixed interest securities are less liquid than equities and involve more
dealingcosts

Similarlytherecouldbecreditrisksassociatedwithcorporatebondswhichcan
bemitigatedbyinvestingingradebondsbutthiswillbeatthecostofpotential
higherreturn.Somelowgradebondsareworsethanqualityequitiesasregards
creditrisk.

Theremaybetaxdisadvantagescomparedwithotherassets.

Normally,longerdatedsecuritiesofferahigherreturnthanshortdatedassets.
Butinexceptionalcircumstances(downwardslopingyieldcurve)thereversecan
alsohappen.Insuchcasesitmaybemoreappropriatetoinvestshort.

Iftheinterestratesarelikelytorise,itmaybemoreappropriatetoinvestshort
toprotectagainstlossofcapitalvalue.




(iii)
Themainusesare:
administration
accounting
preparingstatutoryreturns
inmakinginvestmentdecisions
financialcontrol,managementinformation
riskmanagement
settingprovisions(forexample,settingasidereservestomeetfuturebenefit
payments)
experiencestatistics
experienceanalyses
premiumrating,
marketing.
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(iv)
Ifdataiscontrolledbyonesingle,integratedsystemthen:
Thereisreducedchanceofinconsistenttreatmentofinformationacrossthe
organizationandovertime
ItimprovesITsecurityasthereislikelytobeabetterlevelofcontroloverthosewho
mayenterinformationoramendinformation.
Informationwillbeeasiertoaccess,egitwillnotinvolvecollatinginformationfrom
severalsystems.
Timewillnotneedtobespentreconcilingdatafromdifferentsystems.
Inthelongrunthiscouldleadtosignificantsavingsinexpenses
(v)Risksofsettingreservingwithinadequatedata

Couldleadtooverreservingorunderreserving

Under reserving could lead to a short fall in funds and an inability to meet
liabilitiesastheybecomepayable

Underreservingwillspeedupthepaymentofdividendsandtax

Over reserving will cause a reduction in the apparent published solvency


margincausingalossofconfidenceinthecompanyifthetruepositionisnot
considered

The insurers investment strategy would need to be more cautious than


otherwisepossiblyreducingtheoverallreturnstoshareholders

Morereinsurancemaybepurchased,cedingmoreprofitstothereinsurer.

Riskoffluctuationinreservesyearonyearfornoreasonbutdatainadequacy
leadingtovolatilityofprofits

Riskofimproperadjustmentintheparametervalueswithouthavingadequate
dataoracompleteview

Riskofregulatorydispleasureresultinginapenaltyorneedtoholdadditional
reservesfordatainadequacy

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Risk of financial statement being qualified by auditor leading to loss of


reputation.

Poor rating by analysts leading to increased cost of capital, loss of customer


confidenceandhencefuturenewbusiness

[15]

Solution9:

(i)Anewlyformedgeneralinsurancecompanyrequirescapitalto:
Evenbeforecommencementofbusiness,itwouldinitiallyrequirecapitaltosetup

shop,conductpriorlaunchdevelopmentactivities(likeapplyingforlicense

approval,conductmarketsurveys),employandpaykeypersonneletc.
Inmanyjurisdictionsacompanyneedstobecapitalizedatacertainleveltobe

eligibleforlicensingtotransactbusiness.
Postlicenseitwillneedcapitaltomeetminimumstatutorysolvencyrequirement
asprescribedinregulationeventhoughcalculatedsolvencyrequirementwillbe

small.

Itmayneedtobewellcapitalizedabovetheminimumrequiredlevelsto
demonstratefinancialstrengthtopotentialcustomers,businesspartnersand

investors.

Sinceitisanewcompanyitwillincursignificantmarketingcostsinbuildingits
brand,runningproductcampaignsetc.

Tosupportaggressivepricingstrategyifitiskeentobuilditsmarketsharefast
Tosupportrisky,mismatchedinvestmentstrategyifitseesanopportunityinto

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makeprofitsbyfollowingsuchastrategy.;
Itwantstofollowaprudentreservingstrategythanwhatisstatutorilyrequiredto

supporttheuncertaintysurroundingamountandtimingofliabilityoutgo(infactit

islikelythatitmayhavevolatileclaimsexperienceduetosmallsizeofportfolio).

Itcouldmaintainprudentreservesthanthatrequiredunderregulationsdotogain

theconfidenceofpotentialcustomers,gainpositiveratingsfromratingagencies.
Meetnewbusinessstrainduetotheadministrationandmanagementexpenses,
commissionandanystatutoryreserveandsolvencycapitalrequirementsinvolved.
Sinceitisanewcompanyitislikelythatproductexpensemarginsareinsufficient
tocoveractualmanagementexpenses.Capitalisrequiredtocoverexpense

overrun.

Investinnewcuttingedgetechnologieswhichwouldresultinbusinessefficiencyin
thelongrun.

Enableacquisitionsofnewbusinesschannels,thirdpartysalestieupsinvolvingup
frontpayments.

(ii)Differentsourcesofcapital
Equitycapital
Reinsurancetoreducetheamountofsolvencycapitalrequired
financialreinsurance(FinRe)
subordinateddebt
bankingproductsincludingliquidityfacilities,contingentcapital,senior
unsecuredfinancingandderivatives

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(iii)
Thereasonscouldbe

Differencesindistributionmodel
a. ATiedagencyvsBancamodel
b. Commissionstructureahigherupfrontcommission
c. Differencesinsalesdevelopmentmodelintermsofassumedproductivity,
developmentofsalesfixedcostsetc.Itistobenotedthatthecompanybeing
comparedtostartedoperations5yearsagoandimpactofinflationonfixedcosts
wouldincreasesalescostsanyway.
d. Differentdistributionchannelsleadingtodifferencesintargetmarketimpacting
averagepolicysizeandhenceexpenserecoveries

Differencesinpricingstrategy
a. Aggressivepricingcomparedtocompetitortogainmarketshareleadingtohigher
expectedlossesandcapital
b. Premiumrateswerehardinthelast5yearsandareexpectedtosoftendueto
increasedcompetition.Henceprofitability/expenserecoverieslikelytofallleading
tohighercapitalrequirement.

Differencesinbusinessmix,
a. Productsbeingofferedarenotcomparableforeg.commercialvspersonal,short
tailvslongtail.
b. differencesinproductmixleadingtodifferentlevelsofprofitability
c. Competitorhasaccesstonichemarket(HNIclients/industrialhouses)which
enablescompetitortoofferhighermargin/serviceintensiveproducts,

Differentreinsurancestrategy
a. Competitorplacesreinsurancewithparentcompanywhichoffersextremely
competitiverates
b. Competitorispartofaglobalgroupandbenefitsfromglobaldiscount
c. Competitorhasplacedreinsurancewithlowerratedreinsurerswhichoffer
competitiveterms(andlocalsolvencycapitaldoesnotchargeforcreditrisk)
d. Insurerisconstrainedbygroupguidelines/riskappetitetoplacereinsurancewith
highlyratedinsurersleadingtohigherreinsurancecostsandhencerelatively
lowerpositiveimpactonsolvencyrequirement.

Differencesinoperatingmodel
a. Competitorispartoflocal/globalfinancialconglomerateandbefitsfromshared
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backofficecosts,technicalsupportfromgroupwhichenablesittomaintainalow
overheadslocally
b. Itreceivessupportfromregional/globalteaminactuarial,financialandother
serviceswhichreducesitsoverheadscostssignificantly
c. Itenjoysgroupdiscountsfromglobalvendors

Economic,businessandregulatoryenvironmenthaschangedinthelast5years
a. Morerestrictiononinvestmentsthanbeforeleadingtolowerinvestmentprofits
thanbefore
b. Markethasbecomemorelitigiousandclaimswhichhavenotbeenseeninthe
pastareexpectedtoariseinthefuture
c. Expectedhigherjudicialinterventionsandcustomerfriendlycourtawardsin
future
d. Higherexpectedcompliancecosts
e. Generalcostsofrunningbusinessandhiringandretainingskilledpeoplehasgone
up

Others
a. Competitorenjoysastronglocalbrandandhencerequireslowermarketing
spend
b. Getsalotofcaptivebusinessfromgroupcompanies

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[TOTALMARKS100]

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