COURSE 8: Fall 2004 -1- GO ON TO NEXT PAGE
Investment
Morning Session
**BEGINNING OF EXAMINATION**
INVESTMENT
MORNING SESSION
Questions 1-4 pertain to the Case Study
1. (5 points) LifeCo’s ALM Report indicates a need to rebalance the assets supporting the
non-traditional life segment.
(a) Describe the constraints on asset sales when rebalancing this portfolio.
(b) Evaluate LifeCo’s investment strategy for this segment, and recommend any
necessary changes.
COURSE 8: Fall 2004 -2- GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-4 pertain to the Case Study
2. (9 points) LifeCo is considering selling its closed block of Institutional Pension (GIC).
Liability book value (in $ millions) $1,500
Maturity (in years) 2
Annual liability crediting rate 6.60%
1 year risk-free rate 1%
You are given the following information:
Scenario 1 Scenario 2
1 year risk-free rate 1 year forward 3% 2%
Withdrawal rate at the end of year 1 4% 2%
Withdrawal rate at the end of year 2 100% 100%
Probability 30% 70%
There are no new deposits.
(a) (4 points) Compare the option pricing method and the actuarial appraisal method
for estimating the fair value of liabilities.
(b) (2 points) Outline practical considerations in applying the option pricing method.
(c) (3 points) Calculate the fair value of liabilities using the option pricing method
with the risk- free interest rate for discounting.
COURSE 8: Fall 2004 -3- GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-4 pertain to the Case Study
3. (9 points) You are LifeCo’s Investment Actuary and a member of the ALM Committee.
The Committee is currently reviewing the risk exposures of the Non-Traditional Life
portfolio as contained in your December 31 ALM Report.
•You have recently switched LifeCo’s ALM reporting to effective duration
from modified duration
•Your effective duration calculations use a base yield curve and a yield
curve shocked by 1 basis point
•No explicit hedge has been set up for the minimum credited interest
guarantees
•LifeCo’s head of Investments has proposed the sale of $50 million (in
present value) of 15-year zero-coupon bonds in order to increase cash
holdings to partially address the key rate duration mismatch
(a) Describe the limitations of LifeCo’s reported effective durations as an interest rate
risk measure.
(b) Estimate the economic impact of a 100bp drop in interest rates based on your
reported effective durations.
(c) Compare this estimate with your reported “margin squeeze” impact and briefly
explain reasons for any differences to the ALM committee.
(d) Describe any interest rate ‘bets’ evident from the reported partial durations.
(e) Estimate the revised partial durations following this proposed transaction.
(f) Estimate the revised impact of margin squeeze following this proposed
transaction.
(g) Explain how the potential margin squeeze should be incorporated into any
assessment of interest rate bets.
COURSE 8: Fall 2004 -4- GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-4 pertain to the Case Study

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