COURSE 8I: Fall 2002 - 1 - GO ON TO NEXT PAGE
Individual Insurance
Morning Session
**BEGINNING OF EXAMINATION**
1. (4 points) Your company is interested in entering the income annuity market and is
considering both fixed and variable payout designs.
(a) Describe the types of income annuity payout options.
(b) Describe pricing assumptions for income annuities.
(c) Explain how you would set the assumed interest rate (AIR) for each of the
following objectives:
(i) A competitive first year payout;
(ii) A payout that has the greatest likelihood of increasing over time; and
(iii) Minimize expected variability of payouts over time.
Course 8I
Fall 2002
COURSE 8I: Fall 2002 - 2 - GO ON TO NEXT PAGE
Individual Insurance
Morning Session
Question 2 pertains to the case study.
2. (12 points) Saturn Life is interested in acquiring a block of life insurance policies from
ABC Life.
You are given the following information about ABC:
•No new life insurance policies ha ve been sold in the last two years.
•There is no reinsurance on the block of life insurance business for sale.
•The pre-tax investment earnings rate in the ABC appraisal is a level 15%.
•The federal income tax rate is 35%.
•ABC will provide a computer model of this business for analysis and due
diligence by potential buyers.
ABC has furnished the following present values (in millions) as of 12/31/2001:
PV@
18%
PV@
15%
PV@
13%
PV@
9.75%
PV@
5.5%
Pre-Tax Solvency Earnings $18.9 $21.0 $22.7 $25.8 $30.9
Taxes 5.2 5.8 6.2 6.9 8.2
Increase in Required Capital (0.8) (0.9) (1.0) (1.3) (1.7)
After-Tax Investment Income on the
Required Capital
0.5 0.6 0.6 0.7 0.8
(a) (2 points) Evaluate the possible discount rates that could be used to value the
block of business and recommend the most appropriate discount rate.
(b) (4 points) Describe the steps you would take to assure the reasonableness of
ABC’s computer model of the block of business. Determine any additional
information that will be needed from ABC in order to va lidate the results of the
model.
(c) (4 points) You are given the following:
•As of 12/31/2001, life insurance solvency reserves are $40 million for the
block;
•ABC proposes a transfer of $30 million in cash to the acquiring company;
•Saturn would hold the same amount of solvency reserves as ABC;
•Initial transaction costs would be $1 million;
•Required capital would be $6 million, and
•Saturn would incur a tax savings of $2 million if it assumes the business.
Using an appropriate discount rate, determine whether Saturn should accept the
$40 million in liabilities for the $30 million initial cash transfer. Show all your
work.
COURSE 8I: Fall 2002 - 3 - GO ON TO NEXT PAGE
Individual Insurance
Morning Session
2. Continued
(d) (2 points) The CFO of Saturn Life has some concerns about the persistency of
ABC’s block of business.
(i) Describe actions that Saturn could take to mitigate replacement activity.
(ii) Explain the disadvantages to a policyholder if they were to replace their
ABC life insurance policy.
3. (6 points) A small Canadian insurance company that primarily sells annuity products
would like to increase life insurance sales by developing a Term-to-100 product.
The following information is provided about the proposed product design and pricing
assumptions:
•Product has no cash value
•Fully guaranteed premiums
•Issued at ages 30 – 60
•Target market is the middle class
•First year commission only; no renewal commissions
•Investment earnings rate is assumed to be 8% per year
•Lapse rate assumption 5% per year
•Mortality assumption is based on company’s annuity experience
•No reinsurance
(a) (3 points) Evaluate the appropriateness of the proposed features and assumptions.
(b) (2 points) Describe additional considerations to be taken into account in setting
lapse rate assumptions for Term-to-100 products.
(c) (1 point) Identify the design and pricing assumption cha nges you would make to
market this product in the United States.
COURSE 8I: Fall 2002 - 4 - GO ON TO NEXT PAGE
Individual Insurance
Morning Session
Question 4 pertains to the case study.