COURSE 8: Fall 2003 -1- GO ON TO NEXT PAGE
Investment
Morning Session
Society of Actuaries Course 8V Fall 2003
**BEGINNING OF EXAMINATION**
MORNING SESSION
Questions 1-6 pertain to the Case Study.
1. (4 points) LifeCo is reviewing its Operational Guidelines for the Use of Derivatives for
consistency with The Group of Thirty recommendations.
(a) Identify and describe the various derivatives risks as outlined in the Group of
Thirty recommendations.
(b) Assess LifeCo’s management of these risks associated with the derivatives used
to hedge its liabilities.
COURSE 8: Fall 2003 -2- GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-6 pertain to the Case Study.
2. (10 points) LifeCo’s ALM committee is concerned about the impact of the following
capital market events on the company’s value:
(1) Low equity market return
(2) Higher than expected credit loss
(3) Low interest rate environment
(a) Describe the minimum guarantees offered in the Variable Annuity product and
how the guarantees can be priced using the
(i) actuarial approach, and
(ii) capital market approach.
(b) Assess the potential impact of the capital market events described above on the
Variable Annuity product.
(c) Recommend risk management strategies to mitigate the risks associated with the
capital market events described above on the Variable Annuity product.
(d) Describe the characteristics of the Payout Annuity product cash out flows.
(e) Assess the potential impact of the capital market events described above on the
Payout Annuity product.
(f) Recommend investment strategies to mitigate the impact of the capital market
events described above on the Payout Annuity product through
(i) asset allocation, and
(ii) use of derivative products.
Justify your recommendations.
COURSE 8: Fall 2003 -3- GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-6 pertain to the Case Study.
3. (5 points) LifeCo’s ALM report for December 2000 indicates a significant mismatch in
the Non-Traditional Life Products segment.
(a) (1 Point) Compare the use of dollar duration to effective duration as a risk metric
for this product line.
(b) (4 Points) Describe various approaches to ALM as outlined by Glacy and Vilms
and assess how each approach might be applied to the non-traditional life segment
in order to mitigate the mismatch problem.
COURSE 8: Fall 2003 -4- GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-6 pertain to the Case Study.
4. (8 points) LifeCo is considering how to evaluate the performance of a new GIC product.
You are given the following pricing assumptions for LifeCo’s new GIC product:
Term: 3 years
Maturity Value: 123% of the initial deposit
Lapse: None
Policyholder Options: None
Premium Size: $1,000
Required Return on Capital: 8% per annum
Required Capital Factor for GICs: 3.6% of liabilities
Asset Return: 8.5%
Tax Rate: 35%
Risk-Free Zero-Coupon Rate Curve: 1-year: 5.70%
2-year: 6.08%
3-year: 6.21%
GIC Competitors:
Required Return on Capital: 12%
Required Capital Factor for GICs: 5% of liabilities
Asset Return: 8%
(a) Compare the “entity-specific” and “fair value” systems.
(b) Calculate the tax-adjusted liability value at issue for LifeCo’s new GIC product
using the Cost of Capital method.
(c) Calculate the liability value at issue and the required spread of LifeCo’s new GIC
product using the Total Return method as presented by Ho, Scheitlin and Tam.
(d) Describe the arguments for and against reflecting an entity’s credit standing in the
fair value of its liabilities.
(e) Assess how the Cost of Capital method reflects credit standing and how this
might impact the valuation of LifeCo’s liabilities.
COURSE 8: Fall 2003 -5- GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-6 pertain to the Case Study.

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