IAI CP1 flashcards

32 cards. Read the term and the definition here. The deck at the top of this page is optional.

Net present value rule

Accept an investment when the present value of inflows at the risk-adjusted rate exceeds outflows. For mutually exclusive projects, select the highest NPV, since IRR can mislead when scales differ.

Equation of value

A statement that the accumulated value of inflows equals that of outflows at a chosen date. Solving it for the interest rate gives the yield on the transaction.

Equivalence principle premium

The premium set so that the expected present value of premiums equals the expected present value of benefits plus expenses. It produces zero expected profit at outset on that basis.

Prospective reserve

At duration t, the expected present value of future benefits minus the expected present value of future net premiums. It equals the retrospective accumulated past premiums less past claims costs.

Profit signature

The stream of expected annual profits per policy initially sold, allowing for the probability the policy remains in force. Its discounted sum at the risk rate is the contract NPV.

Increasing annuity formula

The present value of payments 1, 2, ..., n at times 1 to n equals (a-double-dot_n minus n times v to the n) divided by i. It prices benefits that rise each year.

IRR limitations

The internal rate of return can be multiple or undefined when cash flows change sign repeatedly, and it ignores project scale and duration, so NPV is preferred for ranking.

Thiele's differential equation

Relates the rate of change of reserve to interest, premium, benefit outgo and the sum at risk multiplied by the force of transition. It underlies continuous-time policy value models.

Force of mortality

The instantaneous death rate at exact age x, written mu_x. Survival probability from x to x+t equals the exponential of minus the integral of the force over that period.

Uniform distribution of deaths

An assumption that deaths are spread evenly across each year of age, giving l at fractional age as l_x times (1 minus t q_x) and a linear survival curve within the year.

Constant force of mortality

An assumption that mu is fixed over an interval, so the one-year death probability is 1 minus exp(-mu) and survival over t years is exp(-mu t).

Multiple decrement dependent rate

The probability of leaving a state by a specific cause in the presence of other causes. It is obtained by integrating survival in the multiple decrement table times the cause-specific force.

Select mortality

Mortality that depends on duration since underwriting as well as age, typically lighter in early durations. Tables show a select period before entry into the ultimate rates.

Unit-linked reserve

The bid value of units allocated to the policyholder, plus any non-unit reserve held to cover future expenses and charges not met by the unit fund.

Redington immunisation

A matching condition requiring equal present values, equal durations and asset convexity at least equal to liability convexity. It protects against small parallel shifts in interest rates.

Sum at risk

The excess of the death benefit over the reserve held at that time. It is the amount the insurer must find from its own funds if death occurs.

Required capital

The assets held above best-estimate liabilities so the firm can meet obligations at a chosen confidence level over a chosen horizon, such as a one-in-two-hundred annual shock.

New business strain

The reduction in free surplus when a policy is written, caused by acquisition expenses and the need to establish reserves before premiums are received. It reverses as the policy runs off.

Risk discount rate

The rate used to discount projected shareholder profits, reflecting the return shareholders require. Raising it lowers NPV and may change product rankings.

Break-even year

The first year in which cumulative discounted profit from a product becomes positive. It indicates how long capital remains tied up before the contract repays its strain.

A over E ratio

Actual claims or lapses divided by expected, used in experience analysis. Persistent deviation from one signals that the assumptions used in pricing or reserving need review.

Embedded value

Net assets plus the present value of future shareholder profits from in-force business, after deducting the cost of holding required capital. It is a reporting measure, not a market value.

Scenario testing

Varying several assumptions together to represent a coherent adverse or favourable future, then reporting the effect on results. It complements one-at-a-time sensitivity analysis.

Quota share reinsurance

A treaty ceding a fixed proportion of every premium and claim to the reinsurer. It reduces new business strain and volatility while giving up the same proportion of profit.

Documenting professional judgement

Recording the assumptions chosen, the evidence supporting them and the sensitivity of results, so that another actuary can review and challenge the work.

Model validation

Checking a model against independent hand calculations, reconciling outputs to accounting or experience data, and confirming that inputs are complete, accurate and relevant.

Conflict of interest disclosure

Revealing any interest that could bias advice, such as remuneration linked to a result, and arranging independent review so the advice remains objective.

Best-estimate plus margin

A reserving basis using unbiased expected assumptions with an explicit prudential margin added, rather than hidden conservatism embedded in each individual assumption.

Put-call parity

For European options on a non-dividend share, call minus put equals share price minus the discounted strike. It must hold in any arbitrage-free model.

Risk-neutral up-probability

In a binomial tree, the probability that makes the expected one-step return equal the risk-free rate: (exp(r dt) minus d) divided by (u minus d).

Option delta and gamma

Delta is the change in option value per unit change in the underlying; gamma is the change in delta. Delta hedging removes first-order risk but leaves gamma exposure.

Modified duration

Minus the proportional change in price per unit change in yield. Price change is approximated by minus duration times the yield change plus half convexity times its square.