IAI CP1 key terms

The fund set aside to meet future obligations, calculated by allowing for the actual premiums charged rather than only the valuation basis. It equals the present value of future benefits and expenses minus the present value of future gross premiums.

A policy reserve calculated on the valuation basis where the premium used is the net premium, found by equating present values of benefits and premiums. It excludes expense loadings and therefore differs from reserves based on real premiums.

A reserve measured as the excess of the present value of future benefits and expenses over the present value of future premiums, at the valuation date. It looks forward and is the standard way of defining a policy reserve.

A reserve accumulated from past premiums received less past benefits and expenses paid, rolled forward with interest. In principle it equals the prospective reserve if the same assumptions are used throughout.

A modified reserve that allows for initial acquisition expenses by permitting the first-year net premium to be reduced, producing a reserve lower than the standard net premium reserve. The adjustment is limited so the reserve does not become negative.

A reserve calculated to recognise that acquisition costs are incurred up front while premiums are level, typically by holding less than the full net premium reserve in early years. It aims to avoid new business strain.

The reduction in surplus when a policy is written, because acquisition costs and required reserves exceed the premiums received at outset. It is a key reason insurers need capital to support growth.

The set of assumptions, including interest rate, mortality, morbidity and expenses, used to calculate reserves and premiums. It is normally chosen prudently so that liabilities are not understated.

An assumption reflecting the expected outcome without deliberate margins for adverse deviation. It is used in some modern solvency regimes and contrasted with the prudent basis used for traditional reserves.

A deliberate addition to a best estimate assumption to allow for uncertainty and adverse experience. Margins can be built into the interest, mortality or expense assumptions rather than shown explicitly.

An amount added to the best estimate liability to compensate for the cost of holding capital against the uncertainty of the liabilities. It is distinct from a prudence margin embedded in assumptions.

The capital an insurer holds above its technical provisions to absorb unexpected losses and remain solvent. It is often expressed as a required solvency margin or a risk-based capital requirement.

Assets held in excess of the regulatory and internal capital requirements, available to support new business or to distribute. It measures the financial flexibility an insurer has beyond its minimum needs.

The accumulated value of premiums paid into a policy, less charges and benefits, rolled up at the actual investment return. It is central to analysing with-profits and unit-linked business.

A contract where the policyholder shares in the insurer's profits through regular and terminal bonuses. The insurer smooths payouts, which creates a need to manage the estate and treat generations of policyholders fairly.

The rate at which regular reversionary bonuses are declared on a with-profits policy, or the rate used to distribute surplus. Setting it requires balancing competitiveness against the solvency of the fund.

The liability held for a unit-linked policy, equal to the value of units allocated to the policyholder. The insurer also holds a non-unit reserve to cover future charges and expenses.

A contract where benefits are linked to the value of units in an investment fund chosen by the policyholder. Investment risk generally sits with the policyholder, while the insurer bears expense and mortality risk.

A reserve held in addition to the unit reserve for a unit-linked policy, to cover expected shortfalls between future charges and expenses. It ensures the insurer can meet costs that unit charges do not fund.

The process of determining the price at which units are created or cancelled, including whether to use an offer, bid or single price and how to allow for expenses and tax. Mispricing creates a risk of transfers between policyholders.

A model of future cash inflows and outflows under a set of assumptions, used to test solvency, set reserves and assess the effect of different scenarios. It underlies modern liability measurement.

A projection using one fixed set of assumptions to produce a single outcome. It is simple and transparent but does not show the range of possible results, unlike a stochastic approach.

A projection where one or more assumptions are random variables, producing a distribution of outcomes rather than a single figure. It supports the measurement of risk and the setting of capital.

Running a model under specified adverse or alternative conditions to see how results respond. It tests the robustness of reserves, capital and business plans against plausible stresses.

Applying severe but plausible shocks to assumptions or experience to assess whether an insurer remains solvent. It complements stochastic modelling by focusing on extreme, specified events.

The probability that a life aged exactly x dies before reaching age x+1, usually denoted qx. It is a fundamental input to life insurance premiums and reserves.

The probability that a life aged x survives for a further n years, often written npx. It is derived from mortality rates and is used to value benefits payable on survival.

The instantaneous rate of mortality at age x, written μx. It underlies continuous-time survival models and relates to the mortality rate over a year through the survival function.

A tabulation of mortality experience showing, for each age, the number surviving, deaths and related probabilities. It is used to calculate survival probabilities and life insurance values.

The pattern where mortality is lighter in the years shortly after underwriting than in later years, because healthier lives are selected. It is reflected by using select rates and a select period before ultimate rates apply.

The process of assessing and classifying risks before accepting them, so that premiums reflect the risk presented. It supports selection and helps prevent anti-selection against the insurer.

The tendency of individuals who expect to claim more than average to buy or retain insurance, worsening the insurer's experience. It is countered by underwriting, exclusions and appropriate pricing.

The rate at which insured persons fall sick or become disabled, used in health and income protection business. It plays the same role for morbidity contracts as mortality rates do for life cover.

The premium required to provide the benefits alone, ignoring expenses and profit, calculated on the valuation basis. It is used in the net premium reserve and differs from the office premium actually charged.

The premium actually charged to the policyholder, including loadings for expenses, profit and contingencies. It is sometimes called the gross premium and is used in gross premium reserves.

A cost incurred when a policy is set up, such as commission, underwriting and administration, which is not matched by a level premium in the first year. It is a major cause of new business strain.

The principle that an insurer should treat policyholders in line with what they could reasonably expect from the contract and past practice. It constrains how surplus and bonuses are distributed.