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IAI CP3 practice questions

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Question 1Actuarial Risk Management (Subject CA1)

A life insurer writes a large block of immediate annuities. Which risk is most directly increased by this product mix?

  1. Longevity risk Correct answer.
  2. Expense risk
  3. Persistency risk
  4. Mortality risk

Explanation

Annuity business pays out while the annuitant survives, so the insurer is exposed to policyholders living longer than assumed. Mortality risk (mortality being higher than expected) works against the insurer on death-benefit business, not on annuities.

Question 2Actuarial Risk Management (Subject CA1)

Under Solvency II, which item qualifies as Tier 1 own funds?

  1. Ordinary share capital plus retained earnings Correct answer.
  2. Undated subordinated debt with a coupon deferral trigger
  3. A letter of credit from a bank
  4. Subordinated debt with a ten-year maturity

Explanation

Tier 1 capital must be fully available to absorb losses on a going-concern basis, and paid-up ordinary capital and retained earnings meet that test. Subordinated debt and other instruments are classified into lower tiers reflecting their reduced loss absorbency.

Question 3Actuarial Risk Management (Subject CA1)

A pension scheme holds a portfolio of equities and corporate bonds. Which risk is best described as the risk that its assets fail to match the timing and amount of benefit payments?

  1. Operational risk
  2. Currency risk
  3. Credit risk
  4. Asset-liability mismatch risk Correct answer.

Explanation

Mismatch risk arises when the cash flow profile and sensitivity of assets differ from those of liabilities. Equities and corporate bonds do not replicate the interest-rate and inflation sensitivity of pension liabilities, creating funding volatility.

Question 4Actuarial Risk Management (Subject CA1)

An insurer estimates that a 1-in-200 adverse event would reduce its available capital by 400 million. Its best-estimate liabilities are 2,500 million and its risk margin is 150 million. Using the Solvency II SCR as a value-at-risk measure, what is the approximate SCR?

  1. 400 million Correct answer.
  2. 550 million
  3. 2,650 million
  4. 150 million

Explanation

The SCR is calibrated to a 99.5% one-year value-at-risk, so the capital required is the loss at the 1-in-200 adverse scenario, here 400 million. The risk margin and technical provisions are separate components of the balance sheet.

Question 5Actuarial Risk Management (Subject CA1)

A reinsurer provides cover under which the cedant retains losses below an agreed amount and the reinsurer pays the excess up to a limit for each loss event. Which type of reinsurance is this?

  1. Excess of loss Correct answer.
  2. Quota share
  3. Stop loss
  4. Surplus treaty

Explanation

Excess of loss reinsurance indemnifies the cedant for the portion of each loss above a retention up to a limit. Quota share and surplus are proportional arrangements sharing all losses pro rata, and stop loss covers aggregate losses over a period.

Question 6Actuarial Risk Management (Subject CA1)

A defined benefit scheme's liabilities have a duration of 18 years while its bond assets have a duration of 11 years. Interest rates fall by 1%. What is the most likely effect on the scheme's funding position?

  1. The deficit narrows because assets rise more than liabilities
  2. The deficit widens because assets fall while liabilities rise
  3. The position is unchanged because both move by the same amount
  4. The deficit widens because liabilities rise more than assets Correct answer.

Explanation

A fall in interest rates increases the present value of both assets and liabilities, but the longer-duration liabilities gain more. With a duration gap of about seven years, the scheme's funding position deteriorates.

Question 7Actuarial Risk Management (Subject CA1)

Which statement best describes the role of the risk margin in Solvency II technical provisions?

  1. It is the amount of capital required at the 99.5% confidence level
  2. It represents the present value of expected future expenses
  3. It compensates a transferee for taking on the non-hedgeable risk of the liabilities Correct answer.
  4. It provides a buffer against adverse investment returns on the asset portfolio

Explanation

The risk margin is the amount a third party would require to assume the insurance obligations, covering the cost of holding SCR for non-hedgeable risks. It is calculated using the cost-of-capital method.

Question 8Actuarial Risk Management (Subject CA1)

An underwriter observes that a proposed term assurance applicant has a family history of a genetic disorder. Which principle governs the use of predictive genetic test results in underwriting in many jurisdictions?

  1. Insurers may only use results the applicant has disclosed, subject to regulatory limits Correct answer.
  2. Insurers may never use any family history information
  3. Insurers may require applicants to undergo genetic testing before acceptance
  4. Insurers may use genetic results without restriction

Explanation

Many regulatory regimes restrict insurers from requiring genetic tests and limit use to results already known to the applicant, often with moratorium thresholds. Family history itself remains permissible underwriting evidence.

Question 9Actuarial Risk Management (Subject CA1)

A general insurer's combined ratio is 108% and its investment return on assets is 4% of premium. What is the approximate operating ratio?

  1. 104% Correct answer.
  2. 112%
  3. 4%
  4. 108%

Explanation

The operating ratio is the combined ratio less the investment return expressed as a percentage of premium. Here 108% minus 4% gives 104%, indicating an underwriting loss partly offset by investment income.

Question 10Actuarial Risk Management (Subject CA1)

Which feature most clearly distinguishes a with-profits policy from a unit-linked policy?

  1. The policyholder bears the full investment risk of the underlying assets
  2. The policy has no surrender value before maturity
  3. Premiums are invested in a separately identifiable unit account
  4. Benefits include discretionary bonuses supported by the with-profits fund Correct answer.

Explanation

With-profits policies provide guarantees plus discretionary bonuses, and the insurer pools and smooths investment experience in the with-profits fund. Unit-linked policies pass investment risk directly to the policyholder through unit prices.

Question 11Actuarial Risk Management (Subject CA1)

An insurer's liabilities are highly sensitive to inflation because of escalating annuity payments, but its assets are fixed-interest bonds. Which action best reduces this mismatch?

  1. Hold more cash
  2. Increase the equity allocation
  3. Invest in inflation-linked bonds Correct answer.
  4. Shorten the asset duration

Explanation

Inflation-linked bonds have cash flows that rise with the inflation index, matching the escalating liability profile. This directly hedges the inflation sensitivity that fixed-interest bonds leave exposed.

Question 12Actuarial Risk Management (Subject CA1)

Which of the following best describes the purpose of an insurer's own risk and solvency assessment (ORSA)?

  1. To set premium rates for each class of business
  2. To assess the adequacy of solvency over the business planning horizon using the insurer's own risk profile Correct answer.
  3. To determine the risk margin for technical provisions
  4. To calculate the minimum capital requirement using the standard formula

Explanation

The ORSA is a forward-looking assessment of the insurer's own risk profile and capital needs relative to its strategy and business plan. It complements, rather than replaces, the regulatory capital calculation.

Question 13Actuarial Risk Management (Subject CA1)

A life insurer's mortality experience is significantly lighter than assumed on its whole-of-life portfolio. What is the immediate effect on its liabilities?

  1. Liabilities decrease because fewer death claims are expected
  2. Liabilities are unchanged because mortality is a non-economic assumption
  3. Liabilities increase because expense assumptions must be revised
  4. Liabilities increase because policyholders are expected to survive longer Correct answer.

Explanation

Lighter mortality means death benefits are paid later and premiums are collected for longer, which generally increases the present value of whole-of-life liabilities. The effect depends on the balance of premiums and benefits, but the direction is adverse for this product.

Question 14Actuarial Risk Management (Subject CA1)

Which control is most effective at mitigating the risk of mis-selling in the sale of investment products?

  1. Increasing the commission paid to sales staff
  2. Relying on verbal explanations without written records
  3. Reducing the frequency of compliance monitoring
  4. Documented suitability assessment and product disclosure at the point of sale Correct answer.

Explanation

Mis-selling risk is controlled through documented suitability checks and clear disclosure so that customers understand the product and its risks. Written records also provide evidence for later complaint handling.

Question 15Actuarial Risk Management (Subject CA1)

A company operates a final-salary pension scheme. Which change would most reduce the scheme's exposure to longevity risk?

  1. Increasing the equity allocation of the scheme's assets
  2. Buying a bulk annuity policy transferring the liability to an insurer Correct answer.
  3. Extending the retirement age assumption downwards
  4. Reducing the scheme's contribution rate

Explanation

A bulk annuity, or buy-in or buy-out, transfers the longevity and investment risk of the covered members to an insurer. Changing asset allocation or contributions does not remove the underlying demographic exposure.

Question 16Actuarial Risk Management (Subject CA1)

Which statement about the matching adjustment under Solvency II is correct?

  1. It applies only to unit-linked business
  2. It allows a higher discount rate for liabilities backed by assets with fixed cash flows and matching duration Correct answer.
  3. It removes the need to hold any technical provisions
  4. It replaces the risk margin with a fixed percentage of liabilities

Explanation

The matching adjustment permits an addition to the discount rate reflecting the spread on matching, fixed-cash-flow assets held to maturity. It recognises the reduced liquidity risk where cash flows are closely matched.

Question 17Actuarial Risk Management (Subject CA1)

An insurer's claims data show that reported losses for a liability class are developing adversely. Which reserving response is most appropriate?

  1. Reduce reserves because fewer claims have been reported to date
  2. Reduce the premium rate for the class
  3. Increase the estimated ultimate loss ratios and strengthen incurred but not reported reserves Correct answer.
  4. Leave reserves unchanged because development is a random fluctuation

Explanation

Adverse development indicates that initial estimates of ultimate losses were too low, so ultimate loss ratios and IBNR reserves should be revised upwards. Ignoring the signal understates liabilities.

Question 18Actuarial Risk Management (Subject CA1)

Which of the following is a key advantage of using a risk-based capital regime over a simple premium-based solvency requirement?

  1. It guarantees that insurers will not fail
  2. It eliminates the need for reinsurance
  3. It removes the need for regulatory supervision
  4. Capital held is more closely aligned with the risks actually borne by the insurer Correct answer.

Explanation

Risk-based capital links required capital to the insurer's specific risk profile, rewarding good risk management and discouraging excessive risk-taking. It supplements, but does not replace, supervision or other risk controls.

Question 19Actuarial Risk Management (Subject CA1)

A bank-style liquidity stress test shows that an insurer's cash inflows fall short of outflows in a mass lapse scenario. Which action best addresses this liquidity risk?

  1. Increase the proportion of assets held in unlisted equities
  2. Hold a portfolio of readily marketable assets sufficient to cover stressed outflows Correct answer.
  3. Invest more heavily in illiquid long-dated infrastructure debt
  4. Rely on future premium income to meet surrender demands

Explanation

Liquidity risk is managed by holding sufficient high-quality, marketable assets that can be sold quickly without material loss. Illiquid assets and uncertain future premiums are unreliable sources of cash in a stress.

Question 20Actuarial Risk Management (Subject CA1)

Which item is typically treated as a liability in an insurer's balance sheet under Solvency II?

  1. Technical provisions for outstanding claims and unearned premium Correct answer.
  2. Retained earnings from prior years
  3. Paid-up ordinary share capital
  4. A revaluation reserve on property holdings

Explanation

Technical provisions represent obligations to policyholders and are the principal liability of an insurer. Share capital, retained earnings and revaluation reserves are components of own funds on the asset side of the net position.

Question 21Actuarial Risk Management (Subject CA1)

A life insurer is considering writing a new product with a guaranteed minimum investment return. Which combination of risks does this guarantee most directly create for the insurer?

  1. Persistency risk only
  2. Investment return risk and option risk from the embedded guarantee Correct answer.
  3. Mortality risk only
  4. Expense risk only

Explanation

A guaranteed minimum return exposes the insurer to the risk that asset returns fall below the guarantee and to the cost of the embedded option, which policyholders exercise to their advantage. These are financial rather than purely demographic risks.

Question 22Actuarial Risk Management (Subject CA1)

Which statement best explains why diversification reduces an insurer's aggregate risk?

  1. Diversification increases the correlation between risks
  2. Each individual risk is eliminated entirely by diversification
  3. Diversification guarantees that no losses will occur
  4. Imperfectly correlated risks combine so that total variability is lower than the sum of individual variabilities Correct answer.

Explanation

When risks are less than perfectly correlated, the variance of the combined portfolio is less than the sum of individual variances. This is the mathematical basis of diversification, but it does not eliminate risk altogether.

Question 23Actuarial Risk Management (Subject CA1)

An insurer calculates its SCR using an internal model. Which requirement is central to gaining regulatory approval for that model?

  1. Ensuring the model is never recalibrated
  2. Showing that the model produces a lower SCR than the standard formula
  3. Demonstrating that the model appropriately reflects the insurer's risk profile and is used in decision-making Correct answer.
  4. Confirming that the model uses only historical data

Explanation

Internal models must pass use tests and statistical quality standards, showing that they reflect the insurer's actual risk profile and inform management decisions. Producing a lower capital figure is not a valid justification.

Question 24Actuarial Risk Management (Subject CA1)

Which statement correctly describes the treatment of future premiums in the valuation of technical provisions for most non-life business?

  1. Future premiums are generally excluded, so provisions cover only obligations arising from business already written Correct answer.
  2. Future premiums are included only if the insurer expects to make a profit
  3. Future premiums are included in the risk margin calculation
  4. Future premiums are always included in full

Explanation

Technical provisions relate to obligations already incurred, so expected future premiums on renewal business are normally excluded. Including them would anticipate profits not yet earned.

Question 25Actuarial Risk Management (Subject CA1)

A firm's enterprise risk management framework identifies a risk that is within appetite but has a high potential impact and low likelihood. Which treatment is most consistent with a risk appetite framework?

  1. Transfer the entire risk regardless of cost
  2. Ignore the risk because its likelihood is low
  3. Monitor the risk, quantify its tail impact and hold capital or mitigation proportionate to the exposure Correct answer.
  4. Increase the risk limit so that no action is required

Explanation

Low-likelihood, high-impact risks still require quantification and monitoring because their tail impact can threaten solvency. Capital and mitigation should be proportionate to the assessed exposure within the stated appetite.

Question 26Actuarial Risk Management (Subject CA1)

An insurer is designing a new critical illness product. Which actuarial technique is most appropriate for setting the initial premium rates when limited credible data are available?

  1. Adopt the pricing basis used by a competitor for a similar product.
  2. Set premiums using a risk-based capital model rather than an experience model.
  3. Use a deterministic model with a single best-estimate assumption set.
  4. Apply a credibility-weighted blend of the insurer's own experience and relevant industry data. Correct answer.

Explanation

Credibility theory allows an insurer to combine its own limited experience with broader industry or reinsurer data, weighting each source by its credibility. This produces a more stable and defensible estimate than relying solely on sparse internal data or on a single deterministic scenario.

Question 27Actuarial Risk Management (Subject CA1)

A life insurer holds a portfolio of conventional without-profit endowment assurances. Which asset class would typically provide the closest cash-flow matching for these liabilities?

  1. Commercial property with long lease terms and upward-only rent reviews.
  2. Domestic equities with a diversified dividend income stream.
  3. Short-dated money-market instruments rolled over at maturity.
  4. Long-dated fixed-interest bonds with redemption yields matching the liability discount rate. Correct answer.

Explanation

Without-profit endowment assurances have guaranteed maturity payments at known future dates, so fixed-interest bonds with matching terms and redemption proceeds are the natural matching asset. Equities, property and short-dated money-market instruments introduce market, liquidity or reinvestment risk that is not needed to back guaranteed cash flows.

Question 28Actuarial Risk Management (Subject CA1)

An insurer's underwriting team is reviewing a large commercial property risk. Which factor would most directly increase the estimated probable maximum loss (PML) for a single fire event?

  1. The insurer has purchased a proportional reinsurance treaty for this class.
  2. The property houses highly flammable stock with no compartmentation between storage areas. Correct answer.
  3. The property is located in a region with a low earthquake hazard.
  4. The property is protected by a modern sprinkler system.

Explanation

Probable maximum loss estimates the worst credible loss from a single event, so combustible contents and the absence of fire compartmentation increase both the likelihood of spread and the severity of damage. Sprinklers, low earthquake hazard and reinsurance affect the net retained loss or the likelihood of other perils, but they do not increase the gross PML from fire.

Question 29Actuarial Risk Management (Subject CA1)

A life insurer is reviewing its expense assumptions for a unit-linked savings product. Which expense is most likely to be classified as an initial (acquisition) expense rather than a maintenance expense?

  1. Ongoing fund management charges deducted from the unit fund.
  2. Annual policy statements sent to policyholders.
  3. Commission paid to the intermediary at the point of sale. Correct answer.
  4. Regular administration costs for processing premium collections.

Explanation

Initial expenses are incurred when a policy is written, and commission paid at the point of sale is a classic acquisition cost that must be recovered over the policy term. Fund management charges, premium processing and annual statements are recurring costs of maintaining the policy in force.

Question 30Actuarial Risk Management (Subject CA1)

An insurer is assessing the capital required to support a portfolio of immediate annuities. Which risk is most directly addressed by holding additional capital for longevity risk?

  1. The risk that interest rates rise and the market value of the bond portfolio falls.
  2. The risk that annuitants live longer than assumed, increasing the number of payments made. Correct answer.
  3. The risk that annuitants die earlier than assumed, reducing the number of payments made.
  4. The risk that the insurer's credit rating is downgraded by a rating agency.

Explanation

Longevity risk is the risk that mortality improvements are faster than assumed, so annuitants live longer and receive more payments than priced. Holding capital against this risk protects the insurer against the resulting increase in liability values and cash-flow outgo.

Question 31Actuarial Risk Management (Subject CA1)

A general insurer writes household contents business. Which combination of risks would a stress and scenario test most appropriately examine together?

  1. A simultaneous increase in claims inflation and a fall in the market value of the insurer's bond portfolio. Correct answer.
  2. A change in the insurer's marketing budget and a change in its office rental costs.
  3. An increase in the number of policyholders and a decrease in the number of staff.
  4. A change in the insurer's brand logo and a change in its website design.

Explanation

Stress and scenario testing examines combinations of adverse events that could threaten solvency, such as rising claims costs occurring at the same time as investment losses. Operational changes such as marketing, staffing or branding are business-planning matters rather than solvency stresses.

Question 32Actuarial Risk Management (Subject CA1)

A life insurer is deciding how to invest assets backing its with-profits fund. Which investment strategy is most consistent with the fund's objective of smoothing payouts to policyholders?

  1. Invest only in long-dated fixed-interest bonds to match the guaranteed sum assured.
  2. Invest in a diversified mix of equities, property and bonds, supported by a smooth investment policy and a free estate. Correct answer.
  3. Invest in a single high-yield corporate bond to maximise income.
  4. Invest entirely in short-dated government bills to minimise volatility.

Explanation

With-profits funds typically hold a diversified portfolio with a substantial equity and property content to earn higher long-term returns, while smoothing is supported by the inherited estate and by the discretion to hold back or enhance bonuses. A diversified mix balances the return objective against the need to control volatility in payouts.

Question 33Actuarial Risk Management (Subject CA1)

An insurer is using a reinsurance treaty to protect its capital against large single losses. Which feature of the treaty most directly determines the amount of risk retained by the insurer for each loss?

  1. The length of the treaty period.
  2. The currency in which the reinsurance premium is paid.
  3. The retention or deductible level specified in the treaty. Correct answer.
  4. The reinsurance premium rate charged by the reinsurer.

Explanation

The retention or deductible is the amount of each loss that the insurer keeps before reinsurance responds, so it directly determines retained risk. Premium rates, treaty duration and currency affect cost or administration but do not define the loss retention.

Question 34Actuarial Risk Management (Subject CA1)

A life insurer is assessing the effect of a fall in interest rates on its non-linked whole-of-life business. Which statement best describes the likely impact on the insurer's financial position?

  1. Liability values are likely to decrease because lower rates reduce the present value of future outgo.
  2. Liability values are likely to increase because future guaranteed benefits are discounted at lower rates, while asset yields fall on reinvestment. Correct answer.
  3. The effect on liabilities is neutral because the guaranteed sum assured is fixed at outset.
  4. Asset values are certain to rise by the same amount as liabilities, so the net position is unchanged.

Explanation

A fall in interest rates reduces the discount rate applied to future guaranteed benefits, so the present value of liabilities rises. At the same time, reinvestment yields on fixed-interest assets fall, which can squeeze the insurer's margin between asset returns and guaranteed benefits.

Question 35Actuarial Risk Management (Subject CA1)

An insurance company is reviewing its capital management policy. Which action would most directly increase the insurer's available regulatory capital?

  1. Issuing new ordinary share capital to investors. Correct answer.
  2. Increasing the proportion of assets held in high-risk equities.
  3. Reducing the level of reinsurance purchased for catastrophe risk.
  4. Increasing the assumed future investment return used in pricing.

Explanation

Issuing new ordinary share capital raises the insurer's own funds and therefore increases available regulatory capital. Changing the investment mix, reducing reinsurance or raising pricing assumptions changes the risk profile and capital requirements rather than directly adding capital resources.

Question 36Actuarial Risk Management (Subject CA1)

A general insurer is reviewing its exposure to a single large industrial client that operates several separate factories. Which risk mitigation approach would most effectively reduce the insurer's concentration risk from this client?

  1. Increasing the policy deductible so the client bears more of each small loss.
  2. Purchasing a facultative reinsurance cover that attaches above a specified loss level for this client. Correct answer.
  3. Reducing the premium charged to the client to reflect its good claims record.
  4. Extending the policy to cover additional perils for the same client.

Explanation

Facultative reinsurance arranged specifically for this client transfers the excess loss above the retention to the reinsurer, directly reducing the insurer's concentration exposure. Deductibles affect small losses, broader cover increases exposure and premium reductions do not change the risk concentration.

Question 37Actuarial Risk Management (Subject CA1)

An insurer is considering using a new data source to refine its motor claims frequency model. Which governance requirement is most important before the model is used for pricing decisions?

  1. Ensuring that the model uses the most complex algorithm available.
  2. Confirming that the data were collected by a third party rather than internally.
  3. Ensuring the data are representative of the insured population and are of sufficient quality and completeness. Correct answer.
  4. Confirming that the data source is the cheapest available option.

Explanation

Model inputs must be relevant, accurate and complete for the purpose for which they are used, so representativeness and data quality are the key governance tests. Cost, algorithmic complexity and the identity of the data collector are not substitutes for data suitability.

Question 38Actuarial Risk Management (Subject CA1)

A life insurer is analysing the effect of a mass lapse scenario on a unit-linked product with surrender charges. Which outcome is most likely in the short term?

  1. An immediate cash outflow to policyholders, partly offset by surrender charges, and a fall in future fund management charges. Correct answer.
  2. An increase in future fund management charges because fewer policies share fixed costs.
  3. A reduction in the insurer's liquidity risk because fewer policies remain in force.
  4. No cash-flow effect because unit-linked benefits are paid from the unit fund.

Explanation

A mass lapse triggers surrender payments from the unit fund, creating a cash outflow that is partly mitigated by surrender charges. The insurer also loses the future fund management charges it would have earned on the lapsed policies, which reduces future profits.

Question 39Actuarial Risk Management (Subject CA1)

An insurer is assessing the credit risk of its corporate bond portfolio. Which factor is most relevant to the probability of default of an individual issuer?

  1. The currency in which the bond pays coupons.
  2. The issuer's credit rating and financial strength indicators. Correct answer.
  3. The frequency with which the bond pays coupons.
  4. The duration of the bond relative to the insurer's liabilities.

Explanation

Default probability is driven by the issuer's ability and willingness to meet its obligations, which is captured by credit ratings and financial strength indicators. Duration, currency and coupon frequency affect market risk and cash-flow timing but are not primary measures of default likelihood.

Question 40Actuarial Risk Management (Subject CA1)

A life insurer is reviewing its reinsurance arrangements for a large block of term assurance business. Which factor would most strongly support the decision to retain more mortality risk rather than cede it?

  1. The insurer has a large, well-diversified portfolio and strong capital coverage. Correct answer.
  2. The reinsurer offers a lower premium rate than the insurer's own expected claims cost.
  3. The insurer expects mortality experience to become more volatile in the future.
  4. The insurer wishes to reduce its exposure to catastrophic mortality events.

Explanation

A large diversified portfolio and strong capital position reduce the need to transfer mortality risk, because the insurer can absorb adverse experience and benefits from retaining the associated margin. Greater volatility, favourable reinsurance pricing or a desire to reduce catastrophe exposure would all argue for ceding more risk.

Question 41Life Insurance and Pensions Practice

Under a defined benefit occupational pension scheme, which party normally bears the investment risk on the scheme assets during the accumulation phase?

  1. The scheme trustee, personally and without limit
  2. The pension regulator, through the compensation system
  3. The active member, through the level of contributions paid
  4. The sponsoring employer, through the scheme's funding obligation Correct answer.

Explanation

In a defined benefit arrangement the benefit is fixed by a formula, usually linked to salary and service, so the employer must make good any funding shortfall. The member's retirement income does not vary with investment returns, which is why investment and longevity risk sit with the sponsor.

Question 42Life Insurance and Pensions Practice

A life insurer sells a unit-linked endowment policy where benefits are expressed as units whose price fluctuates with the underlying fund. Which statement best describes the investment risk allocation?

  1. The policyholder bears the investment risk on the unit fund Correct answer.
  2. The reinsurer bears the risk through a quota share treaty
  3. The insurer guarantees the unit price at maturity
  4. The risk is shared equally between insurer and policyholder

Explanation

Unit-linked business is a defined contribution style product: the policyholder's benefit equals the value of the units at the relevant date. The insurer's exposure is limited to charges and any explicit guarantees it has written, so market risk passes to the customer.

Question 43Life Insurance and Pensions Practice

Which of the following is the primary purpose of the trustees' statement of investment principles in an occupational pension scheme?

  1. To provide the schedule of contributions payable by the employer
  2. To record the scheme's investment policy, including the balance of asset classes and the approach to risk Correct answer.
  3. To disclose the personal tax position of each member to the tax authority
  4. To set the actuarial assumptions used in the scheme's funding valuation

Explanation

The statement of investment principles documents how the trustees invest scheme assets, covering asset allocation, risk measurement, and the extent of any socially responsible investment considerations. It is a governance disclosure aimed at members and regulators rather than a tax or funding document.

Question 44Life Insurance and Pensions Practice

Which contract feature allows a policyholder to receive benefits earlier than the original maturity date because of a qualifying event?

  1. A surrender value provision
  2. A terminal illness benefit Correct answer.
  3. A waiver of premium rider
  4. A paid-up policy option

Explanation

A terminal illness benefit accelerates the sum assured when the policyholder is diagnosed with a terminal condition with a short life expectancy, typically twelve months. It pays the death benefit early rather than adding a separate sum.

Question 45Life Insurance and Pensions Practice

An annuity provides a guaranteed income for life in exchange for a lump sum. Which risk does this transfer from the individual to the annuity provider?

  1. Credit risk on the individual's mortgage
  2. Liquidity risk during the accumulation phase
  3. Longevity risk Correct answer.
  4. Inflation risk, if the annuity is level

Explanation

A life annuity pools mortality risk across policyholders, so the provider bears the risk that the annuitant lives longer than expected. The individual no longer faces the risk of outliving their capital.

Question 46Life Insurance and Pensions Practice

In a personal pension arrangement, which statement correctly describes the treatment of contributions for a basic-rate taxpayer under a relief-at-source system?

  1. The member claims the basic-rate relief through an annual tax return
  2. The employer must pay the relief directly to the member
  3. The provider reclaims basic-rate relief and adds it to the member's contribution Correct answer.
  4. Relief is granted only on contributions above a fixed threshold

Explanation

Under relief at source the member pays contributions net of basic-rate tax, and the scheme administrator reclaims the basic-rate amount from the tax authority and invests it in the member's fund. Higher-rate relief, where available, is claimed separately by the member.

Question 47Life Insurance and Pensions Practice

Which of the following best describes the role of an appointed actuary to a life insurance company?

  1. To audit the annual financial statements for shareholders
  2. To manage the insurer's investment portfolio on a discretionary basis
  3. To market the insurer's products to brokers and independent advisers
  4. To provide an independent opinion on the adequacy of reserves and the insurer's financial condition Correct answer.

Explanation

The appointed actuary is responsible for advising the board on reserving, capital, and the financial condition of the company, and often must certify solvency matters to the regulator. Independence from marketing and investment management is essential to that role.

Question 48Life Insurance and Pensions Practice

A pension scheme member is offered a transfer value to move accrued benefits to a personal pension. Which factor is most directly relevant to whether the transfer is likely to be suitable?

  1. The level of the transfer value relative to the value of the benefits given up Correct answer.
  2. The investment performance of the scheme's default fund last year
  3. The brand recognition of the receiving personal pension provider
  4. The number of years the member has worked for the current employer

Explanation

Suitability turns on comparing the transfer value with the actuarial value of the guaranteed benefits being surrendered, together with the member's circumstances and attitude to risk. A transfer is generally only suitable where the value is adequate and the member can bear the loss of guarantees.

Question 49Life Insurance and Pensions Practice

A 55-year-old member of a defined benefit scheme with a normal retirement age of 65 wishes to retire early with an immediate pension. How is the benefit most commonly adjusted?

  1. It is converted into a unit-linked fund
  2. It is increased because the member stops contributing early
  3. It is reduced for early payment to reflect the longer expected payment period Correct answer.
  4. It is paid in full with no adjustment

Explanation

Early retirement before normal pension age normally attracts an actuarial reduction because the pension starts earlier and is expected to be paid for longer. Some schemes allow unreduced early retirement on grounds such as ill health or employer consent.

Question 50Life Insurance and Pensions Practice

An insurer writes with-profits business and applies a market value reduction on some surrenders. What is the purpose of this adjustment?

  1. To convert the policy into a paid-up contract automatically
  2. To apply an early surrender penalty that increases shareholder profit
  3. To protect remaining policyholders from the cost of paying out more than the fund can support Correct answer.
  4. To recover the insurer's marketing costs from exiting policyholders

Explanation

A market value reduction applies when asset values have fallen, so that surrendering policyholders receive a fair share of the fund and do not take value from those who remain. It aligns the payout with the underlying asset value at the time of exit.