I85PREP
⌘ K
IFoA SA2 study materials
IFoA SA2 study resources

IFoA SA2 practice questions

One question at a time. Build your IFoA SA2 understanding.

First 50 of 200 questions. Each one lists the choices, the correct answer, and an explanation. The checker at the top of this page saves progress in this browser when it is available.

Continue in the practice tool above to load more questions, 50 at a time.

Question 1Life insurance

Under a unit-linked life insurance contract, which party bears the investment risk on the policyholder's unit fund?

  1. The regulator, because it sets the minimum unit price
  2. The policyholder, because benefits fluctuate with the value of the underlying units Correct answer.
  3. The reinsurer, because it indemnifies the insurer against market falls
  4. The insurer, because it guarantees the unit price at maturity

Explanation

In unit-linked business the policyholder selects and bears the investment risk, since the benefit is a number of units whose value moves with the underlying assets. The insurer typically guarantees only charges or a minimum death benefit, not the unit price itself, so it does not absorb market falls on the fund.

Question 2Life insurance

Which reserving basis is required for a life insurer's statutory (regulatory) balance sheet under a risk-based solvency regime?

  1. A prudent basis with explicit risk margins Correct answer.
  2. A basis equal to the surrender value of each policy
  3. A basis set solely by the appointed actuary's judgement without disclosure
  4. A best-estimate basis with no margins

Explanation

Regulatory reserves are normally calculated on a prudent basis that includes margins for adverse deviation, so that liabilities are not understated. A pure best estimate is used for internal economic capital work, but statutory reserves add explicit prudence or risk margins on top.

Question 3Life insurance

A life insurer writes 20-year term assurance. Which risk is most directly reduced by holding a larger free asset base relative to its liabilities?

  1. Mortality risk, because deaths are fewer when assets are higher
  2. Solvency risk, because the insurer can absorb adverse experience without breaching capital requirements Correct answer.
  3. Credit risk, because bonds default less often when the insurer is stronger
  4. Expense risk, because administration costs fall as assets grow

Explanation

Free assets act as a buffer that absorbs adverse deviations in mortality, expenses or investment returns, so they directly reduce the probability of breaching capital requirements. They do not change the underlying mortality, expense or default experience themselves.

Question 4Life insurance

In a with-profits fund, what is the main purpose of a smoothing policy applied to declared bonuses?

  1. To transfer investment risk from the policyholder to the shareholder
  2. To guarantee that bonuses never fall below the previous year's level
  3. To align the fund's asset mix with the insurer's shareholders' funds
  4. To spread investment returns across generations of policyholders and damp year-to-year benefit volatility Correct answer.

Explanation

Smoothing shares out the fund's investment returns over time, so that a cohort's payouts are less volatile than the underlying asset returns and returns are distributed more fairly between generations. It does not create a guarantee, and investment risk remains substantially with policyholders.

Question 5Life insurance

Which item is normally treated as an asset admissibility issue rather than a liability issue on a life insurer's regulatory balance sheet?

  1. The reserve for incurred but not reported death claims
  2. The deferred acquisition cost asset, which may be disallowed in full or in part Correct answer.
  3. The provision for future policy administration expenses
  4. The value placed on future bonus expectations

Explanation

Admissibility rules govern which assets may be counted towards solvency, and deferred acquisition costs are often restricted or disallowed because they cannot be realised on wind-up. Reserves and provisions for claims and expenses sit on the liability side.

Question 6Life insurance

A term assurance policy has a level premium, and the insurer expects mortality to increase with duration. What is the typical shape of the expected death strain over the policy term?

  1. Zero throughout, because term assurance carries no reserve
  2. Constant, because the premium and sum assured are level
  3. Rising with duration as mortality rates increase, weighted by the sum at risk Correct answer.
  4. Falling steadily to zero because the reserve builds up

Explanation

The death strain is the excess of the sum assured over the reserve, multiplied by the probability of death. For term assurance the reserve stays low relative to the sum assured, so rising mortality with duration makes the expected death strain increase over the term.

Question 7Life insurance

Which pricing assumption change would most directly increase the premium for a conventional without-profit endowment assurance?

  1. A reduction in the assumed expense inflation rate
  2. A reduction in the assumed mortality rate
  3. A reduction in the assumed rate of investment return Correct answer.
  4. An increase in the assumed rate of investment return

Explanation

A lower assumed investment return means less interest is earned to fund the maturity benefit, so a higher premium is needed. Higher returns, lighter mortality or lower expenses all reduce the required premium.

Question 8Life insurance

Which statement best describes the role of the with-profits actuary in relation to fair treatment of policyholders?

  1. To maximise shareholder transfers from the inherited estate each year
  2. To advise on the equitable distribution of surplus between policyholder generations and between policyholders and shareholders Correct answer.
  3. To certify that bonuses can never be reduced in future years
  4. To set the fund's equity backing ratio without reference to the fund's liabilities

Explanation

The with-profits actuary advises on how surplus is generated and distributed, balancing the reasonable expectations of different policyholder cohorts against shareholder entitlements. This is a fairness and governance role, not a mandate to maximise shareholder extraction or to promise fixed bonuses.

Question 9Life insurance

An insurer's mortality experience shows significantly more deaths than assumed in its term assurance portfolio. Which immediate effect should be expected on its regulatory position?

  1. No effect, because mortality experience is smoothed over the policy term
  2. An increase in reserves and a reduction in free surplus, other things equal Correct answer.
  3. An increase in free surplus because claims release reserves
  4. A reduction in reserves because fewer policies remain in force

Explanation

Heavier mortality raises claim outgo and requires reserves to be strengthened, which reduces available surplus and hence solvency cover. The release of reserves on death does not offset this, because the claim paid exceeds the reserve held.

Question 10Life insurance

Why does a life insurer typically hold a higher proportion of fixed-interest assets when backing conventional guaranteed non-profit liabilities than when backing unit-linked liabilities?

  1. Because equity returns are always lower than bond returns over the long run
  2. Because fixed interest is required by law for all life insurance liabilities
  3. Because the guaranteed liabilities have fixed, interest-sensitive cash flows that are better matched by bonds Correct answer.
  4. Because unit-linked policyholders are prohibited from holding bonds

Explanation

Guaranteed liabilities are sensitive to interest rates, so bonds of appropriate term match and immunise those cash flows, reducing risk. In unit-linked business the investment risk sits with the policyholder, so the asset mix is driven by the policyholder's chosen fund rather than by matching insurer guarantees.

Question 11Life insurance

A life insurer is considering writing a large block of annuity business with level nominal payments. Which asset-liability mismatch is of greatest concern?

  1. Mismatch between the number of policies and the number of staff administering them
  2. Mismatch between nominal annuity outgo and assets whose returns are sensitive to inflation Correct answer.
  3. Mismatch between annuity payments and the insurer's expense base
  4. Mismatch between fixed nominal annuity payments and equity holdings

Explanation

Level nominal annuities are exposed to inflation risk on the asset side: if assets are real or inflation-linked, their returns vary while the liability is fixed, creating a mismatch. Better matching uses fixed nominal assets of appropriate duration, so inflation sensitivity in the asset portfolio is the key concern.

Question 12Life insurance

Under a risk-based capital regime, which combination of risks is typically captured by the required capital calculation for a life insurer?

  1. Only operational risk, because other risks are covered by reinsurance
  2. Only market risk, because life risks are diversified away
  3. Only insurance risk, because investment risk affects assets not liabilities
  4. Market, credit, insurance and operational risks, aggregated with allowance for diversification Correct answer.

Explanation

Risk-based capital frameworks capture the main risk categories the insurer faces, including market, credit, insurance (mortality, morbidity, longevity, lapse) and operational risk. These are aggregated using correlation assumptions that recognise diversification benefits, so no single risk is treated as the sole driver.

Question 13Life insurance

A life insurer's persistency worsens sharply, with many policies lapsing in early durations. What is the most likely effect on profitability of the term assurance book?

  1. Profitability falls because acquisition costs are not recovered from the shortened premium stream Correct answer.
  2. Profitability improves because reserves are released on lapse
  3. No effect, because lapses simply release reserves
  4. Profitability improves because fewer claims are paid

Explanation

With level or front-loaded acquisition costs, a policy must stay in force long enough for premiums to recover the initial expense. Early lapses truncate the premium income while the acquisition cost has already been incurred, so profitability falls.

Question 14Life insurance

In the context of life insurance pricing, what does the gross premium valuation approach require?

  1. Ignoring surrenders and lapses because they are policyholder options
  2. Discounting expected future cash flows using assumptions that include margins for adverse deviation Correct answer.
  3. Setting the premium equal to the net premium with no expense loading
  4. Using only the current yield curve with no allowance for future experience

Explanation

Gross premium valuation projects all future cash flows (premiums, claims, expenses, surrenders) and discounts them using assumptions that include prudent margins. This contrasts with net premium valuation, which uses a net premium based on the valuation basis and ignores some cash flows.

Question 15Life insurance

Why might a life insurer use reinsurance for a large single life policy with a very high sum assured?

  1. To transfer the mortality risk above a retention limit to the reinsurer Correct answer.
  2. To eliminate the insurer's obligation to pay claims to the policyholder
  3. To avoid holding any reserves for the policy
  4. To increase the policyholder's surrender value

Explanation

Reinsurance, for example on a risk premium or yearly renewable term basis, transfers mortality risk above the insurer's retention to the reinsurer. This protects the insurer's capital against a single large claim while the insurer remains liable to the policyholder.

Question 16Life insurance

A with-profits fund has a large inherited estate. Which use of the estate is most consistent with treating policyholders fairly?

  1. Distributing it entirely to shareholders as a dividend
  2. Using it to support future bonus declarations and to absorb adverse experience for the benefit of policyholders Correct answer.
  3. Holding it indefinitely without any policy for its distribution
  4. Using it to reduce premiums for new policyholders only

Explanation

The inherited estate is accumulated surplus that has not yet been distributed, and it exists partly to support the fund's guarantees and smooth bonuses. Using it to absorb adverse experience and support future bonuses is consistent with policyholders' reasonable expectations, subject to a clear and disclosed distribution policy.

Question 17Life insurance

Which factor most affects the level of the mathematical reserve for a conventional endowment assurance policy at a given duration?

  1. The insurer's marketing budget
  2. The valuation basis, including the assumed interest rate and mortality Correct answer.
  3. The number of claims reported in the current week
  4. The policyholder's occupation at the time of application

Explanation

The mathematical reserve is the present value of future benefits less the present value of future net premiums, so it depends on the valuation assumptions for interest, mortality and expenses. The policyholder's occupation affects underwriting at outset rather than the reserve at a later duration.

Question 18Life insurance

What is the main purpose of an asset-liability study for a life insurer?

  1. To project asset and liability cash flows under a range of scenarios and assess the resulting mismatch risk Correct answer.
  2. To calculate the number of staff needed in the claims department
  3. To set the commission rates paid to brokers
  4. To determine the marketing strategy for new products

Explanation

An asset-liability study projects both sides of the balance sheet under various economic and demographic scenarios to quantify mismatch risk and inform investment strategy. It is not a marketing, commission or staffing exercise.

Question 19Life insurance

An insurer's longevity assumptions for its annuity book are revised to reflect continuing improvements in mortality. What is the effect on the reserves and capital position?

  1. No effect, because longevity risk is fully reinsured
  2. Reserves decrease and free surplus increases
  3. No effect, because annuity payments are fixed in nominal terms
  4. Reserves increase and free surplus decreases Correct answer.

Explanation

Lighter future mortality means annuity payments are expected to be made for longer, so the present value of the liability rises. Higher reserves reduce available surplus and therefore the capital position, unless the change is offset by hedging or reinsurance.

Question 20Life insurance

In a conventional without-profit life policy, what is the effect of an increase in the valuation interest rate on the mathematical reserve, other things equal?

  1. The reserve increases
  2. The reserve decreases Correct answer.
  3. The reserve is unchanged
  4. The reserve becomes equal to the sum assured

Explanation

A higher valuation interest rate discounts future benefits and net premiums more heavily, reducing the present value of the net liability and hence the reserve. This is why a fall in interest rates tends to strengthen reserves.

Question 21Life insurance

A life insurer is designing a unit-linked product with a guaranteed minimum death benefit. Which risk does the guarantee create for the insurer?

  1. Market risk, because the insurer must top up the fund if its value falls below the guaranteed amount Correct answer.
  2. Longevity risk, because the policyholder may live longer than expected
  3. Lapse risk, because the policyholder cannot surrender
  4. Expense risk, because administration costs are guaranteed

Explanation

A guaranteed minimum death benefit obliges the insurer to pay the shortfall if the unit fund is worth less than the guarantee at death, so the insurer bears market risk on that embedded option. The policyholder continues to bear the risk on fund values above the guarantee.

Question 22Life insurance

An insurer is setting the equity backing ratio for a with-profits fund with significant guaranteed liabilities. Which consideration most strongly argues for a lower equity weighting?

  1. The need to match fixed guarantees and avoid forced selling of equities in a falling market Correct answer.
  2. The aim of reducing the fund's expense ratio
  3. The expectation that equity returns are always higher than bond returns
  4. The desire to maximise the fund's exposure to equity risk

Explanation

Guaranteed liabilities are fixed in nature, and a high equity weighting increases the risk that assets fall below the level needed to meet guarantees, potentially forcing sales of equities at depressed prices. A lower equity weighting better matches the guarantees and reduces the risk of breaching them.

Question 23Life insurance

A life insurer is considering writing a block of immediate needs annuities where payments cease on death but are paid for life. Which combination of risks is most relevant to pricing this product?

  1. Mortality risk only, because the payment amount is fixed
  2. Credit risk and expense risk only, because payments are fixed
  3. Longevity risk and investment risk, because payments depend on survival and on the return earned on reserves Correct answer.
  4. Mortality risk and lapse risk, because the policyholder may die or surrender

Explanation

Immediate needs annuities pay an income for life, so the insurer bears longevity risk if annuitants live longer than assumed, and investment risk because it must earn sufficient return on reserves to fund the payments. Lapse risk is limited because these contracts typically have no surrender value.

Question 24Life insurance

In a risk-based capital framework, why is diversification benefit between different risk modules usually capped or restricted?

  1. Because regulators do not permit any recognition of diversification
  2. Because correlations can increase in stressed conditions, so full diversification may not be available when needed Correct answer.
  3. Because diversification benefit is impossible to measure
  4. Because life insurers face only one type of risk

Explanation

Correlation assumptions used to aggregate risk modules are estimated in normal conditions, but in stress events correlations can rise and diversification may break down. Caps or restrictions on diversification benefit therefore ensure capital remains adequate in tail scenarios.

Question 25Life insurance

A life insurer holds a portfolio of deferred annuities where policyholders can choose when to convert to income. What is the key risk arising from this option, and how might it be managed?

  1. There is no risk because the conversion terms are fixed at outset
  2. Policyholders may convert when interest rates are low, creating expense risk; managed by reducing commissions
  3. Policyholders may die before conversion, creating longevity risk; managed by buying more equities
  4. Policyholders may convert when interest rates are high, creating reinvestment risk; managed by matching assets to the expected conversion profile Correct answer.

Explanation

If policyholders can time conversion, they are likely to convert when annuity rates are favourable to them, which is when interest rates are high, leaving the insurer to reinvest at lower yields. Managing this involves matching assets to the expected conversion profile and pricing for the option.

Question 26Life insurance

A life insurer is pricing a 20-year level term assurance. Which combination of assumptions determines the expected present value of death claims?

  1. Mortality rates by duration, the discount rate and the timing of claim payment Correct answer.
  2. The lapse rate and the expense inflation rate only
  3. The sum assured and the commission scale only
  4. Mortality rates by duration and the discount rate only

Explanation

The present value of death claims depends on the probability of death in each future period, the amount payable, the point within the period at which the claim is assumed to be paid, and the rate used to discount it. Lapse, expense and commission assumptions affect other cash flow components rather than the death claim value itself.

Question 27Life insurance

An actuary is valuing a conventional without-profit endowment assurance. Which change to the valuation basis would reduce the mathematical reserve?

  1. An increase in the assumed expense loading
  2. An increase in the valuation interest rate Correct answer.
  3. A fall in the valuation interest rate
  4. A strengthening of the mortality assumption

Explanation

The mathematical reserve is the present value of future benefits plus expenses less the present value of future premiums. Raising the valuation interest rate discounts both sides more heavily, and because the benefit outgo typically exceeds the premium income in later durations, the net reserve falls. Strengthening mortality or expense assumptions increases the reserve.

Question 28Life insurance

Which statement best describes the purpose of a gross premium valuation for a life insurance portfolio?

  1. It compares the present value of future premiums with future benefits, expenses and profit, allowing for all cash flows Correct answer.
  2. It tests solvency by discounting only guaranteed benefits at a prudent rate
  3. It determines the statutory minimum capital requirement under a risk-based regime
  4. It calculates the asset share attributable to each policyholder

Explanation

A gross premium valuation projects all future cash flows on a realistic or best-estimate basis, including premiums, benefits, expenses and profit, and discounts them to assess whether the premium charged is adequate and the portfolio is profitable. It is broader than a net premium reserve and is not itself a capital calculation.

Question 29Life insurance

A life insurer writes unit-linked business where the policyholder bears investment risk. Which risk remains with the insurer?

  1. The risk that unit prices fall before the policy matures
  2. The risk that expense charges are insufficient to cover actual costs Correct answer.
  3. The risk that the policyholder's chosen fund underperforms its benchmark
  4. The risk that the policyholder surrenders when markets are low

Explanation

In unit-linked business the investment risk is borne by the policyholder, but the insurer still guarantees charges and bears expense risk if the charges deducted from the fund are insufficient to cover actual administration costs. Mortality and expense risk typically remain with the insurer.

Question 30Life insurance

Which asset class most closely matches the liability profile of a portfolio of level immediate annuities?

  1. Long-dated fixed-interest bonds with duration matched to the annuity outgo Correct answer.
  2. Short-dated money market instruments
  3. Direct commercial property holdings
  4. Equities with high expected dividend yield

Explanation

Level immediate annuity payments are fixed in nominal terms and continue until death, so long-dated fixed-interest assets whose duration and cash flow timing match the expected annuity outgo provide the closest match. This reduces interest rate and reinvestment risk.

Question 31Life insurance

Which factor most directly increases the required capital for longevity risk in an annuity portfolio?

  1. A reduction in the assumed lapse rate
  2. A fall in the assumed future improvement in mortality rates
  3. An increase in the assumed future improvement in mortality rates Correct answer.
  4. An increase in the assumed expense inflation rate

Explanation

Longevity risk is the risk that annuitants live longer than assumed, so a higher assumed rate of future mortality improvement increases the expected duration of payments and the capital held against the risk. Expense inflation and lapse assumptions relate to different risk modules.

Question 32Life insurance

Which statement best describes the role of the appointed actuary in a life insurer's with-profits fund?

  1. To set the investment strategy without reference to the board
  2. To advise on the fair allocation of surplus between policyholders and shareholders Correct answer.
  3. To guarantee the solvency of the fund to policyholders
  4. To determine the market value of the insurer's equity shares

Explanation

The appointed actuary advises the board on the fair treatment of policyholders, including how surplus and the inherited estate should be allocated between policyholders and shareholders. The actuary does not unilaterally set investment strategy, guarantee solvency or value shares.

Question 33Life insurance

A life insurer experiences a sharp rise in early-duration lapses on its regular premium savings policies. What is the most likely effect on profitability?

  1. Profitability improves because reserves are released immediately
  2. Profitability improves because fewer claims are paid
  3. Profitability is unaffected because lapses are assumed to be zero
  4. Profitability falls because acquisition costs are not recovered Correct answer.

Explanation

Regular premium savings policies typically incur high acquisition costs at outset that are recovered through charges over the policy term. Early lapses mean those costs are not recouped, so profitability falls and reserves may need strengthening.

Question 34Life insurance

An insurer is designing a with-profits product with a guaranteed minimum maturity value. Which risk is created by this guarantee?

  1. The risk that expense inflation exceeds the assumed rate
  2. The risk that investment returns fall below the level needed to fund the guarantee Correct answer.
  3. The risk that the insurer's reinsurer becomes insolvent
  4. The risk that policyholders live longer than expected

Explanation

A guaranteed minimum maturity value creates investment risk for the insurer because if asset returns are poor the insurer must top up the fund from its own resources to meet the guarantee. Longevity, expense and counterparty risks are separate risk categories.

Question 35Life insurance

An actuary is setting the equity backing ratio for a with-profits fund with substantial guaranteed liabilities. Which consideration points towards a lower equity backing ratio?

  1. A desire to maximise the expected long-term return for policyholders
  2. The need to reduce the risk of failing to meet guarantees in adverse markets Correct answer.
  3. A high level of free assets relative to the guarantees
  4. An expectation that equity markets will outperform bonds over the long term

Explanation

Where guarantees are significant, holding more equities increases the chance that the fund falls short of the guaranteed level in a market downturn. A lower equity backing ratio reduces the volatility of the fund relative to the guarantees and hence the risk of needing shareholder support.

Question 36Life insurance

A life insurer is assessing the capital impact of writing a large block of deferred annuities where policyholders may convert to income at a guaranteed rate. Which risk is most significant?

  1. The risk that policyholders take the income earlier than assumed, when interest rates are low Correct answer.
  2. The risk that policyholders die before retirement
  3. The risk that the insurer's equity portfolio outperforms
  4. The risk that administration expenses fall below assumptions

Explanation

A guaranteed conversion rate creates an option for the policyholder. If interest rates fall, the guaranteed rate becomes valuable and policyholders are likely to convert early, forcing the insurer to fund income at a cost above market rates. This is an interest rate and option risk.

Question 37Life insurance

Which method is most appropriate for estimating the cost of the guaranteed minimum death benefit embedded in a unit-linked policy?

  1. An application of the net premium reserve formula
  2. A deterministic calculation using best-estimate assumptions only
  3. A simple comparison of the sum assured with the current fund value
  4. A stochastic projection of fund values and mortality to value the option Correct answer.

Explanation

The guaranteed minimum death benefit is an option whose value depends on the path of fund values and the timing of death. Stochastic projection of fund values combined with mortality assumptions captures the asymmetric payoff and is the appropriate valuation approach.

Question 38Life insurance

An insurer is reviewing its reinsurance arrangements for a large single life policy. Which form of reinsurance most directly limits the insurer's exposure to a single very large claim?

  1. Quota share reinsurance on the whole portfolio
  2. Individual surplus or facultative reinsurance on the large policy Correct answer.
  3. Catastrophe excess of loss cover
  4. Aggregate stop loss cover

Explanation

Individual surplus or facultative reinsurance cedes the portion of a single policy above the insurer's retention, directly capping its exposure to that life. Quota share spreads risk across the whole portfolio and catastrophe cover responds to accumulations rather than a single large claim.

Question 39Life insurance

Which statement best explains why a life insurer's risk-based capital model applies a correlation matrix between risk modules?

  1. To recognise that risks do not all crystallise simultaneously, giving a diversification benefit Correct answer.
  2. To ensure that total capital equals the sum of individual module capital
  3. To remove the need to hold capital for operational risk
  4. To guarantee that the insurer will not fail

Explanation

A correlation matrix aggregates standalone risk module capital while recognising that adverse outcomes in different modules are unlikely to occur simultaneously at full severity. This produces a diversification benefit so total capital is less than the simple sum.

Question 40Life insurance

A life insurer is considering investing in corporate bonds to back its annuity liabilities. Which risk does this introduce compared with holding government bonds?

  1. Persistency risk from policyholder surrender
  2. Expense risk from rising administration costs
  3. Longevity risk from annuitants living longer
  4. Credit risk from issuer default and spread widening Correct answer.

Explanation

Corporate bonds carry credit risk because the issuer may default or its spread may widen, reducing market value. Government bonds are treated as credit-risk-free in the domestic currency, so switching to corporate bonds introduces this additional risk.

Question 41Life insurance

An actuary is projecting the asset share for a with-profits endowment policy. Which item is deducted from the asset share calculation?

  1. The shareholder transfer from the fund
  2. The investment return credited to the policy
  3. The cost of life cover and expenses charged to the policy Correct answer.
  4. The final bonus declared at maturity

Explanation

The asset share accumulates premiums at the earned investment return and deducts the charges for mortality (life cover) and expenses, together with any other deductions such as tax. Bonuses and shareholder transfers are distributions of the resulting surplus, not deductions in building the asset share.

Question 42Life insurance

Which assumption change would most increase the premium for a conventional without-profit term assurance policy?

  1. An increase in the assumed lapse rate
  2. An increase in the assumed mortality rates Correct answer.
  3. A reduction in the assumed expense inflation rate
  4. A reduction in the assumed mortality rates

Explanation

For term assurance the premium primarily covers the expected cost of death claims, so higher assumed mortality rates increase expected claim outgo and therefore the premium. Lower mortality, lower expenses or higher lapses would tend to reduce the required premium.

Question 43Life insurance

A life insurer is setting mortality assumptions for a pension annuity portfolio. Which source of data is most relevant for estimating future mortality improvement?

  1. The insurer's expense experience
  2. The insurer's own term assurance mortality experience
  3. The insurer's lapse experience on unit-linked savings
  4. National population mortality trends and cohort studies Correct answer.

Explanation

Future mortality improvement is best estimated from national population trends and cohort studies, which capture long-term improvements in longevity. The insurer's own annuity experience may be too small or immature to estimate improvement reliably, and term assurance experience reflects different lives.

Question 44Life insurance

An insurer's with-profits fund has a large inherited estate. Which use of the estate is most consistent with fair treatment of policyholders?

  1. Distributing the entire estate to shareholders immediately
  2. Using part of the estate to support guarantees and smooth bonuses, with the remainder shared fairly Correct answer.
  3. Retaining the estate indefinitely with no policyholder benefit
  4. Using the estate solely to fund executive bonuses

Explanation

The inherited estate belongs in part to policyholders who contributed to it, so it should be used to support guarantees, smooth bonuses and meet the reasonable expectations of policyholders, with any distribution to shareholders agreed fairly and transparently.

Question 45Life insurance

A life insurer is pricing a product with a guaranteed annuity conversion option. Which market condition makes the option most valuable to policyholders?

  1. Rising interest rates and falling longevity
  2. Falling expense inflation and stable mortality
  3. Rising equity markets and stable interest rates
  4. Falling interest rates and improving longevity Correct answer.

Explanation

The guaranteed annuity option becomes valuable when market annuity rates fall, which happens when interest rates fall and longevity improves. In those conditions the guaranteed rate exceeds the rate available in the market, so policyholders exercise the option and the insurer bears the cost.

Question 46Life insurance

Which statement best describes the treatment of future premiums in a net premium reserve calculation for a conventional endowment assurance?

  1. Future premiums are ignored entirely
  2. Future premiums are included at the gross premium actually charged
  3. Future premiums are included at the net premium, which excludes expense loadings Correct answer.
  4. Future premiums are included only if the policy has a surrender value

Explanation

The net premium reserve uses a net premium that is calculated from the valuation basis and covers benefits only, excluding expense loadings. The gross premium reserve, by contrast, uses the actual gross premium and allows for expenses.

Question 47Life insurance

A life insurer is assessing the impact of a fall in interest rates on its without-profit endowment portfolio. Which effect is most likely?

  1. Mathematical reserves fall because mortality improves
  2. Mathematical reserves are unchanged because benefits are fixed
  3. Mathematical reserves rise because future benefits are discounted less heavily Correct answer.
  4. Mathematical reserves fall because discounting is at a lower rate

Explanation

A fall in interest rates reduces the discount rate applied to future benefit outgo, increasing its present value relative to future premiums and therefore raising the mathematical reserve. This is a key interest rate risk for without-profit business.

Question 48Life insurance

An insurer is reviewing the design of a unit-linked product with a guaranteed minimum death benefit. Which feature most reduces the cost of the guarantee to the insurer?

  1. A guarantee set at the higher of the fund value and a sum assured that reduces over time Correct answer.
  2. A guarantee set at the higher of the fund value and a fixed sum assured
  3. A guarantee that applies only if the policyholder dies in the first year
  4. A guarantee that increases automatically each year

Explanation

A death benefit guarantee that reduces over time lowers the insurer's exposure as the fund is expected to grow, so the option is less likely to be in the money. A fixed or increasing guarantee exposes the insurer to a larger and longer-lasting shortfall.

Question 49Life insurance

A life insurer is considering a bulk annuity buy-in for a defined benefit pension scheme. Which risk is transferred to the insurer?

  1. The risk that the scheme's sponsor becomes insolvent
  2. The risk that the scheme's administration costs rise
  3. The risk that members live longer than assumed Correct answer.
  4. The risk that the scheme's investment committee makes poor decisions

Explanation

In a bulk annuity buy-in the insurer assumes the longevity risk of the scheme's members, paying an income to the scheme in exchange for a premium. Sponsor insolvency, investment decisions and administration costs remain with the scheme unless separately transferred.

Question 50Life insurance

An actuary is assessing the capital required for lapse risk on a unit-linked savings product with a minimum guaranteed fund value. Which lapse scenario is likely to be most adverse for the insurer?

  1. A modest increase in lapses when fund values equal the guarantee
  2. No change in lapse experience
  3. Mass lapse when fund values are high
  4. Mass lapse when fund values are low Correct answer.

Explanation

If policyholders lapse en masse when fund values are low, the insurer must meet the minimum guarantee on policies that would otherwise have recovered, crystallising losses and removing future charges. Lapsing when fund values are high is less costly because the guarantee is out of the money.