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IFoA SA3 practice questions

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Question 1General insurance

A UK motor insurer writes a large book of comprehensive policies. Under the Ogden approach to personal injury claims, which discount rate assumption does the reserving actuary normally apply when valuing future care and earnings losses?

  1. A zero discount rate applied to all heads of damage
  2. The insurer's own expected return on invested surplus
  3. A negative real discount rate reflecting assumed investment returns on index-linked gilts Correct answer.
  4. A positive real discount rate based on expected equity returns

Explanation

The Ogden discount rate is set by reference to assumed returns on very low-risk investments, and since 2017 in the UK it has been set at a negative real rate (later revised but still below zero in real terms). Because claimants are assumed to invest damages prudently, the rate is not based on equity returns or the insurer's own portfolio. Reserving actuaries therefore apply a negative real discount assumption to future care and loss of earnings.

Question 2General insurance

An actuary is setting reserves for a commercial property portfolio that has experienced only three large fire losses in ten years. Which reserving approach is most appropriate for the large loss component?

  1. Reserve at the largest single observed loss for each future accident year
  2. Apply a deterministic average of the three observed losses to every future year
  3. Use an exposure-based frequency-severity model with a heavy-tailed severity distribution Correct answer.
  4. Assume no large losses will occur because of the low observed frequency

Explanation

With very few large losses, a simple average is unstable and gives no sense of tail risk. A frequency-severity model with a heavy-tailed severity distribution captures the low frequency and high severity that characterise large property claims. This allows the actuary to reflect parameter uncertainty and to estimate return periods beyond the observed data.

Question 3General insurance

In UK general insurance, which of the following best describes the role of the claims equalisation reserve under current Solvency II reporting?

  1. It is a discretionary reserve that is not recognised as a technical provision under Solvency II Correct answer.
  2. It is a required technical provision that must be held for all non-life insurers
  3. It is calculated as the difference between best estimate and risk margin
  4. It replaces the risk margin in the calculation of technical provisions

Explanation

Under Solvency II, technical provisions consist of a best estimate plus a risk margin, and equalisation reserves are not permitted as a technical provision. Insurers may hold such reserves within their own funds or equity, but they are discretionary. They cannot be used to reduce the required capital calculation.

Question 4General insurance

An actuary is reviewing a motor portfolio and finds that reported claim counts have fallen while average severity has risen. Which explanation is most consistent with this pattern?

  1. A genuine reduction in the frequency of all claim sizes combined with stable severity
  2. A reduction in the number of small claims being reported, with the underlying large claims unchanged
  3. A change in the mix of business towards higher-risk drivers
  4. An increase in the policy excess that removes small claims from the reported data Correct answer.

Explanation

Raising the excess removes small claims from the reported data, reducing reported frequency while leaving the larger claims that drive average severity. The average of the remaining claims therefore rises even if the underlying severity distribution is unchanged. This is a classic reporting-threshold effect that actuaries must adjust for.

Question 5General insurance

Which of the following is the primary purpose of the risk margin within Solvency II technical provisions?

  1. To remunerate a hypothetical transferee for bearing the non-hedgeable risk of the liabilities Correct answer.
  2. To cover the expected cost of claims that have already been incurred but not reported
  3. To fund the insurer's own administrative expenses over the run-off period
  4. To provide a buffer against adverse investment returns on the insurer's assets

Explanation

The risk margin is designed to represent the cost of capital that a hypothetical transferee would require to take on the non-hedgeable risks of the insurance liabilities. It is calculated using a cost-of-capital approach applied to the projected solvency capital requirement. It is distinct from the best estimate, which covers expected claim costs.

Question 6General insurance

A reinsurance treaty covers losses above a retention of GBP 500,000 per risk, with a limit of GBP 2,000,000. A single risk produces a gross loss of GBP 3,200,000. How much does the reinsurer pay?

  1. GBP 3,200,000
  2. GBP 500,000
  3. GBP 2,000,000 Correct answer.
  4. GBP 2,700,000

Explanation

Under a per-risk excess of loss treaty, the reinsurer pays the amount by which the loss exceeds the retention, subject to the treaty limit. The excess is GBP 3,200,000 minus GBP 500,000, which equals GBP 2,700,000, but this is capped at the limit of GBP 2,000,000. The reinsurer therefore pays GBP 2,000,000 and the cedant retains the remainder.

Question 7General insurance

An actuary is using the Bornhuetter-Ferguson method for a long-tail liability class. Which situation makes this method particularly appropriate?

  1. The actuary wants to give full credibility to the latest reported loss ratio
  2. The class has experienced a structural change in claims handling that affects all years equally
  3. The class has a long history of stable, fully developed claims
  4. The most recent accident year has very little reported claims data but a reliable a priori loss ratio Correct answer.

Explanation

Bornhuetter-Ferguson blends an a priori expected loss with the reported-to-date claims, weighting by the proportion of claims expected to be reported. It is therefore well suited to immature accident years where reported data are sparse but an exposure-based prior is credible. It avoids the volatility of chain-ladder on thin data.

Question 8General insurance

Which of the following best describes the treatment of unexpired risk reserves in UK general insurance reserving?

  1. They are calculated only for claims that have already been reported
  2. They are required to cover the possibility that future claims on in-force policies exceed future premium income Correct answer.
  3. They are prohibited under Solvency II for all lines of business
  4. They are a component of the best estimate for outstanding claims

Explanation

An unexpired risk reserve (or premium provision) covers the excess of expected future claims and expenses over future premiums for business already written. Under Solvency II this is captured within the premium provision for future exposure. It is separate from the claims provision for incurred claims.

Question 9General insurance

A portfolio has expected annual claim frequency of 0.05 per policy and expected severity of GBP 20,000. If the insurer writes 10,000 policies, what is the expected aggregate annual claim cost?

  1. GBP 10,000,000 Correct answer.
  2. GBP 1,000,000
  3. GBP 100,000
  4. GBP 200,000,000

Explanation

Expected aggregate cost equals the number of policies multiplied by the frequency and then by the average severity. That is 10,000 times 0.05 times GBP 20,000, which gives GBP 10,000,000. This is the pure premium before loadings for expenses and profit.

Question 10General insurance

An actuary is assessing the adequacy of reserves for an asbestos-exposed liability portfolio. Which feature most complicates the estimation of the ultimate loss?

  1. The long reporting delay and uncertain future litigation environment create extreme tail uncertainty Correct answer.
  2. The claims are reported promptly and settle quickly
  3. The severity distribution is tightly bounded and well known
  4. The frequency of claims has been stable for decades

Explanation

Asbestos claims are characterised by very long reporting delays, sometimes decades after exposure, and by an uncertain legal and litigation environment. These features create extreme tail uncertainty that standard development methods struggle to capture. The actuary must use scenario analysis and judgement alongside statistical methods.

Question 11General insurance

Which of the following best describes the function of an insurance-linked security such as a catastrophe bond in an insurer's capital management?

  1. It eliminates the need for the insurer to hold any regulatory capital
  2. It guarantees a fixed return to the insurer regardless of catastrophe experience
  3. It provides reinsurance coverage that is recognised as a technical provision
  4. It transfers catastrophe risk to capital market investors in exchange for a coupon Correct answer.

Explanation

A catastrophe bond transfers specified catastrophe risk to capital market investors, who receive a coupon and lose principal if a defined trigger event occurs. It provides the sponsor with collateralised protection and diversifies its sources of reinsurance capacity. It does not remove the need for regulatory capital entirely.

Question 12General insurance

An actuary is calibrating a risk model and finds that the empirical loss data show more extreme events than a normal distribution would predict. Which distributional feature should the model incorporate?

  1. A symmetric distribution with zero skew
  2. A thinner tail than the normal distribution
  3. A heavier tail than the normal distribution Correct answer.
  4. A distribution with a lower variance than the normal

Explanation

When observed data contain more extreme events than a normal distribution predicts, the empirical distribution has heavier tails. The actuary should adopt a heavy-tailed distribution such as lognormal, Pareto or a generalised Pareto for the tail. Ignoring this would understate the capital requirement.

Question 13General insurance

Which of the following is the most appropriate treatment of reinsurance recoveries when estimating net technical provisions under Solvency II?

  1. Deduct expected reinsurance recoveries from gross best estimate, adjusted for the counterparty default risk Correct answer.
  2. Ignore reinsurance recoveries entirely and reserve on a gross basis
  3. Add reinsurance recoveries to the gross best estimate to reflect the cost of cover
  4. Deduct only recoveries that have already been received in cash

Explanation

Net technical provisions are calculated by deducting expected reinsurance recoveries from the gross best estimate. The recoveries are adjusted for the risk of counterparty default, which is reflected in the calculation. This gives a realistic net position for the insurer.

Question 14General insurance

An actuary is reviewing a claims-made professional indemnity portfolio. Which feature distinguishes it from an occurrence-based policy for reserving purposes?

  1. Claims are always reported in the same year as the incident
  2. Claims are attributed to the policy in force when the claim is first made Correct answer.
  3. Claims are attributed to the policy in force when the incident occurred
  4. Claims cannot be reinsured on a claims-made basis

Explanation

Under a claims-made policy, cover responds to claims first made during the policy period, regardless of when the incident occurred. Reserving must therefore reflect reporting patterns and the effect of extended reporting periods. This differs from occurrence-based cover, where the incident date determines the policy year.

Question 15General insurance

A reinsurer offers a quota share treaty with a 30% cession and a 20% ceding commission. The cedant's gross written premium is GBP 50,000,000. What is the net premium retained by the cedant before commission?

  1. GBP 50,000,000
  2. GBP 35,000,000 Correct answer.
  3. GBP 15,000,000
  4. GBP 42,500,000

Explanation

Under a 30% quota share, the reinsurer receives 30% of premium, which is GBP 15,000,000. The cedant retains the remaining 70%, which is GBP 35,000,000. The ceding commission is a separate payment from the reinsurer to the cedant and does not change the premium split itself.

Question 16General insurance

Which of the following best explains why actuaries use exposure-based methods for a new line of business with no credible claims history?

  1. Exposure-based methods eliminate all estimation uncertainty
  2. Exposure-based methods are required by Solvency II for all new business
  3. Exposure data are only available after claims have been settled
  4. Exposure data provide a stable basis for estimating expected losses when claims are sparse Correct answer.

Explanation

When claims history is sparse, exposure measures such as premium, policy counts or payroll provide a stable basis for estimating expected losses. The actuary applies an assumed loss ratio to the exposure to derive an expected loss. This reduces reliance on volatile and unreliable claims data.

Question 17General insurance

An actuary is analysing a liability portfolio and observes that the chain-ladder development factors have been falling steadily over recent years. Which factor is the most likely explanation?

  1. Slower claims settlement increasing the outstanding claims at each age
  2. A change in the discount rate applied to the reserves
  3. A one-off reserve strengthening in the most recent year
  4. Faster claims settlement reducing the proportion of claims outstanding at each development age Correct answer.

Explanation

Falling development factors mean that a smaller proportion of claims remains outstanding at each development age, which is consistent with faster settlement. This could reflect improved claims handling or a shift in case mix. The actuary should investigate whether the trend is expected to continue before projecting it.

Question 18General insurance

Which of the following best describes the purpose of the Solvency Capital Requirement (SCR) under Solvency II?

  1. To ensure the insurer can meet its obligations over a one-year period with 99.5% confidence Correct answer.
  2. To fund the insurer's dividend payments to shareholders
  3. To cover the best estimate of all future claim payments
  4. To provide a margin for the cost of reinsurance over the policy term

Explanation

The SCR is calibrated to ensure that the insurer can meet its obligations over the next twelve months with a probability of at least 99.5%. It covers the unexpected loss above the best estimate, not the expected claim cost itself. It is a risk-based capital requirement covering all material risks.

Question 19General insurance

An actuary is using the expected loss ratio method to set reserves for an immature accident year. Which assumption is most critical to the validity of the result?

  1. That the discount rate will remain constant over the projection
  2. That all claims will be settled within twelve months
  3. That the selected loss ratio accurately reflects the underlying expected cost of the business Correct answer.
  4. That the reinsurance programme will not change in future years

Explanation

The expected loss ratio method applies a selected a priori loss ratio to earned premium to estimate ultimate losses. Its validity depends critically on the accuracy of that selected ratio, which must reflect the underlying risk and pricing of the business. If the ratio is misjudged, the entire reserve estimate is biased.

Question 20General insurance

Which of the following best describes the concept of basis risk in the context of a parametric catastrophe cover?

  1. The risk that the insurer's premium income falls short of expectations
  2. The risk that interest rates move against the insurer's asset portfolio
  3. The risk that the insurer's actual losses differ from the index or trigger used by the cover Correct answer.
  4. The risk that the reinsurer becomes insolvent

Explanation

Parametric covers pay out based on an index or physical trigger rather than the insurer's actual losses. Basis risk arises when the actual loss experience diverges from the trigger, so the payout may not match the loss. This is a key limitation of index-linked and parametric protection.

Question 21General insurance

An actuary is evaluating the effect of a reinsurance programme on the insurer's capital requirement. Which outcome is most likely when the insurer purchases effective excess of loss cover?

  1. The net capital requirement is unaffected because reinsurance is not recognised
  2. The net capital requirement rises because reinsurance premiums reduce profit
  3. The net capital requirement falls because retained tail risk is reduced Correct answer.
  4. The net capital requirement becomes zero because all risk is transferred

Explanation

Excess of loss reinsurance reduces the insurer's retained tail risk, which lowers the capital required for the underlying underwriting risk. The benefit is partly offset by counterparty default risk on the reinsurer. The net effect is normally a reduction in the SCR for non-life underwriting risk.

Question 22General insurance

Which of the following is the most appropriate way for an actuary to communicate reserve uncertainty to a board of directors?

  1. Withhold the uncertainty analysis to avoid confusing the board
  2. Report only the most pessimistic scenario to be prudent
  3. Provide a single point estimate without any indication of uncertainty
  4. Present a central estimate with a range or distribution of possible outcomes Correct answer.

Explanation

Best practice is to present a central estimate alongside a range or distribution that reflects the uncertainty in the reserve. This allows the board to understand the potential variability and to make informed decisions. Reporting only a point estimate or only a pessimistic scenario misrepresents the risk.

Question 23General insurance

An actuary observes that a motor insurer's loss ratio has improved sharply in the most recent year while premium rates have been falling. Which explanation warrants the most investigation?

  1. A reduction in the number of policies written
  2. A change in case reserving practice that has reduced outstanding claim estimates Correct answer.
  3. A genuine improvement in claims experience driven by safer vehicles
  4. A change in the reinsurance programme

Explanation

A sharp improvement in the loss ratio alongside falling premium rates is a warning sign that may indicate reserve releases from changes in case reserving practice rather than genuine improvement. The actuary should investigate whether case estimates have been reduced, which could flatter the result. This is a classic reserving red flag.

Question 24General insurance

Which of the following best describes the role of the actuarial function under Solvency II?

  1. To set the insurer's investment strategy and asset allocation
  2. To provide an independent audit opinion on the insurer's financial statements
  3. To approve the insurer's reinsurance programme
  4. To coordinate and oversee the calculation of technical provisions and opine on underwriting risk Correct answer.

Explanation

The actuarial function under Solvency II is responsible for coordinating and overseeing the calculation of technical provisions and for providing an opinion on underwriting risk and reinsurance. It also contributes to risk management and capital assessment. It does not replace the external audit or set investment strategy.

Question 25General insurance

An actuary is assessing the impact of a one-in-two-hundred-year flood event on a property portfolio. Which approach is most appropriate for estimating the resulting loss?

  1. Assume the loss equals the largest single claim observed historically
  2. Apply the average annual loss to the portfolio
  3. Use the chain-ladder development factor for the latest accident year
  4. Use a catastrophe model that simulates event severity and exposure Correct answer.

Explanation

Estimating losses from an extreme event such as a one-in-two-hundred-year flood requires a catastrophe model that simulates event severity and applies it to the exposed portfolio. Historical averages and single observed claims cannot capture the tail. Chain-ladder development is designed for reserving, not for extreme event loss estimation.

Question 26General insurance

An actuary is reviewing a UK motor portfolio and wants to test whether the reported claim counts are consistent with the underlying exposure. Which data check is most directly suited to this purpose?

  1. Comparing the gross written premium to the reinsurance premium ceded in the year
  2. Comparing the number of open claims to the number of policies cancelled in the year
  3. Comparing the paid claims to the case reserves held at the previous valuation date
  4. Comparing the ratio of claims to earned exposure units (e.g. vehicle-years) against prior periods and industry benchmarks Correct answer.

Explanation

Frequency measures such as claims per vehicle-year are the standard way to test whether claim counts are proportionate to exposure, and comparison with history and benchmarks reveals anomalies. The other comparisons mix unrelated quantities and would not isolate exposure consistency.

Question 27General insurance

Which of the following best describes the role of the grossing-up (development) factors in the chain-ladder technique?

  1. They estimate the proportion of ultimate claims reported by each development period so that cumulative claims can be projected to ultimate Correct answer.
  2. They adjust historical claims for inflation so that all years are on a common cost basis
  3. They allocate expenses to accident years in proportion to earned premium
  4. They convert paid claims into incurred claims by adding case reserves

Explanation

Chain-ladder factors represent the expected ratio of cumulative claims at successive development periods, so applying them projects reported claims to an estimated ultimate. They do not convert paid to incurred, adjust for inflation, or allocate expenses.

Question 28General insurance

An underwriter asks why an actuary distinguishes between attritional and large claims when building a frequency-severity model for commercial property. Which explanation is most appropriate?

  1. Large claims are excluded from reserving because they are unpredictable and cannot be estimated
  2. Splitting the data reduces the number of parameters so that no distributional assumptions are required
  3. The two populations have different frequency and severity behaviour, so modelling them separately improves fit and allows large claims to be treated with an extreme value approach Correct answer.
  4. Attritional claims are always reinsured while large claims are retained, so they must be modelled separately for accounting purposes

Explanation

Attritional and large losses typically follow different frequency and severity patterns; separating them lets the actuary fit a stable body model to attritional claims and a heavy-tailed model to large ones. This is a modelling judgement, not an accounting or reinsurance rule.

Question 29General insurance

An actuary is setting the premium for a new household contents product using a frequency-severity approach. Which combination of assumptions is required to derive the pure risk premium?

  1. Expected investment return and expected expense ratio
  2. Expected claim frequency per policy and expected claim severity per claim Correct answer.
  3. Expected reserve development and expected reinsurance recovery
  4. Expected lapse rate and expected commission rate

Explanation

The pure risk premium under a frequency-severity approach is the product of expected frequency and expected severity. Investment return, expenses, lapses and reserve development affect other parts of the pricing or reserving calculation but not the pure risk premium itself.

Question 30General insurance

An actuary is reviewing a commercial liability portfolio and observes that a small number of large claims dominate the incurred losses in each accident year. Which reserving consideration is most important?

  1. That the chain-ladder method should be applied to the total incurred without adjustment because it is assumption-free
  2. That individual large claims should be reviewed case by case and the remaining attritional claims projected separately Correct answer.
  3. That reserves should be set equal to the paid-to-date plus the largest single case reserve
  4. That the loss ratio method should be used because it ignores individual claims

Explanation

When a few large claims dominate, the actuary should review them individually and model the attritional body separately so that projections are not distorted by lumpy case reserves. Chain-ladder is not assumption-free, and the other approaches ignore the very claims that drive the result.

Question 31General insurance

Which of the following best describes how an insurer's equalisation provision differs from its unexpired risk provision?

  1. The equalisation provision is set by the tax authority, whereas the unexpired risk provision is set by the reinsurer
  2. The equalisation provision covers unexpired business, whereas the unexpired risk provision smooths catastrophe experience
  3. The equalisation provision is a reinsurance asset, whereas the unexpired risk provision is a deferred acquisition cost
  4. The equalisation provision smooths the impact of years with unusually high claims, whereas the unexpired risk provision covers the possibility that future claims on unexpired business exceed unearned premium Correct answer.

Explanation

Equalisation provisions build up in good years to absorb volatility from unusually heavy claims, while unexpired risk provisions recognise a deficit where expected future claims on in-force business exceed the unearned premium. They address different risks and are not interchangeable.

Question 32General insurance

An actuary is assessing the credit risk from reinsurance recoveries on a long-tail liability portfolio. Which factor is most relevant to the assessment?

  1. The level of the cedant's acquisition costs and the commission paid to brokers
  2. The creditworthiness of the reinsurer and the timing of recoveries relative to when the cedant pays the underlying claims Correct answer.
  3. The number of policyholders in the underlying portfolio and their geographic spread
  4. The investment return earned on the cedant's technical provisions

Explanation

Reinsurance credit risk depends on the counterparty's ability to pay and on the lag between the cedant settling claims and recovering from the reinsurer. Policyholder spread, acquisition costs and investment returns affect other risks but not the recoverability of reinsurance balances.

Question 33General insurance

An actuary is estimating the ultimate loss for an immature accident year where no reliable development pattern is yet available but a credible pricing loss ratio exists. Which method is most appropriate?

  1. The expected loss ratio method, applying the pricing loss ratio to earned premium to derive ultimate losses Correct answer.
  2. The paid-to-paid method, extrapolating the most recent payment
  3. The case reserve method, holding the current case reserves as the ultimate
  4. The chain-ladder method applied to the most recent diagonal only

Explanation

Where development data are too immature to support a projection but a credible expected loss ratio exists, the expected loss ratio method provides a stable estimate by applying that ratio to earned premium. The other methods either require development data that are unavailable or ignore information beyond current case reserves.

Question 34General insurance

Which of the following best describes the purpose of the risk margin within Solvency II technical provisions?

  1. To cover the cost of reinsurance purchased to protect the portfolio
  2. To fund the insurer's future new business growth and distribution costs
  3. To provide a buffer against adverse investment returns on the insurer's asset portfolio
  4. To ensure that the technical provisions are sufficient for another insurer to take over the portfolio, by remunerating the cost of holding regulatory capital for non-hedgeable risks Correct answer.

Explanation

The risk margin is the amount, in addition to the best estimate, needed so that a transferring insurer would be able to meet the obligations, and it is calculated as the cost of holding the required capital for non-hedgeable risks. It is not an investment buffer, a growth fund or a reinsurance cost.

Question 35General insurance

An actuary is analysing a property portfolio exposed to windstorm and wants to estimate the loss for a 1-in-200-year return period. Which approach is most appropriate?

  1. A chain-ladder projection of the most recent five accident years
  2. An average of the last ten years of reported windstorm losses
  3. A deterministic scenario using the largest single historical loss inflated for exposure growth
  4. A catastrophe model that simulates event frequencies and severities and produces a loss exceedance curve Correct answer.

Explanation

Tail events such as a 1-in-200-year windstorm are estimated using catastrophe models that simulate a full distribution of events and derive the exceedance curve. Historical single events or averages cannot reliably represent the tail, and chain-ladder is a reserving tool for reported development.

Question 36General insurance

An actuary is reviewing a broker's submission for a fleet motor account and notices that the sum insured for each vehicle appears to be the purchase price rather than the current replacement cost. Which issue is most relevant for the pricing review?

  1. The broker should be asked to remove the sum insured from the submission entirely
  2. The sum insured may not reflect the correct basis of cover, so the exposure measure and hence the expected loss cost could be misstated Correct answer.
  3. The purchase price is always the appropriate measure for total loss settlement
  4. The sum insured is irrelevant to motor pricing because motor claims are settled on a third-party basis only

Explanation

If the sum insured is on the wrong basis, the exposure measure used to derive expected loss costs will be inconsistent with the cover actually provided. The actuary should establish the correct basis before relying on the data. Motor cover is not exclusively third party, and removing the exposure measure would remove essential information.

Question 37General insurance

Which of the following best describes the effect of a higher assumed inflation rate on the estimated ultimate cost of a long-tail liability portfolio?

  1. Ultimate costs increase, with the effect larger for claims settled further in the future Correct answer.
  2. Ultimate costs increase only for the paid claims and not for the outstanding claims
  3. Ultimate costs decrease, because higher inflation reduces the present value of future payments
  4. Ultimate costs are unaffected, because inflation affects only the investment return on assets

Explanation

Higher claims inflation raises the projected cost of future settlements, and the effect compounds with the time to settlement, so longer-tailed claims are more sensitive. Discounting affects the present value but does not offset the higher nominal cost in the way described.

Question 38General insurance

An actuary is asked to project claim numbers for a personal accident portfolio where the policy count has grown rapidly. Which approach is most appropriate for the exposure base?

  1. Use earned exposure units such as policy-months, so that growth in the portfolio is reflected in the expected claim counts Correct answer.
  2. Use the total number of policies ever written, since this captures the full history
  3. Use the number of claims reported in the latest month, since this reflects the current portfolio size
  4. Use the number of claims handlers employed, since this drives the reporting rate

Explanation

Earned exposure units such as policy-months align the expected claim counts with the risk actually exposed during the period, which is essential when the portfolio is growing. Latest-month claims and cumulative policy counts do not correctly represent exposure in each period.

Question 39General insurance

An actuary is considering using a generalised linear model (GLM) for motor claim frequency. Which feature of the GLM makes it particularly suitable for this application?

  1. It removes the need to select rating factors because the model chooses them automatically
  2. It allows a non-normal error distribution and a link function, so claim counts can be modelled with a Poisson or negative binomial distribution Correct answer.
  3. It requires all rating factors to be continuous rather than categorical
  4. It guarantees that the fitted model will have no residual deviance

Explanation

GLMs extend linear models by allowing distributions such as Poisson or negative binomial for count data and a link function relating the mean to the linear predictor. They do not eliminate residual deviance, automatically choose factors, or require only continuous covariates.

Question 40General insurance

An insurer writes a book where the largest single risk is a petrochemical plant representing 15% of the total exposure. Which risk concentration issue is most relevant to the actuary?

  1. The concentration only affects expenses, not the loss distribution
  2. A single event at that location could generate losses disproportionate to the portfolio's average, so aggregate and single-risk accumulations must be assessed Correct answer.
  3. The concentration should be ignored because the policy count is large
  4. The concentration is irrelevant because reinsurance will cover any loss in full

Explanation

A dominant single risk can produce a loss far above the portfolio average, so the actuary must assess single-risk and accumulation exposure rather than relying on average loss statistics. Reinsurance reduces but does not eliminate the need for this assessment, and the concentration affects the loss distribution, not just expenses.

Question 41General insurance

Which of the following best describes the purpose of an experience rating plan in commercial motor insurance?

  1. To replace the need for any exposure-based rating factors
  2. To transfer the entire claims cost of the fleet to the reinsurer
  3. To adjust the premium for a specific fleet to reflect its own claims experience relative to the expected level Correct answer.
  4. To set a uniform premium for all fleets regardless of their individual loss history

Explanation

Experience rating modifies the manual premium for an individual risk according to its own loss experience, giving credit for better-than-average records and surcharges for worse. It does not set uniform premiums, transfer all claims to reinsurers, or remove the need for exposure rating factors.

Question 42General insurance

An actuary is testing the sensitivity of reserves to the assumed development pattern for a liability class. Which approach best demonstrates the range of reasonable outcomes to the board?

  1. Present the lowest estimate only, to demonstrate competitiveness
  2. Present the highest estimate only, to ensure the board is aware of the worst case
  3. Present only the single central estimate, since presenting alternatives could confuse the board
  4. Present reserve estimates under a base case and several alternative development assumptions, showing the resulting range and the key drivers Correct answer.

Explanation

A sensitivity analysis showing the base case alongside alternative assumptions communicates the range of reasonable outcomes and the drivers of uncertainty, which supports informed decision-making. Presenting only one figure, whether central or extreme, conceals the uncertainty the board needs to understand.

Question 43General insurance

An actuary is evaluating whether to use a paid or incurred basis for projecting a long-tail liability class with significant case reserves. Which consideration is most relevant?

  1. The choice is irrelevant because both bases produce identical projections
  2. Incurred data are always superior because they include every future claim
  3. Incurred data incorporate case reserves and can be more stable, but may be distorted by changes in case reserving practice, whereas paid data are less affected by reserving philosophy Correct answer.
  4. Paid data are always superior because they cannot be manipulated

Explanation

Incurred data bring in case reserves, which can stabilise projections but introduce sensitivity to changes in case reserving practice. Paid data are less exposed to that philosophy but may be slower to develop, so the actuary weighs both. Neither basis is universally superior, and the projections will generally differ.

Question 44General insurance

A regulator asks an insurer to explain how it ensures that its reserving process is robust. Which control is most directly relevant?

  1. A policy of using only one reserving method for every class of business
  2. A guarantee that reserves will never be increased after the initial estimate
  3. Documented peer review of assumptions and methods, with sign-off by an appropriate senior actuary Correct answer.
  4. An agreement that reserves are set by the sales team to support growth targets

Explanation

Robust reserving relies on documented methods and assumptions that are independently reviewed and signed off by an appropriately senior actuary. Guarantees against future increases, single-method policies and sales-driven reserving all undermine rather than strengthen the process.

Question 45General insurance

An actuary is analysing a portfolio of small commercial property risks and finds that the number of claims per policy follows a distribution whose variance exceeds its mean. Which distribution is most appropriate for the claim counts?

  1. Poisson
  2. Negative binomial Correct answer.
  3. Normal
  4. Binomial

Explanation

Overdispersion, where the variance exceeds the mean, is not consistent with the Poisson assumption and is commonly modelled with the negative binomial distribution, which allows extra variability. Binomial and normal distributions are not the standard choice for overdispersed claim counts.

Question 46General insurance

Which of the following best describes the treatment of deferred acquisition costs (DAC) in general insurance financial reporting?

  1. Acquisition costs are capitalised indefinitely until the policy lapses
  2. Acquisition costs are netted against reinsurance recoveries in the balance sheet
  3. Acquisition costs are recognised in full when the policy is written, regardless of the earning period
  4. Acquisition costs are deferred and amortised over the period in which the related premium is earned, matching cost with revenue Correct answer.

Explanation

Deferring acquisition costs and amortising them as the related premium is earned matches the cost of acquiring the business with the revenue it generates. Recognising the full cost immediately or capitalising indefinitely would distort the timing of profit recognition, and DAC is not netted against reinsurance recoveries.

Question 47General insurance

An actuary is assessing the impact of a change in the reinsurance programme from quota share to excess of loss on the volatility of the insurer's net result. Which outcome is most likely?

  1. Net result volatility increases for small, frequent losses but decreases for large losses, compared with the quota share arrangement Correct answer.
  2. Net result volatility is unchanged because total gross losses are the same under both arrangements
  3. Net result volatility becomes zero because the reinsurer bears all the risk
  4. Net result volatility decreases for all loss sizes because excess of loss covers every claim

Explanation

Quota share shares all losses proportionally and so smooths both attritional and large losses, whereas excess of loss retains attritional losses and protects only the layer above the attachment. Moving to excess of loss therefore tends to increase volatility at low loss levels and reduce it for large losses.

Question 48General insurance

An actuary is reviewing a claims-made professional indemnity portfolio and needs to project the ultimate cost of claims already reported. Which feature most affects the projection compared with an occurrence policy?

  1. Claims are always reported in the year the negligent act occurred, so development is immediate
  2. The policy does not cover defence costs, so severity is lower
  3. The reporting pattern is affected by the claims-made trigger, so development patterns reflect reporting behaviour as well as settlement behaviour Correct answer.
  4. Coverage cannot be extended by any reporting clause, so no late claims arise

Explanation

Under a claims-made policy, cover responds to claims reported during the policy period, so the development pattern reflects when claims are notified as well as how they settle. This differs from occurrence cover, where the trigger is the date of the incident, and it is not true that reporting is immediate or that late claims cannot arise.

Question 49General insurance

An actuary is deciding whether to use a deterministic or stochastic approach to estimate the capital requirement for a property catastrophe portfolio. Which consideration is most relevant?

  1. The choice is irrelevant because both approaches produce identical capital figures
  2. A stochastic approach captures the full distribution of losses and correlations across events, which is important for tail capital estimates, whereas a deterministic scenario gives a single point estimate Correct answer.
  3. A stochastic approach is unnecessary because capital requirements depend only on the mean loss
  4. A deterministic approach is always preferred because it requires no assumptions

Explanation

Capital requirements depend on the tail of the loss distribution and on how losses aggregate across events, which a stochastic simulation captures and a single deterministic scenario cannot. Deterministic approaches are not assumption-free, capital is not based on the mean alone, and the two approaches generally give different results.

Question 50General insurance

An actuary is assessing a proposed new motor product and wants to estimate the expected loss ratio before any data are available. Which approach is most appropriate?

  1. Use the average loss ratio of the entire insurance market without adjustment
  2. Use the loss ratio of comparable existing products adjusted for differences in cover, rating factors and target market Correct answer.
  3. Use a loss ratio of zero because no data exist for the new product
  4. Use the insurer's overall expense ratio as a proxy for the loss ratio

Explanation

In the absence of product-specific data, the actuary can benchmark against comparable products, adjusting for differences in cover, rating factors and target market to make the comparison meaningful. A zero loss ratio, an expense ratio proxy or an unadjusted market average would not reflect the expected cost of the new product.