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IFoA SP1 practice questions

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Question 1Health and care

A private medical insurance product covers inpatient treatment. Which of the following best describes the fundamental purpose of a morbidity table in pricing this product?

  1. To set the commission payable to brokers for distributing the product
  2. To estimate the expected number of claims or claim costs per policy exposed at each age and duration Correct answer.
  3. To project the future investment return earned on the insurer's reserves
  4. To determine the statutory solvency capital requirement for the insurer's equity portfolio

Explanation

A morbidity table summarises the incidence or cost of sickness or injury by age, sex and sometimes duration, so it underpins the expected claim outgo in pricing. Investment return and capital requirements are handled by separate assumptions such as the valuation interest rate and the risk margin, not by the morbidity table itself.

Question 2Health and care

An insurer offers critical illness cover with a survival period of 14 days after diagnosis before the benefit is payable. What is the primary purpose of including this survival period in the product design?

  1. To reduce the cost of claims arising from diagnoses where the insured dies very soon afterwards Correct answer.
  2. To guarantee that all claims are settled within two weeks of notification
  3. To ensure the policyholder pays an extra premium for each additional day of cover
  4. To transfer the mortality risk of the insured to the reinsurer entirely

Explanation

A survival period means the insured must live for a set time after diagnosis before the sum assured is paid, which removes claims closely following diagnosis where death is imminent. This lowers expected claim costs and aligns the benefit with the intention of providing a living benefit rather than a death benefit.

Question 3Health and care

In long-term care insurance, which of the following is the most common trigger for benefit payment?

  1. The insured being unable to perform a specified number of activities of daily living Correct answer.
  2. The insured being diagnosed with a single named condition only
  3. The insured being made redundant from employment
  4. The insured reaching the state pension age

Explanation

Long-term care benefits are typically triggered by functional impairment, measured by the inability to perform a set number of activities of daily living such as bathing, dressing or feeding, or by cognitive impairment. This reflects the need for ongoing care rather than a specific diagnosis or an age milestone.

Question 4Health and care

Which of the following statements best describes the role of the state in a healthcare financing system that uses social health insurance?

  1. The state provides no funding and relies entirely on voluntary private insurance purchased by individuals
  2. The state sets no rules and allows providers to charge whatever fees they choose
  3. The state pays for all care directly from general taxation with no contributory element
  4. The state mandates participation and often administers or regulates funds, with contributions shared between employers and employees Correct answer.

Explanation

Social health insurance involves compulsory membership, usually funded by earnings-related contributions split between employers and employees, with the state setting the rules and often running the funds. This differs from tax-funded national health services and from purely voluntary private markets.

Question 5Health and care

An insurer is setting assumptions for a new income protection product. Which combination of decrements must the pricing basis reflect?

  1. Only the investment return and expense inflation assumptions
  2. Sickness inception rates, recovery rates and mortality of both healthy and sick lives Correct answer.
  3. Only the mortality rate of healthy lives
  4. Only the lapse rate at each policy duration

Explanation

Income protection benefits depend on the incidence of sickness, how long claimants remain unable to work, and the chance of death while healthy or while claiming. A model that ignores recovery or sick-life mortality would misstate the expected duration and cost of claims.

Question 6Health and care

A critical illness insurer is reviewing its experience and finds that the proportion of policies lapsing after a premium increase is higher than assumed. What is the most likely direct consequence for the insurer?

  1. The insurer's regulatory capital requirement will fall without any change in reserves
  2. The morbidity table used for pricing becomes invalid immediately by regulation
  3. Adverse selection may worsen because healthier lives are more likely to lapse, raising future claim costs per policy Correct answer.
  4. Mortality rates among remaining policyholders will fall automatically

Explanation

When premiums rise, policyholders who perceive themselves as low risk are more likely to lapse, leaving a pool with a higher average risk. This adverse selection raises expected claim costs per remaining policy and can erode profitability if not anticipated in the pricing basis.

Question 7Health and care

An actuary is valuing a portfolio of individual private medical insurance policies. Which factor most directly reduces the technical provisions held for incurred but not reported claims?

  1. A longer average policy duration
  2. A lower assumed discount rate
  3. A higher assumed rate of medical inflation
  4. A shorter average delay between treatment and claim notification Correct answer.

Explanation

Incurred but not reported reserves cover claims for treatment already received but not yet notified, so the reserve depends on reporting delay and expected claim cost. A shorter notification delay reduces the amount of unreported liability outstanding at the valuation date.

Question 8Health and care

Which of the following best explains why medical inflation is often assumed to exceed general price inflation in health insurance pricing?

  1. The number of insured lives is expected to fall steadily over time
  2. Advances in medical technology and increased utilisation of services tend to raise costs faster than the general basket of goods Correct answer.
  3. Hospitals are required to hold larger reserves than other businesses
  4. Governments always mandate that healthcare providers increase their fees each year

Explanation

Health costs are driven by new treatments, technology and rising utilisation, which historically outpace growth in general consumer prices. Pricing therefore often assumes a medical inflation rate above general inflation to reflect this trend.

Question 9Health and care

An insurer writes group income protection and is considering the effect of a shorter deferred period on premiums. Which statement is correct?

  1. A shorter deferred period reduces expected claim costs because fewer claims are reported
  2. The deferred period has no effect on premium because it only affects administration
  3. A shorter deferred period transfers morbidity risk to the state
  4. A shorter deferred period increases expected claim costs because benefits start sooner after sickness begins Correct answer.

Explanation

The deferred period is the waiting time before benefits become payable, so a shorter wait means the insurer pays for more of the sickness spell. This raises expected claim costs and hence the premium required for the same benefit level.

Question 10Health and care

A critical illness product offers cover only up to age 65 with no benefit on death. Which pricing consideration is most relevant when comparing it with a whole-of-life critical illness contract?

  1. The absence of a death benefit increases the mortality risk borne by the insurer
  2. The product requires a larger reserve because benefits are paid earlier
  3. The shorter coverage period reduces exposure to claims at older ages when incidence is highest Correct answer.
  4. The product has no lapse risk because cover is temporary

Explanation

Critical illness incidence rises steeply with age, so limiting cover to age 65 removes the period of highest claim frequency. This substantially reduces expected claim cost relative to a whole-of-life contract with the same sum assured.

Question 11Health and care

Which of the following is a key reason why insurers use reinsurance for large health insurance portfolios?

  1. To guarantee that the insurer makes a profit on every policy
  2. To avoid the requirement to price the product at all
  3. To protect against large individual claims and to obtain access to reinsurer morbidity expertise Correct answer.
  4. To eliminate the need to hold any technical provisions

Explanation

Reinsurance can cap the insurer's exposure to large or aggregating claims and often brings pricing and underwriting expertise from the reinsurer. It supports capital management and risk transfer but does not remove the need for reserves or pricing.

Question 12Health and care

An actuary is analysing the effect of an ageing population on a private medical insurance portfolio. Which outcome is most consistent with demographic trends?

  1. Mortality improvements reduce the cost of all health benefits
  2. Claim costs per policy are likely to fall because older people use fewer services
  3. The number of claims is unaffected by age but only by policy duration
  4. Claim costs per policy are likely to rise as the average age of the insured pool increases Correct answer.

Explanation

Healthcare utilisation and morbidity costs generally increase with age, so an ageing insured pool raises expected claim cost per policy. Mortality improvement can actually increase the cost of benefits that depend on survival, such as long-term care.

Question 13Health and care

Which of the following best describes the underwriting purpose of a moratorium (or full medical underwriting) approach in private medical insurance?

  1. To calculate the regulatory solvency capital requirement
  2. To determine whether pre-existing conditions are covered and to set appropriate terms at outset Correct answer.
  3. To set the investment strategy for the insurer's reserves
  4. To decide the commission paid to the distribution channel

Explanation

Underwriting assesses the applicant's health to identify pre-existing conditions and to decide exclusions, loadings or acceptance terms. This controls anti-selection and aligns premium with risk, which is distinct from investment, capital and distribution decisions.

Question 14Health and care

A health insurer's critical illness experience shows that diagnosis rates for a particular cancer have risen sharply due to improved screening. What is the most likely effect on the insurer if the pricing basis is not updated?

  1. Claim costs will be underestimated and the product may become loss-making Correct answer.
  2. Mortality rates will fall and offset the extra claims entirely
  3. The insurer will be required to reduce premiums by regulation
  4. Claim costs will be overestimated and reserves will be excessive

Explanation

Improved screening detects more cases, increasing the number of valid critical illness claims and bringing some diagnoses forward. If the morbidity basis does not reflect this, expected claim costs are understated and the product may be underpriced.

Question 15Health and care

Which of the following statements about a health insurer's exposure to aggregation risk is correct?

  1. Aggregation risk is measured solely by the average claim size
  2. Aggregation risk only matters for individual life policies, not health policies
  3. A single event such as an epidemic can cause many claims at once, so capital must allow for correlated losses Correct answer.
  4. Aggregation risk is fully removed by charging higher premiums to each policyholder

Explanation

Health claims can be correlated through events such as epidemics or new treatments affecting many insureds simultaneously, creating aggregation risk. Capital and reinsurance arrangements must reflect this correlation rather than relying on average claim size alone.

Question 16Health and care

An actuary is projecting claim costs for a long-term care portfolio. Which assumption change would most increase projected costs?

  1. Assuming that more claimants remain in care for longer periods Correct answer.
  2. Assuming lower expense inflation
  3. Assuming a higher discount rate for reserves
  4. Assuming a higher rate of policy lapse at early durations

Explanation

Long-term care costs depend heavily on the duration of care spells, so assuming longer stays directly increases the expected benefit period and cost. Lapse, discount rate and expense inflation affect other parts of the projection or act in the opposite direction.

Question 17Health and care

Which of the following best explains the concept of adverse selection in voluntary health insurance markets?

  1. Premium increases always reduce the number of claims proportionally
  2. The state requires insurers to accept all applicants at a uniform premium
  3. Higher-risk individuals are more likely to buy or retain cover, so the insured pool is riskier than the general population Correct answer.
  4. Insurers deliberately select only the healthiest applicants to maximise profit

Explanation

Adverse selection arises when those with greater expected healthcare needs are more inclined to purchase or keep insurance, especially where premiums are community-rated. This raises the average cost of the insured pool and can lead to a spiral of rising premiums and lapses.

Question 18Health and care

A health insurer is considering offering a product with a no-claims discount. Which pricing and risk implication is most relevant?

  1. It may encourage favourable persistency but can create cross-subsidy and anti-selection effects between claim levels Correct answer.
  2. It removes the need for any morbidity assumptions in pricing
  3. It guarantees that claim frequency will fall to zero over time
  4. It eliminates morbidity risk entirely because claims are discouraged

Explanation

No-claims discounts reward those who do not claim, which can improve persistency among low-risk policyholders but may also concentrate higher-risk lives in higher premium bands. The actuary must allow for the resulting mix of business and behavioural effects.

Question 19Health and care

An insurer is pricing a group critical illness contract where experience rating will apply after the first year. How should the actuary allow for this in the initial premium?

  1. Assume the first-year premium will be the only premium ever charged
  2. Include a margin for the risk that experience deteriorates before the first rating adjustment and for the cost of future experience-rating volatility Correct answer.
  3. Set the premium equal to the expected claim cost with no expenses or margins
  4. Ignore group experience entirely because group business is never experience rated

Explanation

Experience-rated group contracts expose the insurer to the risk that claims exceed the initial premium before rates can be adjusted, and to volatility in future rating cycles. The initial premium should therefore include appropriate margins and reflect the cost of that risk.

Question 20Health and care

Which of the following best describes the actuarial treatment of a guaranteed renewable private medical insurance contract in the valuation?

  1. The contract has no value because premiums are fixed forever
  2. Guaranteed renewability removes all morbidity risk from the insurer
  3. The insurer cannot cancel or re-rate individual policies, so future deterioration in morbidity must be allowed for in reserves and pricing Correct answer.
  4. The insurer can re-underwrite each policyholder annually, so no allowance for future deterioration is needed

Explanation

Under guaranteed renewability the insurer must continue cover on the existing terms, so it bears the risk of future morbidity deterioration without being able to re-rate the individual. This must be reflected in the pricing and reserving basis over the expected lifetime of the contract.

Question 21Health and care

An actuary is assessing the sensitivity of a long-term care product to a change in the assumed rate of mortality improvement. Which outcome is most plausible?

  1. Mortality improvement has no effect on a care product because care is not life-contingent
  2. Mortality improvement affects only the death benefit and not care benefits
  3. Faster mortality improvement lengthens expected periods of care need, increasing projected benefit costs Correct answer.
  4. Faster mortality improvement shortens all care periods and reduces costs

Explanation

Improving mortality means people live longer, which can extend the time spent in a state requiring care and increase the number of years of benefit payment. For long-term care the survival assumption is therefore a key driver of cost, not a neutral factor.

Question 22Health and care

Which of the following best explains why a health insurer might hold a larger risk margin for a critical illness portfolio than for a mortality portfolio of similar size?

  1. Critical illness portfolios are exempt from capital requirements
  2. Critical illness benefits are always paid at death, making them more predictable
  3. Critical illness claim incidence is more uncertain and can shift with medical advances and screening, increasing parameter and model risk Correct answer.
  4. Mortality risk is not modelled by insurers and so requires no margin

Explanation

Critical illness experience is sensitive to changes in diagnosis, treatment and screening, so the parameter and model uncertainty is greater than for mortality. This additional uncertainty supports a larger risk margin for the same portfolio size.

Question 23Health and care

A health insurer observes that claim costs for its income protection product are higher than expected in the first year of each policy. Which explanation is most consistent with this pattern?

  1. The deferred period is too long, so claims are concentrated early
  2. Morbidity rates are always highest in the first year and fall thereafter for all products
  3. Anti-selection at outset, because applicants with existing health concerns are more likely to buy cover Correct answer.
  4. Investment returns are lower in the first year of a policy

Explanation

Higher first-year claims can indicate anti-selection, where people anticipating a claim are more likely to take out cover, and where underwriting does not fully capture existing conditions. This pattern would prompt a review of underwriting and the pricing basis at early durations.

Question 24Health and care

Which of the following is the most appropriate way for an insurer to allow for the cost of medical advances in pricing a long-term health product?

  1. Assume medical advances always reduce claim costs
  2. Exclude medical advances because they cannot be quantified
  3. Assume medical costs rise at the same rate as general inflation indefinitely
  4. Include an explicit allowance for expected technological and treatment cost growth in the claim cost projection Correct answer.

Explanation

Medical advances affect both the cost and the range of treatments available, so the projection should include an explicit allowance for expected growth in treatment costs. Assuming parity with general inflation or ignoring the effect would misstate long-term liabilities.

Question 25Health and care

A health insurer is reviewing the effect of a change in the state-provided healthcare system on demand for its private medical insurance. Which outcome is most likely if state waiting times increase?

  1. The insurer's claim costs will fall because more treatment is available publicly
  2. The insurer will be required to reduce premiums by the regulator
  3. Demand for private cover will fall because state care is free
  4. Demand for private cover may rise as individuals seek faster access to treatment Correct answer.

Explanation

Where state provision is slower, individuals may purchase private insurance to obtain quicker access, increasing demand. This interaction between public and private systems is an important environmental factor in pricing and product design.

Question 26Health and care

A private medical insurance (PMI) policy is described as 'guaranteed renewable'. What does this mean for the policyholder?

  1. The insurer may decline renewal only if the policyholder's claims experience exceeds a stated threshold.
  2. The insurer cannot cancel the policy or refuse renewal, but may adjust premium rates for all policies in the same class. Correct answer.
  3. The insurer must renew the policy each year at the premium rates originally quoted at inception.
  4. The policyholder is contractually obliged to renew the policy every year until a stated expiry age.

Explanation

Guaranteed renewability means the insurer cannot refuse renewal or cancel an individual policy, so the policyholder retains cover, but the insurer keeps the right to re-rate the whole class of business. This protects the insured against loss of cover after deterioration in health, while preserving the insurer's ability to reflect emerging claims costs. It does not fix premiums individually, and it does not force the policyholder to renew.

Question 27Health and care

An insurer is designing a group income protection (IP) scheme and is choosing the level of the deferred period. Which combination correctly describes the usual effect of lengthening the deferred period?

  1. Premiums rise and the insurer's exposure to short-term absence falls.
  2. Premiums rise and the insurer's exposure to short-term absence rises.
  3. Premiums fall and the insurer's exposure to short-term absence rises.
  4. Premiums fall and the insurer's exposure to short-term absence falls. Correct answer.

Explanation

A longer deferred period means the insurer pays nothing during the early weeks or months of a claim, when the incidence of short-term sickness absence is highest and recovery most likely. Removing this early claim cost reduces both expected claim outgo and the number of claims the insurer must administer, so premiums fall. Hence the exposure to short-term absence falls as well as the premium.

Question 28Health and care

Which statement best describes the role of a waiting period in a critical illness (CI) policy sold alongside or shortly after a PMI policy?

  1. It is a period at the start of the policy during which a claim arising from a condition that existed before inception is not paid. Correct answer.
  2. It delays payment of the sum assured until the policyholder has survived a fixed period after diagnosis.
  3. It is the interval between the insurer receiving a claim notification and settling the claim.
  4. It is the period during which the policyholder may cancel the policy and receive a full refund of premiums.

Explanation

A waiting (or qualifying) period at the start of cover excludes claims arising from conditions that already existed at inception, protecting the insurer against anti-selection by applicants who suspect they are already ill. It is distinct from a survival period after diagnosis, which is used to define when a valid claim becomes payable. Confusing the two is a common error because both involve time limits.

Question 29Health and care

An insurer is pricing a PMI product and must decide how to reflect expected future advances in medical technology. Which approach is most appropriate?

  1. Apply an explicit allowance for medical inflation above general inflation, reviewed regularly against emerging experience. Correct answer.
  2. Set premiums using current claim costs only, since medical advances will be reflected when the policy is next re-rated.
  3. Assume claim costs rise in line with general price inflation, since medical advances are unpredictable.
  4. Reduce the assumed claim cost trend to reflect the expectation that new treatments will lower average claim costs.

Explanation

Medical costs historically rise faster than general prices because new technologies and treatments expand what can be done, often at high unit cost. A prudent pricing basis therefore includes a specific medical-inflation loading above general inflation, kept under review as experience emerges. Ignoring the trend, or assuming it will be corrected only at the next re-rating, understates the cost of the current premium period.

Question 30Health and care

A health insurer's CI portfolio shows a rising incidence of claims for a cancer where improved screening detects early-stage disease. How should the actuary most appropriately respond in the next premium review?

  1. Investigate whether the product definition pays on early-stage diagnosis and reflect any resulting cost trend in the pricing basis. Correct answer.
  2. Increase the assumed mortality improvement rate applied to the CI decrement.
  3. Ignore the trend as a data artefact, because early-stage detection does not represent a genuine claim event.
  4. Immediately reduce premiums to reflect the improved health outcomes implied by earlier detection.

Explanation

If the policy definition pays out on early-stage or carcinoma-in-situ diagnoses, better screening genuinely increases claim frequency and the insurer must reflect it in the pricing basis. The actuary should first establish whether the definition triggers payment and quantify the trend before adjusting assumptions. The key principle is that product wording determines whether a clinical trend becomes an insurance cost.

Question 31Health and care

Which factor most directly increases the capital a health insurer must hold against a block of long-term care (LTC) policies?

  1. An increase in the assumed rate of voluntary lapses among healthy policyholders.
  2. An increase in the assumed rate of LTC claim incidence at older ages. Correct answer.
  3. A reduction in the assumed rate of future investment return on the backing assets.
  4. A shortening of the average delay between claim notification and settlement.

Explanation

Higher assumed claim incidence raises expected future benefit outgo and lengthens the period over which the insurer expects to pay claims, both of which increase the required capital. Capital for LTC is particularly sensitive to morbidity and longevity assumptions because benefits may be paid for many years. Investment return affects the value placed on liabilities but acts through discounting rather than directly changing the benefit stream.

Question 32Health and care

In a voluntary individual PMI market with community rating, which mechanism best explains why healthy lives progressively leave the pool?

  1. Policyholders lapse when investment returns on their savings component fall below expectations.
  2. The regulator requires insurers to charge the same premium to all applicants, which prevents any risk-based pricing.
  3. Medical inflation raises premiums for everyone, so the healthiest lives can no longer afford cover.
  4. Insurers compete by offering lower premiums to low-risk lives, so the remaining pool has higher average claim cost and premiums must rise further. Correct answer.

Explanation

Where insurers can attract low-risk lives with cheaper products, healthy policyholders gravitate to the lowest-cost option, leaving the original pool with a worse risk mix. Average claim cost then rises and premiums must increase, which drives out further healthy lives in a spiral. This is the adverse selection spiral that community-rated voluntary markets are prone to.

Question 33Health and care

An insurer is considering a no-claims discount (NCD) on a PMI product. Which effect is most consistent with actuarial expectations?

  1. It may reduce small claim frequencies but weakens the pooling of risk and can penalise policyholders who claim legitimately. Correct answer.
  2. It guarantees a reduction in the insurer's expense ratio because administration is simplified.
  3. It removes the need to underwrite at inception because poor risks will self-select out of the scheme.
  4. It eliminates anti-selection because all policyholders face identical discounts regardless of claims.

Explanation

An NCD gives policyholders a financial incentive to avoid claiming, which can reduce the frequency of small claims and improve persistency of good risks. However, it segments the pool by claims behaviour, weakens the mutual sharing of risk, and may discourage necessary early treatment. It does not remove the need for underwriting, and it introduces cross-subsidies and complexity rather than simplifying administration.

Question 34Health and care

An insurer is pricing a group CI contract that will move to experience rating after the first year. Which approach to the first-year premium is most appropriate?

  1. Charge a premium based on pooled manual rates for comparable groups, with an allowance for the group's known characteristics. Correct answer.
  2. Charge a premium based purely on the group's own past claims, since experience rating will follow.
  3. Charge a premium set at the level expected to be charged in year two, so that the premium is level over the contract.
  4. Charge a premium equal to the insurer's best estimate of the group's expected claims with no margin.

Explanation

With no credible experience for the group, the first-year premium must be based on pooled manual rates adjusted for the group's size, industry and demographics. This provides a credible starting point and avoids the volatility of relying on a single year's claims. Experience rating then refines the rate once credible data accumulate.

Question 35Health and care

A health insurer observes that claims on an IP product are higher than expected in the first year after a significant increase in the sum insured. Which explanation is most plausible?

  1. A change in the state benefit system reducing the insurer's claim exposure.
  2. Selection against the insurer, because only unhealthy lives buy higher sums insured.
  3. Moral hazard, because higher benefits increase the incentive to claim and to prolong absence. Correct answer.
  4. A reduction in the deferred period, which would lower early claim costs.

Explanation

When benefits rise relative to the income they replace, the financial incentive to remain off work lengthens and claiming becomes more attractive, which is moral hazard. The effect is strongest where the replacement ratio is high and monitoring of claims is weak. It is a behavioural response to the level of cover rather than a change in the underlying health of the insured group.

Question 36Health and care

Which statement best explains why an insurer writing CI business holds a larger risk margin than for a comparable term assurance portfolio?

  1. CI premiums are typically lower, so a proportionally larger margin is needed to cover fixed expenses.
  2. CI benefits are paid on death, which introduces mortality risk that term assurance does not have.
  3. CI claims are more uncertain in timing and diagnosis, and the product often pays a lump sum on conditions whose incidence is harder to predict. Correct answer.
  4. CI policies have longer policy terms than term assurance, so discounting has a greater effect on the liability.

Explanation

CI benefits depend on the incidence of a wide range of diagnoses, many of which are subject to changes in medical practice, screening and definitions, making the claim process less predictable than death. This greater uncertainty justifies a larger risk margin for the same level of confidence. The margin reflects the volatility and parameter uncertainty of the morbidity assumption.

Question 37Health and care

An actuary is assessing a long-term care product and considers two scenarios: a higher rate of mortality improvement and a higher rate of LTC incidence. Which statement correctly contrasts their effects on expected claim cost?

  1. Both increase expected claim cost, but mortality improvement acts mainly by increasing the number of lives surviving into the claim-prone ages. Correct answer.
  2. Mortality improvement has no effect on an LTC portfolio because benefits depend on morbidity, not mortality.
  3. Higher LTC incidence reduces expected claim cost because claims are settled sooner.
  4. Mortality improvement reduces expected claim cost because fewer people reach the ages at which care is needed.

Explanation

Mortality improvement raises the number of survivors at older ages, and because LTC incidence rises steeply with age, this increases the expected number and duration of claims. Higher incidence acts directly on the probability of claiming at each age. Both therefore increase expected claim cost, but through different mechanisms.

Question 38Health and care

An insurer is reviewing the treatment of a guaranteed renewable PMI contract in its internal model. Which approach is most consistent with sound actuarial practice?

  1. Assume the insurer will close the class to new business at the first adverse experience, eliminating renewal risk.
  2. Model the contract as a series of annual policies with no allowance for renewal, because premiums can be re-rated each year.
  3. Assume all policyholders renew for life, because the contract is guaranteed renewable.
  4. Model expected future renewals, allowing for the insurer's right to re-rate the class and for the risk of selective lapsation. Correct answer.

Explanation

Guaranteed renewability gives the insurer the right to re-rate the class but not to cancel individuals, so the model should project renewals and allow for the risk that healthy lives lapse while poorer risks remain. This selective lapsation is a key source of renewal risk. Treating the contract as a single-year policy ignores the insurer's continuing obligation and the resulting exposure.

Question 39Health and care

A health insurer is reviewing the effect of a new state-funded treatment pathway that will cover a procedure previously paid for by PMI policies. Which consequence is most likely for the insurer's PMI portfolio?

  1. Claim costs rise because policyholders will seek the newly available treatment more often.
  2. The insurer's expense ratio falls because claims administration for the procedure is eliminated entirely.
  3. Claim costs are unaffected because PMI policies always pay regardless of state provision.
  4. Claim costs fall for that procedure, but premiums may need to be reduced and the risk mix may worsen as some policyholders question the value of cover. Correct answer.

Explanation

If the state now funds a procedure previously met by PMI, the insurer's claim cost for that procedure falls. However, the value of cover to policyholders is reduced, which may prompt healthy lives to lapse and increase pressure to reduce premiums. The net effect on the portfolio depends on how quickly premiums and persistency respond.

Question 40Health and care

Which of the following best describes the purpose of a pre-existing condition exclusion in a PMI policy?

  1. To prevent applicants from obtaining cover for medical conditions they already have, which would otherwise create anti-selection. Correct answer.
  2. To exclude conditions that develop after inception but within the first year of cover.
  3. To limit cover to conditions treated within the insurer's network of providers.
  4. To allow the insurer to cancel the policy if the policyholder's health deteriorates.

Explanation

A pre-existing condition exclusion denies cover for conditions that existed before the policy started, which limits the insurer's exposure to applicants who buy cover knowing they need treatment. This is a form of underwriting that mitigates anti-selection without requiring full medical disclosure. It does not relate to network restrictions or to post-inception deterioration.

Question 41Life insurance

A life insurer's product design team is reviewing a without-profit endowment assurance. Which cash flow item arises only because the contract contains a savings element rather than pure protection?

  1. The death benefit payable on death before the end of the term
  2. The insurer's fixed administration expenses for maintaining the policy record
  3. The commission paid to the intermediary at the point of sale
  4. The maturity payment payable if the life assured survives to the end of the term Correct answer.

Explanation

An endowment assurance pays a benefit on survival to maturity as well as on death, and that survival payment is the defining savings element. Pure protection contracts generate only death or morbidity claims, so the maturity payment is the item that exists solely because of the savings component.

Question 42Life insurance

Which statement best describes the role of the actuarial profession in life insurance company management?

  1. Actuaries are responsible for the sales conduct of tied intermediaries
  2. Actuaries set the investment strategy for the shareholder funds without reference to liabilities
  3. Actuaries certify the annual statutory accounts in place of the external auditor
  4. Actuaries quantify and manage the financial risks of the contracts and report on solvency Correct answer.

Explanation

The actuarial function is concerned with measuring, pricing and managing the financial risks that arise from life insurance contracts, including assessing the capital needed to remain solvent. It supports rather than replaces the audit function and does not own investment mandates or distribution conduct.

Question 43Life insurance

An insurer writes unit-linked business where the policyholder bears the investment risk. Which item in the insurer's cash flow projection is most directly affected by the fund performance of the underlying units?

  1. The guaranteed sum assured payable on death
  2. The fixed policy administration fee expressed in currency terms
  3. The fund management charge deducted from unit values Correct answer.
  4. The insurer's office rent

Explanation

Under unit-linked contracts the insurer's income is largely the charges levied on the unit fund, so a fall in fund value reduces the charge income collected. The death benefit guarantee, fixed fees and office rent are not directly driven by unit performance in the same way.

Question 44Life insurance

A life insurer is projecting cash flows for a conventional with-profit policy. Which approach is most consistent with the way asset shares are normally modelled?

  1. Project the fund using the insurer's best-estimate equity return with no allowance for expenses
  2. Use the statutory valuation basis throughout, ignoring the actual investment policy
  3. Accumulate premiums less charges and claims plus an allocation of investment return and expenses Correct answer.
  4. Accumulate the policy's own premiums and claims at the risk-free rate only

Explanation

An asset share tracks the accumulation of premiums received less charges, claims and expenses, credited with the investment return actually earned on the assets backing the fund. It is a realistic accumulation rather than a statutory reserving calculation.

Question 45Life insurance

Which factor most directly increases the level of a life insurer's required mathematical reserves for a given block of non-linked business?

  1. An increase in the assumed rate of mortality at the valuation date
  2. A reduction in the assumed rate of investment return used in the valuation Correct answer.
  3. A rise in the assumed rate of interest credited to reserves
  4. A fall in the assumed level of future expenses

Explanation

Lowering the valuation interest rate reduces the discounting of future benefits and increases the present value of liabilities, so reserves rise. Higher assumed returns or lower expense assumptions would reduce the required reserve.

Question 46Life insurance

A life insurer is selecting assets to back a block of immediate annuities in payment. Which asset characteristic is most important for matching?

  1. Long duration and predictable income to match the annuity payments Correct answer.
  2. Short duration to allow frequent reinvestment
  3. Equity exposure to provide inflation protection for fixed annuities
  4. High short-term price volatility to capture capital gains

Explanation

Immediate annuities are long-dated, predictable fixed outgo, so the natural match is long-duration fixed-interest assets whose income and redemption proceeds align with the payment schedule. Short-dated or volatile assets create reinvestment and mismatch risk.

Question 47Life insurance

Which item is normally classified as a liability in a life insurer's balance sheet rather than as capital?

  1. The mathematical reserves for in-force policies Correct answer.
  2. The subordinated debt issued to support solvency
  3. The retained earnings held as free reserves
  4. The paid-up ordinary share capital

Explanation

Mathematical reserves represent the insurer's obligations to policyholders and are reported as technical liabilities. Share capital, retained earnings and subordinated debt are all forms of capital and surplus supporting the business.

Question 48Life insurance

An insurer is pricing a term assurance and wishes to increase the level of prudence in the premium. Which change would achieve this?

  1. Adding an explicit margin to the assumed expenses Correct answer.
  2. Reducing the level of initial commission
  3. Using a higher assumed rate of investment return
  4. Using a lower assumed rate of mortality

Explanation

Adding a margin to the expense assumption increases the expected outgo and so raises the prudent premium. Prudence is introduced by making assumptions less favourable to the insurer's financial position.

Question 49Life insurance

A life insurer is considering writing a large block of single-premium immediate annuities. Which risk is most significant for this product?

  1. Expense risk from high initial underwriting costs
  2. Morbidity risk from policyholders falling ill
  3. Persistency risk from policyholders lapsing early
  4. Longevity risk from annuitants living longer than assumed Correct answer.

Explanation

Immediate annuities pay an income for life, so the insurer's main exposure is that annuitants survive longer than the mortality assumption implies, increasing total payments. Lapse and morbidity risk are largely absent or immaterial for this product.

Question 50Life insurance

An insurer is analysing the effect of a fall in interest rates on a block of conventional without-profit endowment assurances. Which combination of effects is expected?

  1. Lower investment income and higher present value of liabilities, reducing surplus Correct answer.
  2. Lower investment income offset exactly by lower expenses
  3. Higher investment income and lower present value of liabilities, increasing surplus
  4. No effect on surplus because the contracts are without profit

Explanation

Falling interest rates reduce the return earned on backing assets and increase the present value of fixed future benefits, both of which erode surplus. The offsetting effect is limited because the contracts carry guaranteed benefits.