I85PREP
⌘ K
IFoA SP2 study materials
IFoA SP2 study resources

IFoA SP2 practice questions

One question at a time. Build your IFoA SP2 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 actuarial practice (Specialist Principles)

A life insurer prices a without-profit term assurance using a gross premium basis. Which combination correctly describes the direction of the margins normally included in the premium basis?

  1. Mortality assumptions heavier than best estimate, interest assumption higher than best estimate, and expense assumptions higher than best estimate
  2. Mortality assumptions lighter than best estimate, interest assumption higher than best estimate, and expense assumptions lower than best estimate
  3. Mortality assumptions heavier than best estimate, interest assumption lower than best estimate, and expense assumptions higher than best estimate Correct answer.
  4. Mortality assumptions lighter than best estimate, interest assumption lower than best estimate, and expense assumptions lower than best estimate

Explanation

Prudent margins for a without-profit contract increase the chance that the reserve and premium are adequate: higher assumed mortality, lower assumed interest and higher assumed expenses all raise the gross premium. Lighter mortality or higher interest would reduce the premium and weaken the basis. The three margins therefore work in the same direction of prudence.

Question 2Life insurance actuarial practice (Specialist Principles)

Under a conventional with-profits endowment assurance, which statement best describes how the asset share is used in deciding a reversionary bonus?

  1. The asset share determines the minimum premium that regulation requires the policyholder to pay in that year
  2. The asset share is compared with the sum assured plus declared bonuses to judge whether the fund can support an addition to guaranteed benefits Correct answer.
  3. The asset share is used only to calculate the death benefit payable before the first bonus declaration
  4. The asset share is set equal to the statutory mathematical reserve each year so that no surplus can arise

Explanation

The asset share is the accumulated value of premiums less deductions, accumulated at the fund earning rate. Comparing it with the guaranteed benefits already promised shows whether the fund can afford to add a further guaranteed reversionary bonus. It is an asset-side accumulation, not a reserve or a premium requirement.

Question 3Life insurance actuarial practice (Specialist Principles)

An insurer writes unit-linked business and levies a fund management charge expressed as a percentage of unit fund value. Which statement about the insurer's exposure to this charge is correct?

  1. The charge is guaranteed by the unit fund, so the insurer's shareholders are unaffected by unit price movements
  2. The charge is fixed in monetary terms at outset, so the insurer bears no market risk on the charge
  3. The charge income rises when markets fall, providing a natural hedge to the insurer's expense base
  4. The charge income falls if equity markets fall, so the insurer bears market risk on its charge income Correct answer.

Explanation

A percentage-of-fund charge means the insurer's income varies directly with unit fund values, so a market fall reduces future charge income while fixed expenses continue. This is a real market risk for the insurer, distinct from the policyholder's own investment risk. Hedging or expense-charge design is used to manage it.

Question 4Life insurance actuarial practice (Specialist Principles)

Which item is normally classified as an expense rather than a claim or benefit in a life insurer's analysis of surplus?

  1. Death claims paid in excess of the reserve held
  2. Surrender values paid above asset share
  3. Maturity payments on endowment policies
  4. Commission paid to an intermediary on renewal premiums Correct answer.

Explanation

Commission is an acquisition and maintenance cost, so it enters the expense analysis of surplus. Death claims, surrender values and maturity payments are benefit outgo analysed against reserves or asset shares. Keeping these categories separate allows the insurer to attribute surplus to its true source.

Question 5Life insurance actuarial practice (Specialist Principles)

A life insurer's board reviews the risk appetite statement. Which statement best reflects a sound principle for setting risk appetite in a life office?

  1. Risk appetite should be expressed in quantitative limits linked to capital and earnings, with qualitative statements for risks that cannot be readily quantified Correct answer.
  2. Risk appetite should be delegated entirely to the appointed actuary, since only the actuary understands the risks
  3. Risk appetite should be expressed only in qualitative terms, because quantitative limits are too restrictive for a life insurer
  4. Risk appetite should be set once at launch and then fixed, because changing it would undermine policyholder confidence

Explanation

Effective risk appetite combines quantitative tolerances, such as capital coverage and earnings volatility limits, with qualitative statements for risks like conduct or reputational exposure. It must be reviewed as the business and environment change. Delegating it entirely or expressing it only qualitatively leaves the board without a control framework.

Question 6Life insurance actuarial practice (Specialist Principles)

Which statement correctly distinguishes a life insurer's regulatory solvency capital requirement from its economic capital requirement?

  1. Regulatory capital follows a prescribed formula or standard model, while economic capital is the insurer's own estimate of capital needed for its chosen confidence level and risk horizon Correct answer.
  2. Both measures are identical by definition, differing only in the reporting currency used
  3. Economic capital is prescribed by the supervisor, while regulatory capital is derived from the insurer's internal model
  4. Regulatory capital is always larger than economic capital, because regulators apply a more conservative confidence level in every jurisdiction

Explanation

Regulatory capital is set by rules, whether a standard formula or an approved internal model, and is designed to protect policyholders. Economic capital is the insurer's own assessment of the capital needed to meet its objectives at a stated confidence level and time horizon. The two can differ in either direction.

Question 7Life insurance actuarial practice (Specialist Principles)

A life insurer uses a gross premium valuation to set reserves for a block of without-profit business. Which assumption change would reduce the reserve, all else equal?

  1. A strengthening of the mortality assumption for a term assurance block
  2. A reduction in the assumed future expense inflation rate Correct answer.
  3. An increase in the assumed future expense inflation rate
  4. A reduction in the valuation interest rate

Explanation

Reserves are the excess of the present value of future benefits and expenses over future premiums. Lower assumed expense inflation reduces the present value of future expenses and so lowers the reserve. Higher expenses, a lower valuation rate or heavier mortality all increase the reserve.

Question 8Life insurance actuarial practice (Specialist Principles)

Which statement best describes the role of the with-profits actuary in a UK-style with-profits fund?

  1. Advising the board on the fair treatment of policyholders in bonus and payout decisions, including the exercise of discretion Correct answer.
  2. Setting the fund's investment strategy without reference to the board or investment committee
  3. Determining the level of the fund's regulatory capital requirement independently of the supervisor
  4. Guaranteeing the solvency of the fund personally if investment returns are poor

Explanation

The with-profits actuary advises on the exercise of discretion so that policyholders are treated fairly and the fund's inherited estate is managed appropriately. Investment strategy and capital requirements remain board and supervisory matters. The role is advisory and does not involve personal guarantees.

Question 9Life insurance actuarial practice (Specialist Principles)

An insurer is analysing surplus on a without-profit whole life block. Mortality experience has been lighter than assumed, and the valuation interest rate has been reduced at the year end. How should these two items be treated in the analysis of surplus?

  1. Both items combined into a single mortality item, since basis changes are not separately analysed
  2. Lighter mortality as a positive source of surplus, and the change in valuation basis as a separate item that reduces surplus Correct answer.
  3. Lighter mortality ignored, because only basis changes affect surplus in a without-profit fund
  4. Lighter mortality as a negative source of surplus, and the change in valuation basis as a positive source

Explanation

Lighter than assumed mortality means fewer claims than reserved for, releasing surplus as a positive mortality item. A change in valuation basis is shown separately, and a reduced interest rate strengthens reserves, reducing surplus. Mixing the two would obscure the source of the result.

Question 10Life insurance actuarial practice (Specialist Principles)

A life insurer is designing a unit-linked product with a guaranteed minimum death benefit equal to the higher of the unit fund and a fixed sum assured. Which statement best describes the risk to the insurer?

  1. The insurer bears no risk, because the policyholder bears all investment risk in a unit-linked contract
  2. The insurer bears only expense risk, since the death benefit is always equal to the unit fund
  3. The insurer bears no mortality risk, because the sum assured is fixed at outset
  4. The insurer bears mortality risk and, where the guarantee exceeds the fund, an investment-related cost that must be charged for or hedged Correct answer.

Explanation

The guarantee means the insurer tops up the fund to the sum assured when the fund is lower, so a market fall increases the cost of the death benefit. That is an investment-related guarantee cost on top of normal mortality risk. It must be funded through charges or managed by hedging.

Question 11Life insurance actuarial practice (Specialist Principles)

An insurer is considering writing a large block of annuities in payment. Which combination of risks is most characteristic of this business?

  1. Morbidity risk and expense risk, because annuitants require medical underwriting each year
  2. Mortality risk and lapse risk, because annuitants may die early or surrender their policies
  3. Longevity risk and reinvestment risk, because payments are long-dated and premiums must be reinvested as they are received Correct answer.
  4. Currency risk and credit risk only, because annuity payments are fixed in nominal terms

Explanation

Annuity business exposes the insurer to longevity risk, since annuitants may live longer than assumed, and to reinvestment risk, since premiums received must be invested and assets mature before liabilities. Mortality risk is largely reversed for annuities, and surrender is often restricted.

Question 12Life insurance actuarial practice (Specialist Principles)

A life insurer uses a risk discount rate to price a without-profit contract. Which statement about the choice of risk discount rate is correct?

  1. The risk discount rate has no effect on the present value of future profits, because it cancels with the premium
  2. A higher risk discount rate increases the present value of future profits and makes the pricing appear more profitable
  3. The risk discount rate should equal the valuation interest rate in all circumstances
  4. A higher risk discount rate reduces the present value of future profits and makes the pricing appear less profitable Correct answer.

Explanation

The risk discount rate is used to discount future profits to a present value, so raising it lowers that present value and makes the contract look less profitable. It reflects the return required by shareholders for the risks taken. It is distinct from the valuation interest rate, which is used for reserving.

Question 13Life insurance actuarial practice (Specialist Principles)

An insurer's surrender value basis pays a proportion of the asset share that increases with duration. Which reason best explains this design?

  1. Surrender values should be set at the level of the mathematical reserve to avoid any surplus or strain
  2. Early surrender should be subsidised by the insurer to encourage policyholders to stay in the fund
  3. Early surrender should recoup the insurer's unrecouped acquisition costs and protect remaining policyholders from the strain of early withdrawals Correct answer.
  4. Surrender values must always equal the full asset share at every duration to ensure fairness

Explanation

Acquisition costs are typically recovered over the early years of a contract, so an early surrender value below full asset share protects the fund and remaining policyholders from the resulting strain. The proportion therefore rises with duration as costs are recouped. Setting surrender values at full asset share or at the reserve would create strain or arbitrage.

Question 14Life insurance actuarial practice (Specialist Principles)

A life insurer is reviewing its reinsurance arrangements for a large term assurance portfolio. Which statement best describes a valid reason to use yearly renewable term reinsurance?

  1. It removes the need for the insurer to hold any reserves for the reinsured policies
  2. It guarantees the insurer a fixed profit margin on the portfolio regardless of experience
  3. It transfers all investment and expense risk to the reinsurer, leaving the insurer with mortality risk only
  4. It transfers mortality risk while leaving the insurer to manage investment and expense risk, and the cost can be adjusted as experience emerges Correct answer.

Explanation

Yearly renewable term reinsurance is primarily a mortality risk transfer, with the insurer retaining investment and expense risk. Premium rates are renewable annually, so the cost can reflect emerging experience. It does not transfer all risks, guarantee a profit margin, or eliminate reserve requirements.

Question 15Life insurance actuarial practice (Specialist Principles)

Which statement best describes the treatment of the inherited estate in a with-profits fund when considering a proposed distribution?

  1. The inherited estate should be ignored in payout decisions because it is not attributable to any policyholder
  2. The inherited estate must be distributed in full to current policyholders as soon as it is identified
  3. The inherited estate belongs solely to shareholders and is not subject to any policyholder considerations
  4. The inherited estate should be assessed against the fund's needs, including regulatory capital and the cost of guarantees, before any distribution to policyholders or shareholders Correct answer.

Explanation

The inherited estate is the excess of assets over the amount needed to support policyholder liabilities and regulatory capital. Before distribution, the fund must retain enough to cover capital needs, guarantee costs and future expenses. Distribution in full or ignoring the estate would both be inconsistent with fair treatment.

Question 16Life insurance actuarial practice (Specialist Principles)

A life insurer is assessing the effect of a fall in interest rates on a block of immediate annuities in payment. Which statement is correct?

  1. The present value of liabilities is unaffected, because annuity payments are fixed in nominal terms
  2. The present value of liabilities rises, but reinvestment income is unaffected because assets are held to maturity
  3. The present value of liabilities rises, and reinvestment income on maturing assets falls, so the solvency position may deteriorate Correct answer.
  4. The present value of liabilities falls, and reinvestment income rises, so the solvency position improves

Explanation

Falling interest rates increase the present value of long-dated fixed annuity payments, while maturing assets must be reinvested at lower yields. Both effects weaken the solvency position unless liabilities are matched or hedged. Fixed nominal payments do not protect the present value from discount rate changes.

Question 17Life insurance actuarial practice (Specialist Principles)

An insurer is setting assumptions for a new critical illness product. Which approach best reflects good practice for morbidity assumptions?

  1. Use the insurer's mortality table for assurances without adjustment, since morbidity and mortality are equivalent
  2. Set assumptions once at launch and hold them for the life of the product to preserve consistency
  3. Use the most favourable recent claims experience without adjustment to keep premiums competitive
  4. Use industry and reinsurer data adjusted for the insurer's target market and underwriting, with margins and periodic review Correct answer.

Explanation

Morbidity assumptions should draw on credible industry and reinsurer data, adjusted for the insurer's own market, distribution and underwriting. Prudent margins and regular review are needed because experience can change. Mortality tables are not a substitute, and fixed or cherry-picked assumptions are unsound.

Question 18Life insurance actuarial practice (Specialist Principles)

A life insurer has a large portfolio of unit-linked pensions with expense charges fixed in monetary terms. Which risk is most relevant to the insurer if unit fund values fall sharply?

  1. The insurer's expense charge income rises, giving an offsetting profit
  2. The policyholder bears the entire loss, so the insurer's expense position is unaffected
  3. The insurer's regulatory capital requirement falls proportionately with the fund value
  4. The fixed monetary expense charge may exceed the percentage charge actually collected, so the insurer suffers an expense strain Correct answer.

Explanation

If charges are fixed in money terms while fund values fall, the percentage actually collected may fall below the level needed to cover expenses, creating a strain. This is an expense risk borne by the insurer, not fully passed to policyholders. Capital requirements do not simply fall in proportion.

Question 19Life insurance actuarial practice (Specialist Principles)

Which statement best describes the purpose of an experience investigation in a life office?

  1. To compare actual experience with the assumptions used and to inform future assumption setting and product design Correct answer.
  2. To determine the investment strategy for the insurer's shareholder fund
  3. To replace the need for a valuation of liabilities at the reporting date
  4. To calculate the statutory capital requirement directly from the investigation results

Explanation

Experience investigations compare actual mortality, morbidity, lapse and expense experience with the assumptions made. The findings inform revised assumptions, pricing and product design. They support but do not replace the valuation, and they are not a capital or investment strategy tool.

Question 20Life insurance actuarial practice (Specialist Principles)

A life insurer is considering a bulk annuity buy-in for a defined benefit pension scheme. Which statement best describes the transaction?

  1. The insurer provides only administration services and bears no longevity or investment risk
  2. The insurer takes on the obligation to pay members directly and the scheme is wound up immediately
  3. The insurer receives assets from the scheme and pays benefits to the scheme as they fall due, with the scheme retaining the obligation to members Correct answer.
  4. The insurer guarantees the scheme's investment return without changing the benefit obligation

Explanation

In a buy-in the insurer receives a premium and pays the scheme amounts matching the insured benefits, while the scheme remains responsible for paying members. A buy-out transfers the obligation to the insurer. A buy-in is therefore a risk transfer to the insurer without immediate wind-up.

Question 21Life insurance actuarial practice (Specialist Principles)

An insurer is reviewing its liquidity position. Which statement best describes a liquidity risk specific to life insurance?

  1. Liquidity risk cannot arise in life insurance because premiums are received in advance of claims
  2. A mass lapse event may force asset sales at depressed prices if assets are illiquid relative to the surrender values payable Correct answer.
  3. Liquidity risk arises only from the insurer's equity holdings, which can always be sold at fair value
  4. Liquidity risk is eliminated by holding assets to maturity, regardless of the liability profile

Explanation

Life insurers can face sudden outflows from mass lapses or surrenders, and if assets are illiquid they may have to sell at depressed prices. This is a genuine liquidity risk despite premiums being received in advance. Holding assets to maturity does not remove the need to meet unexpected outflows.

Question 22Life insurance actuarial practice (Specialist Principles)

A life insurer is evaluating whether to hedge its guaranteed annuity option liabilities. Which statement best reflects the key considerations?

  1. The hedge must address both interest rate and longevity risk, and the cost of hedging must be weighed against the capital relief and reduction in earnings volatility Correct answer.
  2. Only interest rate risk matters, since annuitant longevity is fixed by the option terms
  3. Hedging the liability with equities provides a natural offset to the guarantee cost
  4. Hedging is unnecessary because guaranteed annuity options are always priced correctly at outset

Explanation

Guaranteed annuity options expose the insurer to interest rate risk, because low rates make the guaranteed rate more valuable, and to longevity risk once the option is exercised. A hedge must address both, and the cost must be justified by capital relief and reduced earnings volatility. Equities are not a natural offset.

Question 23Life insurance actuarial practice (Specialist Principles)

An insurer is using an internal model to determine its solvency capital requirement. Which statement best describes a key validation challenge for the model?

  1. Proving that the model produces the same capital number every year regardless of changes in the business
  2. Demonstrating that the model captures the tail risks and dependencies relevant to the insurer's actual risk profile, and that its outputs are used in decision-making Correct answer.
  3. Confirming that the model relies on a single deterministic scenario for all risks
  4. Showing that the model reproduces the standard formula exactly in all scenarios

Explanation

Internal model validation must show that the model reflects the insurer's risk profile, including tail risks and dependencies, and that it is genuinely used in management decisions. Reproducing the standard formula, producing constant outputs, or relying on a single scenario would not demonstrate a credible internal model.

Question 24Life insurance actuarial practice (Specialist Principles)

A life insurer is assessing the effect of introducing a new surrender charge that reduces surrender values in early durations. Which consequence is most likely?

  1. Lapse rates will certainly rise, because policyholders dislike charges of any kind
  2. Lapse rates may fall, but the insurer must consider whether the charge is fair and whether it creates conduct or reputational risk Correct answer.
  3. The insurer's mortality risk will increase, because policyholders will retain their policies longer
  4. The insurer's expense risk will be eliminated, because fewer surrenders reduce administration costs

Explanation

Higher surrender charges reduce the attractiveness of early surrender, so lapse rates may fall, improving persistency. However, the insurer must assess fairness and conduct risk, since excessive charges can attract complaints and regulatory scrutiny. Mortality and expense risk are not eliminated by such a change.

Question 25Life insurance actuarial practice (Specialist Principles)

An insurer is deciding how to allocate the cost of its with-profits guarantees between the inherited estate and policyholders. Which approach best reflects fair treatment?

  1. Avoid charging the cost altogether, because guarantees are not a real economic cost
  2. Charge the entire cost to current policyholders, because they are the ones receiving the guarantee
  3. Charge the cost to the fund in a way that reflects the benefit received by each cohort, with disclosure of the methodology and regular review Correct answer.
  4. Charge the entire cost to the inherited estate in all cases, since shareholders own the estate

Explanation

Fair treatment requires the cost of guarantees to be allocated in line with the benefit each cohort receives, supported by disclosure and periodic review. Charging everything to the estate or to current policyholders ignores who benefits, and guarantees are a real economic cost that must be funded.

Question 26Life insurance actuarial practice (Specialist Principles)

A life insurer is pricing a without-profit term assurance product. Which cash flow item is most appropriately included in the premium basis as an explicit allowance rather than being left to emerge in surplus?

  1. The value of the inherited estate held in the with-profits fund
  2. The release of margins from earlier cohorts of policyholders
  3. The expected investment return on the free assets of the company
  4. The expected cost of death claims plus an allowance for expenses and a profit margin Correct answer.

Explanation

A gross premium basis must include all expected outgo, so claim cost, expenses and a profit loading are explicitly built into the premium. Investment return on free assets and margins from other cohorts are not part of the contractual outgo of this contract. The inherited estate belongs to the with-profits fund and is irrelevant to a without-profit pricing basis.

Question 27Life insurance actuarial practice (Specialist Principles)

An actuary is projecting the reserves of a block of conventional without-profit endowment assurances. Which feature of the net premium valuation method is most characteristic?

  1. It discounts all future cash flows at the risk-free curve and adds a risk margin
  2. It is based on the asset share accumulated at the actual investment return
  3. It uses best-estimate assumptions and a cost-of-capital risk margin
  4. It values the contract using only the valuation rate of interest and valuation mortality, with no explicit expense or lapse allowance Correct answer.

Explanation

A net premium valuation uses only interest and mortality assumptions, with the net premium calculated on the same basis as the valuation. Expense, lapse and other margins are not explicit but are implicitly provided by the difference between office and net premiums. Best-estimate plus risk margin and asset-share approaches belong to other frameworks.

Question 28Life insurance actuarial practice (Specialist Principles)

A life office holds a large portfolio of conventional immediate annuities in payment. The actuary is considering the effect of using a lower valuation rate of interest. Which outcome is expected, all else equal?

  1. Reserves decrease because mortality improvement assumptions become less important
  2. Reserves decrease because the discounting of payments is more aggressive
  3. Reserves increase because the present value of the annuity payments rises Correct answer.
  4. Reserves are unchanged because annuity payments are fixed in monetary terms

Explanation

A lower valuation rate of interest increases the present value of a fixed stream of annuity payments, so reserves must rise. The payments themselves are fixed, but their discounted value depends on the interest assumption. Mortality improvement assumptions are separate from the interest rate choice.

Question 29Life insurance actuarial practice (Specialist Principles)

An insurer is reviewing the surplus arising on a block of unit-linked policies. Which item is most appropriately treated as a source of surplus rather than a charge against surplus?

  1. Fund management charges deducted from unit funds Correct answer.
  2. Death claims in excess of the amounts charged to the policyholder
  3. Initial commission paid to intermediaries beyond the loading recovered
  4. Expenses incurred in administering the policies beyond the charged amounts

Explanation

Fund management charges are income to the insurer from the unit funds and, to the extent they exceed the cost of managing the assets, generate surplus. Claims above the charges recovered, excess commission and excess expenses are all outgo that reduces surplus.

Question 30Life insurance actuarial practice (Specialist Principles)

A life insurer is designing a unit-linked contract with a guaranteed minimum accumulation benefit. Which risk is the insurer primarily exposed to?

  1. Investment risk arising from the possibility that the unit fund falls below the guaranteed amount at the guarantee date Correct answer.
  2. Lapse risk arising from policyholders surrendering the contract before the guarantee date
  3. Expense risk arising from fixed monetary charges in the contract
  4. Mortality risk arising from death benefits equal to the unit fund

Explanation

The guarantee bites when the unit fund value is below the guaranteed level, so the insurer bears the investment risk on the shortfall. Lapse, expense and mortality risks may exist but are not the primary exposure created by an accumulation guarantee. The guarantee is fundamentally a financial option written by the insurer.

Question 31Life insurance actuarial practice (Specialist Principles)

An actuary is assessing the capital requirement for longevity risk on a portfolio of annuities in payment. Which approach is most consistent with a sound internal model?

  1. Increase the valuation rate of interest to reflect improved longevity
  2. Apply the same mortality rates as the base valuation and rely on diversification
  3. Apply a stressed set of mortality improvement rates and recalibrate the liability accordingly Correct answer.
  4. Reduce the assumed expense inflation to offset the longevity strain

Explanation

Longevity risk is captured by stressing the mortality improvement assumption and revaluing the liabilities under that stress. Using base assumptions ignores the risk, and adjusting interest or expense assumptions does not address longevity. The capital figure is the difference between the stressed and base liability values.

Question 32Life insurance actuarial practice (Specialist Principles)

A life insurer is setting the surrender value basis for a block of conventional without-profit policies. Which principle should guide the basis most directly?

  1. Surrender values should be set so that surrendering policyholders receive the full value of future profits
  2. Surrender values should be fixed at a constant monetary amount for all durations
  3. Surrender values should always equal the full reserve held for the policy
  4. Surrender values should reflect the asset share of the policy, subject to the insurer's financial position and fairness between continuing and surrendering policyholders Correct answer.

Explanation

Surrender values are normally linked to asset share, adjusted for the insurer's financial position and for fairness between those who surrender and those who remain. Paying the full reserve or all future profits would transfer value from continuing policyholders to those leaving. A constant monetary amount ignores duration and accumulated value.

Question 33Life insurance actuarial practice (Specialist Principles)

A life insurer writes a large block of term assurance and is considering reinsurance. Which statement best describes a valid reason for using yearly renewable term reinsurance?

  1. It guarantees the insurer a profit on the retained portion of the risk
  2. It transfers all investment risk on the reserves to the reinsurer
  3. It transfers mortality risk on the excess over a retention limit while leaving investment and expense risk largely with the insurer Correct answer.
  4. It removes the need for the insurer to hold any solvency capital

Explanation

Yearly renewable term reinsurance cedes mortality risk above the insurer's retention and is renewed annually, so investment and expense risks largely stay with the cedant. It does not transfer investment risk, eliminate capital requirements or guarantee profit. The insurer retains part of the mortality risk below the retention.

Question 34Life insurance actuarial practice (Specialist Principles)

An insurer is reviewing the operation of a with-profits fund and the use of a smoothing policy. Which statement best describes the purpose of smoothing?

  1. To transfer all investment risk from the fund to the shareholders
  2. To dampen the effect of investment fluctuations on payouts to policyholders over time Correct answer.
  3. To ensure the fund's asset share always equals the surrender value
  4. To guarantee that every policyholder receives the same payout regardless of duration

Explanation

Smoothing spreads investment returns across generations of policyholders so that payouts are less volatile than the underlying asset returns. It does not equalise payouts across all policyholders, transfer investment risk to shareholders or force asset share to equal surrender value. The mechanism relies on the fund holding a cushion of assets.

Question 35Life insurance actuarial practice (Specialist Principles)

An actuary is analysing the effect of a fall in equity markets on a with-profits fund with a large inherited estate. Which outcome is most likely in the short term?

  1. Payouts to policyholders are unaffected because they are contractually fixed
  2. The fund's regulatory capital requirement falls because asset values are lower
  3. The fund's free assets fall and the scope for smoothing and for supporting payouts is reduced Correct answer.
  4. The inherited estate automatically increases to offset the fall in asset values

Explanation

A market fall reduces the value of the fund's assets and hence its free assets, weakening its ability to smooth and support payouts. The estate does not automatically rise to offset losses, and with-profits payouts are not contractually fixed. Lower asset values do not necessarily reduce the capital requirement, which depends on the risk profile.

Question 36Life insurance actuarial practice (Specialist Principles)

A life insurer is reviewing its approach to expense assumptions in a gross premium valuation. Which treatment is most appropriate?

  1. Assume expenses remain constant in monetary terms for the whole projection
  2. Project future expenses allowing for inflation and for the expected volume of new and existing business Correct answer.
  3. Ignore expenses because they are covered by the difference between office and net premiums
  4. Assume all acquisition expenses are incurred again at each future duration

Explanation

A gross premium valuation explicitly projects expenses, allowing for inflation and for the business volume over which fixed costs are spread. Constant monetary expenses ignore inflation, and ignoring expenses is appropriate only under a net premium approach. Acquisition expenses are not repeated at every future duration.

Question 37Life insurance actuarial practice (Specialist Principles)

An insurer is considering the risks of writing a large block of unit-linked savings business alongside its existing without-profit book. Which statement best describes a diversification benefit?

  1. Diversification removes all market risk from the combined portfolio
  2. Both books are exposed to identical risks, so capital is simply added together
  3. Diversification guarantees that the combined book cannot make a loss
  4. The unit-linked and without-profit books are exposed to different risks, so aggregate capital is lower than the sum of standalone capital Correct answer.

Explanation

Diversification benefit arises because different risks are not perfectly correlated, so the combined capital is below the sum of standalone requirements. Identical risks would give no benefit, and diversification reduces but never eliminates risk. It cannot guarantee that the combined book avoids losses.

Question 38Life insurance actuarial practice (Specialist Principles)

An actuary is assessing the effect of a significant improvement in mortality on a block of term assurance policies. Which outcome is expected, all else equal?

  1. Claim costs rise and reserves must be strengthened immediately
  2. The insurer must increase the valuation rate of interest to compensate
  3. Claim costs fall and surplus on the block increases Correct answer.
  4. Reserves are unaffected because mortality is a diversifiable risk

Explanation

Lighter mortality means fewer claims than assumed, so claim costs fall and surplus emerges on the term assurance block. Reserves are not strengthened for favourable experience, and mortality is not fully diversifiable. The valuation rate of interest is a separate assumption.

Question 39Life insurance actuarial practice (Specialist Principles)

A life insurer is deciding how to set the risk discount rate for a new with-profits product. Which consideration is most relevant?

  1. The required return to shareholders and the riskiness of the projected cash flows Correct answer.
  2. The expense inflation assumption used in the valuation
  3. The current surrender value basis for existing policies
  4. The regulatory valuation rate of interest prescribed for reserves

Explanation

The risk discount rate should reflect the return shareholders require on capital and the risk of the projected distributable cash flows. The regulatory valuation rate applies to reserves, not pricing. Surrender value bases and expense inflation are separate assumptions that do not determine the discount rate.

Question 40Life insurance actuarial practice (Specialist Principles)

An insurer is reviewing the treatment of a with-profits fund where policyholders have a 90:10 share of surplus with shareholders. Which statement best describes the implication for the inherited estate?

  1. The estate is irrelevant because only the asset share determines payouts
  2. The estate must be distributed to policyholders immediately when the fund is closed to new business
  3. The estate belongs entirely to shareholders and cannot be used to support policyholder payouts
  4. The estate is a resource that can be used to support payouts and smooth returns, subject to any agreed sharing arrangements Correct answer.

Explanation

The inherited estate is a fund of assets that can be used to support payouts and smooth returns, though its ultimate distribution is governed by the 90:10 sharing and any agreed arrangements. It is not wholly shareholder property, is not automatically distributed on closure and is not irrelevant to payouts.

Question 41Life insurance actuarial practice (Specialist Principles)

An actuary is setting assumptions for a critical illness product. Which approach best reflects good practice for the incidence assumption?

  1. Adopt the most optimistic industry rate to keep premiums competitive
  2. Use the mortality table for the same ages without adjustment
  3. Use the insurer's own experience where credible, supplemented by reinsurer or industry data, with allowance for trends and selective withdrawal Correct answer.
  4. Set the assumption once at launch and never revise it

Explanation

Good practice uses credible own experience, supplemented by reinsurer or industry data, with allowance for trends such as improving detection and for selective withdrawal. Using mortality tables unadjusted ignores the different incidence of critical illness. Optimistic assumptions and never revising are unsound.

Question 42Life insurance actuarial practice (Specialist Principles)

A life insurer is reviewing its liquidity position. Which statement best describes a liquidity risk specific to life insurance?

  1. A rise in interest rates increases the market value of fixed interest assets and improves liquidity
  2. Liquidity risk is identical to solvency risk and is measured by the same capital requirement
  3. Liquidity risk cannot arise because life insurance liabilities are long term
  4. A surge in surrenders or claims may force the sale of assets at short notice, potentially at depressed prices Correct answer.

Explanation

Life insurers face liquidity risk when a mass surrender or claim event forces asset sales at short notice, possibly at depressed prices. Long-term liabilities do not eliminate this risk, and liquidity risk is distinct from solvency risk though related. A rise in interest rates typically reduces the value of fixed interest assets.

Question 43Life insurance actuarial practice (Specialist Principles)

An insurer is evaluating whether to hedge guaranteed annuity option liabilities. Which statement best reflects the economic case for hedging?

  1. Hedging guarantees a profit on the annuity block
  2. Hedging reduces the volatility of the liability by offsetting the effect of interest rate and volatility movements, at a cost Correct answer.
  3. Hedging removes the guarantee obligation from the insurer's balance sheet entirely
  4. Hedging is unnecessary because the guarantee only bites when interest rates rise

Explanation

Guaranteed annuity options behave like put options on interest rates, so hedging reduces liability volatility by offsetting interest rate and volatility movements, at a cost. Hedging does not remove the obligation, the guarantee bites when rates fall rather than rise, and it cannot guarantee a profit.

Question 44Life insurance actuarial practice (Specialist Principles)

An actuary is reviewing the design of a with-profits policy where reversionary bonuses, once declared, cannot be reduced. Which statement best describes the consequence for the insurer?

  1. Policyholders bear all the investment risk because bonuses are discretionary
  2. The insurer can reduce declared bonuses if investment returns fall
  3. The insurer bears the risk that future returns are insufficient to support the guaranteed bonus levels Correct answer.
  4. The insurer is protected from adverse investment experience by the bonus mechanism

Explanation

Once declared, reversionary bonuses become guaranteed liabilities, so the insurer bears the risk that future returns will not support them. The insurer cannot reduce them, and policyholders do not bear all the investment risk because the guaranteed element is the insurer's. The mechanism does not protect the insurer from adverse experience.

Question 45Life insurance actuarial practice (Specialist Principles)

A life insurer is considering writing a large block of immediate annuities using a single premium. Which risk is most significant for the insurer over the long term?

  1. Expense risk, because administration costs are fixed in monetary terms
  2. Lapse risk, because annuitants frequently surrender their policies
  3. Longevity risk, because annuitants may live longer than assumed Correct answer.
  4. Mortality risk, because annuitants may die earlier than assumed

Explanation

For immediate annuities the dominant long-term risk is longevity, since payments continue for as long as the annuitant lives. Lapse risk is low because immediate annuities are rarely surrenderable, and early deaths reduce rather than increase the cost. Expense risk exists but is secondary to longevity.

Question 46Life insurance actuarial practice (Specialist Principles)

An insurer is reviewing the effect of introducing a cap on charges for unit-linked policies. Which outcome is most likely?

  1. The insurer's expense risk is eliminated because charges are capped
  2. Policyholders bear more investment risk as a result of the cap
  3. The insurer's projected income from charges falls, reducing expected profitability Correct answer.
  4. The insurer's reserves must fall because charges are lower

Explanation

A charge cap reduces the income the insurer derives from unit funds, lowering expected profitability. It does not eliminate expense risk, since costs may still exceed the capped income. Policyholder investment risk is unchanged, and lower income does not necessarily reduce reserves.

Question 47Life insurance actuarial practice (Specialist Principles)

An actuary is assessing the effect of a fall in interest rates on a block of unit-linked policies with a guaranteed minimum death benefit. Which outcome is expected, all else equal?

  1. The cost of the guarantee falls because lower rates increase unit fund growth
  2. The insurer must reduce the sum assured to control the cost
  3. The guarantee cost is unaffected because it depends only on mortality
  4. The cost of the death benefit guarantee rises because the guarantee is more likely to bite Correct answer.

Explanation

A fall in interest rates tends to reduce unit fund growth, making it more likely that the guaranteed minimum exceeds the fund value at death, so the guarantee cost rises. Lower rates do not increase fund growth, and the guarantee cost depends on investment as well as mortality. The insurer cannot unilaterally reduce the sum assured.

Question 48Life insurance actuarial practice (Specialist Principles)

A life insurer is using an internal model to determine its solvency capital requirement. Which feature is essential for the model to be credible to the regulator?

  1. Exclusive reliance on external vendor software without internal review
  2. A single deterministic scenario that produces the lowest capital figure
  3. Documented methodology, validation against experience and appropriate governance over assumptions Correct answer.
  4. Removal of all expert judgement to avoid challenge

Explanation

Credibility requires documented methodology, validation against experience and strong governance over assumptions and expert judgement. A single favourable scenario or reliance on vendor software without review is not acceptable. Removing expert judgement entirely is neither possible nor desirable.

Question 49Life insurance actuarial practice (Specialist Principles)

An actuary is analysing the emergence of surplus on a without-profit endowment block. Which combination of experience variances would most likely produce a positive surplus?

  1. Heavier mortality, lower investment return and higher expenses than assumed
  2. Lighter mortality, lower investment return and higher expenses than assumed
  3. Lighter mortality, higher investment return and lower expenses than assumed Correct answer.
  4. Heavier mortality, higher investment return and lower expenses than assumed

Explanation

Positive surplus arises when experience is favourable on all three counts: fewer claims, higher investment return and lower expenses than assumed. Any combination containing heavier mortality, lower return or higher expenses will offset or reverse the favourable effect. The other options each contain at least one adverse element.

Question 50Life insurance actuarial practice (Specialist Principles)

An insurer is considering the transfer of a block of without-profit business to another insurer. Which statement best describes the role of the actuarial valuation in the transfer?

  1. It provides a basis for agreeing the value of assets to be transferred relative to the liabilities assumed Correct answer.
  2. It guarantees that the transferring insurer makes a profit on the transaction
  3. It removes the need for policyholder communication about the transfer
  4. It fixes the future premium rates for the transferred policies

Explanation

The actuarial valuation informs the negotiation by comparing the value of assets transferred with the liabilities assumed, so that both parties can agree a fair price. It does not guarantee profit, replace policyholder communication or fix future premiums. The valuation is a key input to the commercial negotiation.