III IC-26 common mistakes
III IC-26 · Understand the traps and how to avoid them.
Computing policy reserves or cash values with a single assumed interest rate and ignoring the valuation mortality table and valuation premium basis that the reserving method specifies.
Candidates memorize the reserve formula as 'PV of future benefits minus PV of future net premiums' and then plug in the pricing assumptions they saw in an earlier chapter, because the pricing and reserving chapters use similar notation. The exam deliberately supplies both sets of assumptions to test whether the candidate knows that statutory reserves use prescribed valuation mortality and valuation interest, not the insurer's pricing basis.
What to do instead
Before computing, write down the three components of the valuation basis (mortality table, interest rate, reserving method) and confirm each is the prescribed one, not the pricing one. Practice computing the same policy's reserve under net premium and modified reserve methods side by side so the assumption differences become visible.
Treating the net level premium reserve as the amount the insurer must hold in every year, instead of recognizing that the reserve plus the present value of future net premiums equals the present value of future benefits, and that the reserve is zero at issue under the net premium method.
The phrase 'the reserve is the fund set aside to pay future claims' is intuitive but incomplete; candidates then answer questions about the reserve at issue or the reserve's relationship to the gross premium as if it were a funded liability from day one. The exam tests the prospective and retrospective equivalence and the treatment of the first-year reserve.
What to do instead
Derive the prospective formula once from first principles and check it against the retrospective formula for the same policy. Then write a one-line statement of what the reserve equals at issue, at the end of year 1, and at maturity, and verify each with a numeric example.
Mixing up the roles of the gross premium, the net premium, and the expense loading when asked to compute a gross premium or an expense-adjusted reserve, and then omitting the present value of future expenses from the reserve calculation.
The net premium is a computational device (it equals the benefit present value divided by the annuity factor), while the gross premium is what the policyholder pays. Candidates who learn the net premium formula first often substitute the gross premium into the reserve formula or drop the expense element entirely, producing an answer that matches a distractor.
What to do instead
Build a three-line worksheet for every premium or reserve question: benefits, expenses, and premiums, each as a present value. Compute the gross premium as (PV benefits + PV expenses) / annuity factor, then compute the expense-adjusted reserve as PV future benefits + PV future expenses minus PV future gross premiums. Reconcile the two before selecting an answer.
Confusing the insurer's statutory accounting treatment of acquisition costs (immediate expensing, producing a first-year strain) with GAAP treatment (deferral and amortization as DAC), and answering reserve or surplus questions using the wrong framework.
Both frameworks appear in the finance domain, and the numeric effect of the same policy is very different under each. Candidates who study the reserving chapter and the financial reporting chapter separately often carry the GAAP deferral concept into a statutory surplus question, or vice versa, because the question stem does not always say 'statutory' in the first sentence.
What to do instead
For every question, first classify it as statutory, GAAP, or tax, and note the treatment of acquisition costs under that framework before doing arithmetic. Keep a one-page comparison table of the three frameworks covering acquisition cost treatment, reserve basis, and recognition timing, and review it before each practice set.
Ignoring the timing convention in annuity and insurance present value factors, such as using an annuity-due factor where an annuity-immediate is required, or discounting a death benefit payable at the end of the year of death as if it were payable at the moment of death.
Exam questions rarely say 'annuity-immediate' explicitly; they describe premiums payable at the start of each year or benefits payable at the end of the year of death. Candidates under time pressure default to the factor they used most recently, and the resulting answer is often among the choices because the examiners compute both conventions.
What to do instead
Before selecting any factor, write 'due' or 'immediate' next to each cash flow in the question. Convert between them explicitly using the (1+i) relationship, and sanity-check the direction of the error: an annuity-due factor is larger than the corresponding immediate factor, so a too-large premium usually signals a due/immediate mix-up.
Answering surplus and capital questions using only the reserve balance, without distinguishing statutory surplus, total adjusted capital, and the risk-based capital ratio, and without applying the company action level thresholds.
Surplus, TAC, and RBC are related but not interchangeable, and the RBC ratio has specific regulatory trigger points. Candidates who learn 'surplus is assets minus liabilities' stop there and then cannot answer a question that asks which regulatory action follows from a given ratio, because they never anchored the thresholds.
What to do instead
Memorize the RBC ratio formula and the four action levels (company, regulatory, authorized control, mandatory control) as a ladder, then practice classifying a given TAC and risk-based capital figure into the correct level. Separately list what counts toward TAC, including the asset valuation reserve and dividend liability adjustments where applicable.
Treating the asset valuation reserve and the interest maintenance reserve as interchangeable, or omitting them from the surplus calculation entirely.
Both are statutory reserves that absorb investment gains and losses, so the names look similar and the chapters that introduce them are adjacent. The distinction matters: the AVR addresses credit-related and equity-related investment risk, while the IMR captures interest-rate-driven realized gains and losses on fixed-income assets and amortizes them into income over time.
What to do instead
Write a two-column comparison of AVR and IMR covering what risk each addresses, how each is funded, and how each flows through the statutory balance sheet and income statement. Then work two numerical examples, one with a bond sold at a gain and one with a defaulted bond, and trace each through both reserves.
Computing a product's profitability or a policy's IRR without matching the cash flow timing to the measurement period, for example discounting premiums received at the start of the year as if received at year-end or ignoring the timing of death benefits within the year.
Profitability questions often present a table of premiums, expenses, and benefits by policy year, and candidates sum the columns and discount the totals as if all flows occurred at the same point. The exam tests whether the candidate can build a year-by-year cash flow vector and discount each element at its correct time.
What to do instead
Lay out a table with one row per policy year and separate columns for premium, expenses, death benefits, and surrender benefits, each placed at its stated timing. Discount each cell individually, then sum. Check the sign pattern of the resulting cash flow vector before computing IRR, since a single sign change is needed for a unique IRR.
Assuming a dividend illustration or a nonforfeiture value is a guaranteed contractual amount, rather than recognizing that dividends are not guaranteed and that nonforfeiture values are subject to statutory minimum standards.
Illustrations present dividends and cash values in the same table format as guaranteed columns, and candidates who have not studied the illustration regulations closely treat all columns as promises. Questions that ask what the insurer is obligated to pay, or that test the standard nonforfeiture law's minimum cash value and minimum paid-up insurance, then produce wrong answers.
What to do instead
For any illustration question, label each column as guaranteed or non-guaranteed before answering. Separately memorize the nonforfeiture options (cash surrender, reduced paid-up, extended term) and the statutory minimum basis for each, and practice computing a minimum cash value from the prescribed mortality and interest assumptions.
Skipping the reconciliation step after computing a numeric answer, so an answer that is off by a factor of the annuity factor, a sign error, or a units error (per 1,000 of face amount versus per policy) is selected because it appears in the option list.
Distractors on this exam are constructed from common intermediate errors, so a wrong method frequently produces a plausible-looking number. Candidates working under time pressure treat the presence of their computed answer in the options as confirmation and move on without checking magnitude or direction.
What to do instead
After every computation, run three checks: units (per 1,000 versus per policy), direction (does a higher assumed interest rate lower the premium and the reserve, as it should), and magnitude (is the reserve between zero and the face amount, and is the gross premium above the net premium). If any check fails, redo the setup rather than adjusting the arithmetic.