I85PREP
⌘ K
III IC-26 study materials
III IC-26 study resources

III IC-26 practice questions

One question at a time. Build your III IC-26 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 Finance

In the statutory accounting framework used for life insurers in the United States, which item is treated as a liability rather than as surplus?

  1. Capital paid in excess of par
  2. Aggregate policy reserves Correct answer.
  3. Asset valuation reserve
  4. Mandatory securities valuation reserve

Explanation

Statutory accounting records policy benefit reserves as liabilities because they represent obligations to policyholders that must be funded from admitted assets. The asset valuation reserve and the interest maintenance reserve are surplus accounts, and paid-in capital is a surplus component.

Question 2Life Insurance Finance

A life insurer's premium income is 500 million, incurred claims and benefits are 300 million, and operating expenses are 120 million. What is the gross operating margin expressed as a percentage of premium?

  1. 60%
  2. 40%
  3. 16% Correct answer.
  4. 24%

Explanation

Operating margin equals premium minus benefits minus expenses, divided by premium. Here (500 − 300 − 120) ÷ 500 = 80 ÷ 500 = 16%. The other figures arise from omitting one of the deduction lines or from dividing by the wrong base.

Question 3Life Insurance Finance

Which reserve basis produces the largest policy reserve for a given block of level-premium whole life business?

  1. Gross premium reserve discounted at the pricing interest rate
  2. Net premium reserve using an aggressive mortality table and a high valuation interest rate
  3. Net premium reserve using a conservative mortality table and a low valuation interest rate Correct answer.
  4. Terminal reserve equal to the cash surrender value

Explanation

Reserves increase when assumed mortality is higher and the valuation interest rate is lower, because future benefit outflows are discounted less and expected to occur sooner. A conservative table with a low valuation rate therefore yields the largest reserve.

Question 4Life Insurance Finance

An insurer's admitted assets are 2,000 million and its liabilities are 1,700 million. What is its surplus ratio, defined as surplus divided by admitted assets?

  1. 117.6%
  2. 17.6%
  3. 15% Correct answer.
  4. 85%

Explanation

Surplus equals admitted assets minus liabilities, or 300 million. Dividing 300 by admitted assets of 2,000 gives a surplus ratio of 15%, which measures the cushion available to absorb adverse experience.

Question 5Life Insurance Finance

Which cash flow item belongs in the operating section of a life insurer's statutory cash flow statement?

  1. Proceeds from the sale of a bond held to maturity
  2. Premiums collected from policyholders Correct answer.
  3. Issuance of surplus notes
  4. Dividends paid to shareholders

Explanation

Premiums collected arise from the insurer's core insurance activity and are reported as operating cash inflows. Investment transactions belong in investing activities, while shareholder dividends and surplus note issuance are financing activities.

Question 6Life Insurance Finance

A universal life policy carries a stated crediting rate of 4.5% while the insurer's net investment yield on supporting assets is 5.0%. Which term describes the 0.5% difference retained by the insurer?

  1. Cost of insurance deduction
  2. Interest spread Correct answer.
  3. Surrender charge
  4. Mortality and expense risk charge

Explanation

The interest spread is the margin between the yield earned on invested assets and the rate credited to policyholder account values. Mortality charges and surrender charges are separate deductions that recover insurance and early-withdrawal costs.

Question 7Life Insurance Finance

Which formula correctly expresses the net amount at risk for a traditional whole life policy?

  1. Face amount plus terminal reserve
  2. Cash surrender value minus face amount
  3. Face amount minus terminal reserve Correct answer.
  4. Terminal reserve minus face amount

Explanation

The net amount at risk is the portion of the death benefit the insurer must fund from its own resources, so it equals the face amount less the reserve already held for the policy. As reserves build over time, the net amount at risk declines.

Question 8Life Insurance Finance

Which asset category generally receives the lowest risk-based capital charge for a life insurer under US risk-based capital rules?

  1. Investment-grade corporate bonds Correct answer.
  2. Real estate held for investment
  3. Common stock of an unaffiliated issuer
  4. Schedule BA partnership interests

Explanation

Risk-based capital assigns charges in proportion to asset risk, and investment-grade bonds carry a low charge because of their modest default risk. Equities, real estate, and Schedule BA alternative assets carry substantially higher charges.

Question 9Life Insurance Finance

A life insurer writes a block of single premium deferred annuities with a seven-year interest rate guarantee. Which asset-liability management risk is most directly created by this product design?

  1. Currency risk from foreign policyholders
  2. Reinvestment risk if assets mature before the guarantee period ends Correct answer.
  3. Morbidity risk from disability claims
  4. Mortality risk from adverse death claim experience

Explanation

A fixed interest guarantee creates exposure when supporting assets mature earlier than the liability and must be reinvested at lower rates. This is a classic reinvestment or interest rate risk, distinct from mortality, morbidity, and currency exposures.

Question 10Life Insurance Finance

An insurer holds a bond purchased at a premium. Under statutory accounting, how is the premium amortized for valuation purposes?

  1. Ignored until the bond matures or is sold
  2. Amortized straight-line over the remaining term regardless of yield
  3. Amortized over the remaining life using the scientific or constant-yield method Correct answer.
  4. Recognized immediately as an unrealized loss in surplus

Explanation

Statutory valuation requires amortization of premium and accrual of discount using the scientific method, which applies a constant yield to the book value. This keeps the carrying amount aligned with the yield actually earned over the bond's life.

Question 11Life Insurance Finance

A term life product is priced with a 10% lapse assumption, but actual lapses run at 25% in the first year. For a block with significant front-end acquisition costs, what is the most likely effect on profitability?

  1. Profitability declines because acquisition costs are recovered over fewer premium payments Correct answer.
  2. Profitability is unchanged because lapses only shift the timing of premiums
  3. Profitability improves because reserves are released earlier
  4. Profitability improves because fewer death claims are paid

Explanation

Front-end acquisition costs are amortized over expected future premiums, so higher early lapses leave unamortized costs with less premium income to recover them. The result is a strain on earnings and on statutory surplus in the early durations.

Question 12Life Insurance Finance

A life insurer reports a statutory loss but positive operating cash flow for the year. Which explanation is most consistent with these results?

  1. The insurer paid unusually large shareholder dividends
  2. The insurer sold a major bond portfolio at a gain during the year
  3. The insurer increased its holding of admitted cash equivalents
  4. The insurer recorded a large increase in statutory policy reserves that reduced net income without consuming cash Correct answer.

Explanation

Increases in statutory reserves are non-cash charges that reduce reported income while premiums continue to generate cash. This divergence between statutory earnings and cash flow is common in growing blocks of long-duration business.

Question 13Life Insurance Finance

Under US statutory accounting, which treatment applies to a bond that has declined in value and is deemed other-than-temporarily impaired?

  1. The decline is ignored until the bond is sold
  2. The decline is recorded as a direct write-down of the asset with a charge to income Correct answer.
  3. The decline is deferred and amortized over the bond's remaining term
  4. The decline is recorded only in the asset valuation reserve without affecting income

Explanation

Other-than-temporary impairment requires the carrying value to be written down to fair value, with the loss recognized in statutory income. The reduced cost basis is then used for subsequent amortization.

Question 14Life Insurance Finance

A company's risk-based capital ratio falls below the company action level but remains above the regulatory action level. What is the primary regulatory consequence?

  1. The insurer must submit a plan to the regulator describing corrective actions Correct answer.
  2. The insurer is prohibited from writing any new business
  3. The insurer must distribute all surplus to policyholders
  4. The regulator must place the insurer into rehabilitation immediately

Explanation

Falling below the company action level triggers a requirement to file an RBC plan with the commissioner outlining the causes and proposed remedies. More severe intervention, such as rehabilitation or a writing prohibition, applies at lower trigger levels.

Question 15Life Insurance Finance

Which item is deducted from capital and surplus when calculating an insurer's total adjusted capital for risk-based capital purposes?

  1. The interest maintenance reserve
  2. Goodwill and other intangible assets Correct answer.
  3. The provision for policyholder dividends
  4. The asset valuation reserve

Explanation

Total adjusted capital adds specified reserve components to statutory capital and surplus but excludes assets that cannot absorb losses, such as goodwill and other intangibles. These are deducted because they have no realizable value in a stress scenario.

Question 16Life Insurance Finance

An insurer's investment portfolio yields 5.2%, its credited rate on interest-sensitive life business is 4.0%, and its expense and mortality charges total 0.6%. What is the approximate spread margin available to the insurer?

  1. 1.8%
  2. 1.2%
  3. 4.6%
  4. 0.6% Correct answer.

Explanation

The spread margin is the investment yield less the credited rate and less the charges recovered, or 5.2% − 4.0% − 0.6% = 0.6%. This residual funds profit, taxes, and any adverse experience.

Question 17Life Insurance Finance

A life insurer experiences an unexpected increase in mortality on a block of term policies in a single year. How does this affect statutory reserves and earnings?

  1. Reserves rise and earnings rise because more claims are paid
  2. Reserves fall and earnings rise because policies terminate early
  3. Reserves rise and earnings are unaffected because claims are funded from reserves
  4. Reserves are unaffected and earnings fall because claim costs exceed the assumed level Correct answer.

Explanation

For term insurance, reserves are typically small and the immediate effect of worse mortality is higher claim costs that reduce earnings. Reserves are not the primary absorber of the shock, so the earnings impact is direct.

Question 18Life Insurance Finance

Which scenario best illustrates disintermediation risk for a life insurer?

  1. Mortality improves faster than assumed in the pricing basis
  2. The insurer's expense ratio rises because of higher technology spending
  3. A bond issuer defaults on a scheduled coupon payment
  4. Policyholders surrender fixed annuities to pursue higher market rates when crediting rates lag Correct answer.

Explanation

Disintermediation occurs when policyholders withdraw funds to obtain better returns elsewhere, forcing the insurer to liquidate assets, often at a loss. It is a cash-flow and interest rate risk tied to the competitiveness of credited rates.

Question 19Life Insurance Finance

An insurer uses a gross premium valuation for an acquired block of business. Which cash flow items should be included in the projection?

  1. Future premiums, benefits, expenses, and persistency assumptions on a best-estimate basis Correct answer.
  2. Only the historical acquisition cost of the block
  3. Only the statutory reserves already established
  4. Only future death benefits and surrender values

Explanation

A gross premium valuation projects all expected cash flows, including premiums, benefits, expenses, and lapses, discounted at an appropriate rate. It is used to test whether recorded reserves plus capital are adequate for future obligations.

Question 20Life Insurance Finance

A life insurer's surplus note carries a stated interest rate and is subordinated to policyholder claims. How is it classified for statutory accounting and capital purposes?

  1. As a surplus item subject to regulatory approval, with interest treated as a capital distribution Correct answer.
  2. As a liability with no capital credit
  3. As an admitted asset of the issuer
  4. As a policy reserve

Explanation

Surplus notes receive limited recognition in surplus because they are subordinated to policyholders and require regulatory approval for repayment. Interest payments are treated like dividends and require approval, reinforcing their capital character.

Question 21Life Insurance Finance

A company's deferred acquisition cost asset is amortized more slowly than actual lapses occur. What is the effect on reported statutory earnings?

  1. Earnings are unaffected because deferred acquisition cost is a surplus item
  2. Earnings are overstated because the asset is not written down in line with experience Correct answer.
  3. Earnings are understated because amortization is too slow
  4. Earnings are understated because reserves increase

Explanation

If the deferred acquisition cost balance exceeds the amount recoverable from future margins, the asset is overstated and earnings are overstated until a write-down occurs. Proper testing compares the unamortized balance with projected recoverable gross profits.

Question 22Life Insurance Finance

An actuarial analysis shows that a block of guaranteed renewable disability income business has morbidity worsening while lapse rates rise. What combined effect should the insurer expect on reserve adequacy?

  1. Reserves may become deficient because higher claims persist on a shrinking, more adversely selected block Correct answer.
  2. Reserves are unaffected because guaranteed renewable premiums cannot change
  3. Reserves decline in proportion to the lapse rate with no offsetting claim effect
  4. Reserves become clearly redundant because fewer policies remain in force

Explanation

Rising lapses concentrate the remaining block among policyholders more likely to claim, while worsening morbidity raises the cost per policy. Together these trends can make existing reserves inadequate even though fewer policies remain.

Question 23Life Insurance Finance

An insurer's liabilities have a longer duration than its assets. Which management action most directly reduces the resulting interest rate risk?

  1. Raising the credited rate on new business to attract premiums
  2. Extending asset duration to better match the liability profile Correct answer.
  3. Increasing the proportion of short-term cash equivalents
  4. Shortening the asset portfolio further to increase yield

Explanation

Duration mismatch risk is reduced by aligning asset duration with liability duration, so extending assets toward the longer liability horizon narrows the gap. Raising credited rates or shortening assets would widen the mismatch.

Question 24Life Insurance Finance

A regulator is evaluating whether an insurer's reserves are adequate given that the insurer has ceded a large quota share to a reinsurer with a lower credit rating. Which factor most affects the reserve credit the insurer may take?

  1. The reinsurer's rating and the collateral or trust arrangements supporting the ceded balances Correct answer.
  2. The premium volume of the assuming reinsurer
  3. The length of time the treaty has been in force
  4. The number of policies ceded to the reinsurer

Explanation

Reserve credit for reinsurance depends primarily on the financial strength of the assuming company and on any collateral, trust, or letter of credit securing the ceded obligations. Without adequate security, the ceding insurer may be required to hold the reserves gross.

Question 25Life Insurance Finance

An insurer prices a universal life product assuming a 5% earned rate and a 4% guaranteed minimum crediting rate. In a sustained low-rate environment, which financial effect is most significant?

  1. The interest spread compresses toward zero or negative, eroding surplus and margin Correct answer.
  2. Mortality charges automatically increase to restore the spread
  3. The guaranteed minimum becomes irrelevant because crediting rates float freely
  4. Reserves fall because lower rates reduce the present value of benefits

Explanation

When earned yields fall toward the guaranteed minimum, the spread the insurer retains shrinks and can become negative. This compresses margins and can strain surplus because the guarantee cannot be reduced on in-force business.

Question 26Life Insurance Finance

Under US statutory accounting principles, how is a life insurer's deferred acquisition cost (DAC) asset treated when the underlying policy lapses?

  1. The unamortized DAC is transferred to surplus without a charge
  2. The unamortized DAC is reallocated to the insurer's reserve liability
  3. The unamortized DAC is amortized over the remaining original schedule
  4. The unamortized DAC is charged to expense immediately Correct answer.

Explanation

Statutory accounting generally does not permit a DAC asset to be carried for a policy that has terminated, because the future premium stream that justified the deferral no longer exists. When a life policy lapses, the remaining unamortized acquisition cost must be written off through the income statement in that period. This produces the well-known statutory earnings strain in years of heavy lapse experience.

Question 27Life Insurance Finance

A life insurer's statutory reserve for a block of term policies is calculated using a valuation mortality table that is less conservative than the table used in pricing. What is the most likely consequence?

  1. Statutory reserves exceed the pricing reserves
  2. Statutory reserves are lower than the pricing reserves Correct answer.
  3. The cash surrender value exceeds the reserve
  4. The gross premium is automatically increased

Explanation

The valuation table sets the minimum statutory reserve, while the pricing table reflects the insurer's expected experience including margins. A less conservative valuation table produces a smaller statutory reserve than the pricing model would indicate. The gap represents reserve redundancy from the regulator's perspective and can release earnings over time.

Question 28Life Insurance Finance

Which item is classified as a liability rather than as capital and surplus on a life insurer's statutory balance sheet?

  1. Aggregate reserve for life policies Correct answer.
  2. Paid-in surplus
  3. Unassigned surplus
  4. Common stock at par value

Explanation

Policy reserves represent obligations to policyholders and are reported as liabilities under statutory accounting. Paid-in surplus, unassigned surplus, and common stock are all components of capital and surplus. The distinction matters because risk-based capital is measured against capital and surplus, not against reserves.

Question 29Life Insurance Finance

A life insurer collects a premium of 1,200 on a policy at the start of the year and pays a first-year commission of 600 plus a death benefit claim of 400 during the year. Ignoring reserves and expenses, what is the statutory pre-tax gain or loss for the year?

  1. A loss of 200
  2. A gain of 200 Correct answer.
  3. A loss of 1,000
  4. A gain of 600

Explanation

Statutory gain equals premiums collected minus benefits and expenses actually incurred in the period. Here 1,200 minus 600 minus 400 leaves 200 of pre-tax gain. No reserve change is specified, so the calculation stops there.

Question 30Life Insurance Finance

Which financial statement item is most directly affected when a life insurer increases the interest rate it credits on a block of interest-sensitive whole life policies?

  1. The amount of paid-in surplus contributed by shareholders
  2. The par value of the insurer's common stock
  3. The policy reserve liability and the interest credited to policyholders Correct answer.
  4. The statutory valuation mortality table used for term policies

Explanation

Higher credited interest raises the account value and therefore the reserve backing the policy, and it also increases the interest credited to policyholder funds as an expense item. Both effects flow through the statutory balance sheet and income statement. Capital accounts and valuation tables are not directly changed by a crediting decision.

Question 31Life Insurance Finance

A life insurer reports a large positive net income but a decline in statutory capital and surplus for the same year. Which item most plausibly explains the divergence?

  1. A substantial dividend payment to shareholders Correct answer.
  2. A decrease in the volume of new business written
  3. An increase in the statutory valuation interest rate
  4. A reduction in the number of agents employed

Explanation

Net income increases surplus, but shareholder dividends are a direct charge against surplus and can more than offset it. A large dividend therefore produces the pattern of positive earnings with declining capital. Operating changes such as agent headcount or new business volume affect earnings rather than being a direct surplus charge.

Question 32Life Insurance Finance

Which measure best describes the statutory surplus strain experienced when a life insurer writes a new traditional whole life policy?

  1. The insurer's risk-based capital ratio declines because of investment losses
  2. The gross premium exceeds the net premium in every policy year
  3. The policy's cash value exceeds the reserve in the first year
  4. First-year statutory reserves and expenses exceed the first-year premium Correct answer.

Explanation

Surplus strain arises when the statutory reserve established plus acquisition expenses in the first year is greater than the premium received. Statutory accounting requires immediate recognition of these outflows, so writing new business temporarily reduces surplus. The strain reverses over the life of the policy as margins emerge.

Question 33Life Insurance Finance

A life insurer's investment department reports that the portfolio's book value yield exceeds its market value yield. What does this most likely indicate about the portfolio?

  1. The portfolio holds no fixed income securities
  2. The insurer has realized gains on all holdings
  3. Bonds were purchased at prices below current market levels
  4. Bonds were purchased at prices above current market levels Correct answer.

Explanation

When bonds are bought at a premium, book value is amortized downward toward par, so book yield based on amortized cost can exceed the yield implied by current market prices. The relationship reflects the difference between the amortized cost basis and market valuation. It does not require any particular asset mix or realized gain pattern.

Question 34Life Insurance Finance

An insurer's statutory reserve for a universal life policy with a secondary guarantee is being tested. Which approach is designed to determine whether additional reserves are required beyond the account value reserve?

  1. Comparing the account value to the face amount
  2. Using the cash surrender value as the reserve floor
  3. Applying the net level premium method to the account value
  4. Applying a prescribed stochastic or deterministic projection of the guarantee's cost Correct answer.

Explanation

Secondary guarantee reserves are determined by projecting fund values and death benefits under prescribed scenarios to test whether the guarantee will be honored. If the projection shows a shortfall, an additional reserve is held. The account value reserve alone does not capture the cost of the guarantee.

Question 35Life Insurance Finance

A life insurer cedes 40% of a block of term business under a yearly renewable term reinsurance agreement. How does this arrangement affect the ceding insurer's statutory financial statements?

  1. Reserves and net amount at risk are reduced, and reinsurance recoverables are recorded as assets Correct answer.
  2. The ceding insurer records the full face amount as an admitted asset
  3. Reserves are unchanged but premiums are reported gross with no offsetting asset
  4. The ceded reserve is recorded as a direct reduction of capital and surplus

Explanation

Under yearly renewable term reinsurance, the ceding insurer transfers a share of mortality risk and reduces both reserves and net amount at risk. The ceded portion is reported as a reinsurance recoverable asset, subject to credit for reinsurance rules. Premiums and claims are reported net of the ceded amounts.

Question 36Life Insurance Finance

A life insurer holds a mortgage loan that is 90 days delinquent on interest payments. Under statutory accounting, what is the most likely treatment of the accrued interest on that loan?

  1. The accrued interest is capitalized into the loan principal
  2. The accrued interest is transferred to a policy reserve
  3. The accrued interest is admitted in full
  4. The accrued interest is non-admitted and written off Correct answer.

Explanation

Statutory accounting is conservative about accrued investment income on delinquent assets. Interest that is past due beyond a prescribed period is generally non-admitted and written off rather than carried as an asset. This prevents overstated surplus from income that may never be collected.

Question 37Life Insurance Finance

An insurer calculates its risk-based capital ratio using a formula that applies factors to asset and insurance risks. If the insurer shifts a portion of its bond portfolio from below investment grade to US Treasury securities, what is the expected effect on the risk-based capital requirement?

  1. The requirement increases because Treasury securities carry a higher charge
  2. The requirement is unchanged because total assets are constant
  3. The requirement declines because the asset risk charge is lower Correct answer.
  4. The requirement declines only if liabilities also decrease

Explanation

The risk-based capital formula assigns higher asset risk factors to lower-rated bonds and minimal factors to Treasury securities. Moving to Treasuries reduces the weighted asset risk, which lowers the required capital. Total asset size is not what drives the charge; the composition and credit quality do.

Question 38Life Insurance Finance

A life insurer's cash flow testing reveals that projected cash flows become negative in a rising interest rate scenario because policy loans increase. Which management action most directly addresses this exposure?

  1. Extending asset duration to lock in higher long-term yields
  2. Shortening asset duration and holding more liquid short-term investments Correct answer.
  3. Increasing the interest rate credited on the affected policies
  4. Reducing the policy loan interest rate to discourage borrowing

Explanation

Rising rates can prompt policy loans and surrenders, creating a need for near-term liquidity. Holding shorter-duration and liquid assets allows the insurer to meet those demands without forced sales at a loss. Extending duration would worsen the mismatch in that scenario.

Question 39Life Insurance Finance

An insurer uses the net premium method to establish statutory reserves for a block of whole life policies. Which statement correctly describes the net premium used in this calculation?

  1. It is the gross premium actually charged to policyholders
  2. It is the premium determined from the valuation mortality and interest assumptions, excluding expense loading Correct answer.
  3. It is the gross premium reduced by the expense loading
  4. It is the premium equal to the policy's cash value at issue

Explanation

The net premium in the net premium reserve method is derived solely from the valuation mortality table and valuation interest rate, with no provision for expenses. The reserve is the excess of the present value of future benefits over the present value of future net premiums. The gross premium includes expense loading and is not the net premium.

Question 40Life Insurance Finance

A life insurer's general account holds a private placement bond that is not publicly traded. How does the lack of a public market most affect the insurer's statutory reporting?

  1. The insurer must determine a reasonable fair value using approved valuation methods and disclose the approach Correct answer.
  2. The bond is automatically valued at par regardless of credit quality
  3. The bond is non-admitted because it lacks a market quotation
  4. The bond is valued at the lower of amortized cost or the last traded price

Explanation

Statutory reporting requires fair value for invested assets, and for private placements the insurer must apply an approved valuation methodology and document it. The absence of a public quotation does not make the asset non-admitted. Par is not an automatic fallback for credit-impaired securities.

Question 41Life Insurance Finance

A life insurer's expense ratio rises sharply while its premium volume is flat. Which explanation is most consistent with this result?

  1. The insurer has shortened the duration of its bond portfolio
  2. The insurer has reduced its per-policy acquisition costs
  3. Mortality experience has improved on the in-force block
  4. Fixed overhead costs are being spread over an unchanged premium base with higher unit costs Correct answer.

Explanation

An expense ratio compares expenses to premium, so rising expenses on a flat premium base increase the ratio. Higher fixed overhead per unit of premium is a direct cause. The other choices either reduce expenses or affect items unrelated to the expense ratio.

Question 42Life Insurance Finance

An insurer writes a block of single premium immediate annuities with lifetime payout guarantees. Which reserve methodology is most appropriate for measuring the insurer's statutory liability on this block?

  1. A reserve equal to the account value credited under the contract
  2. A present value of future annuity payments using prescribed mortality and interest assumptions Correct answer.
  3. A reserve equal to the policy's cash surrender value
  4. A reserve equal to the accumulated premiums paid without interest

Explanation

Immediate annuities with lifetime payouts are valued by discounting expected future payments using prescribed mortality and interest assumptions. Because payments continue for life, the mortality assumption is central to the reserve. Cash surrender value and account value concepts do not apply to these contracts.

Question 43Life Insurance Finance

A life insurer's actuarial memorandum shows that its reserves include a provision for adverse deviation. How does this provision affect the reported statutory reserve?

  1. It has no effect on the reported reserve amount
  2. It transfers the reserve to a separate surplus account
  3. It increases the reserve above the best-estimate level Correct answer.
  4. It reduces the reserve below the best-estimate level

Explanation

A provision for adverse deviation adds a margin to the best-estimate assumptions so that the reserve remains adequate if experience is worse than expected. The result is a reserve higher than the pure best-estimate amount. It does not reduce the reserve or move it out of liabilities.

Question 44Life Insurance Finance

An insurer's actual mortality on a block of whole life policies is significantly lower than the valuation mortality assumption. Over time, what is the effect on the insurer's statutory reserves?

  1. Reserves are unaffected because mortality is fixed at issue
  2. Reserves become redundant relative to experience and release into earnings as policies persist Correct answer.
  3. Reserves increase because lower mortality raises the reserve requirement
  4. Reserves are transferred to the separate account

Explanation

When actual mortality is better than the valuation assumption, the reserves held are more than experience requires, creating redundancy. As the block matures, that redundancy emerges as gains in statutory earnings. The valuation assumption itself is not changed by favorable experience on a particular block.

Question 45Life Insurance Finance

A life insurer has a large block of deferred annuities with market value adjustment features. How does the market value adjustment affect the insurer's disintermediation risk?

  1. It eliminates disintermediation risk entirely because the adjustment is fixed at issue
  2. It increases disintermediation risk by guaranteeing full account value on surrender
  3. It has no effect because the adjustment applies only at death
  4. It reduces disintermediation risk by passing some interest rate loss to surrendering policyholders Correct answer.

Explanation

A market value adjustment reduces the surrender value when rates have risen, so policyholders bear part of the loss from early withdrawal. This discourages disintermediation and protects the insurer's asset-liability position. It mitigates but does not eliminate the risk.

Question 46Life Insurance Finance

A life insurer reports an increase in its statutory reserve liability with no change in the number of policies in force. Which combination of changes is most consistent with this result?

  1. An increase in the valuation interest rate and an increase in lapses
  2. An increase in the valuation interest rate and a decrease in the average policy age
  3. A decrease in the valuation mortality rate and a decrease in average policy duration
  4. A decrease in the valuation interest rate and an increase in the average policy age Correct answer.

Explanation

A lower valuation interest rate increases the present value of future benefits and therefore raises reserves. Older policies also carry higher reserves because the net amount at risk and accumulated liability grow with duration. Together these changes raise reserves without any change in policy count.

Question 47Life Insurance Finance

An insurer is evaluating whether to hold an additional reserve for a block of term policies with a conversion privilege. Which factor most increases the expected cost of the conversion option?

  1. A decline in the number of policyholders exercising the privilege
  2. An increase in the valuation interest rate used for the term reserves
  3. A shortening of the conversion eligibility period
  4. A widening spread between the term premium and the permanent premium at the conversion date Correct answer.

Explanation

The conversion option becomes valuable when guaranteed permanent coverage is cheaper than what the policyholder could otherwise obtain. A wider spread between the term premium and the permanent premium at conversion makes exercise more likely and costly. Shorter eligibility or fewer exercises reduce the option's value.

Question 48Life Insurance Finance

A life insurer uses a three-tier premium tax structure in which a state credits premium taxes against its income tax. How should the insurer reflect this credit in its statutory financial statements?

  1. The credit is recorded as an increase to paid-in surplus
  2. The credit is netted against the policy reserve liability
  3. The full premium tax is expensed with the credit ignored until received in cash
  4. The premium tax expense is reduced by the amount of the credit actually usable Correct answer.

Explanation

When a state permits a premium tax credit against income tax, the insurer recognizes the benefit to the extent it expects to use it. This reduces the net premium tax expense reported. The credit is not a capital contribution or a reserve adjustment.

Question 49Life Insurance Finance

An insurer's block of universal life policies has account values that exceed the statutory reserves computed under the minimum standard. How is this situation generally reflected in statutory reporting?

  1. The reserve is held at the greater of the minimum standard reserve or another prescribed floor, and the excess account value is not a liability Correct answer.
  2. The excess account value is recorded as a deferred gain
  3. The reserve is reduced below the minimum standard to reflect the excess
  4. The reserve is set equal to the account value in all cases

Explanation

Statutory reserving for universal life is governed by prescribed minimum standards and floors, such as the cash surrender value or account value floor where applicable. The reserve is not automatically set to the account value, and excess account value is not deferred as a gain. The insurer holds the amount required by the applicable standard.

Question 50Life Insurance Finance

A life insurer's deferred tax asset arises from temporary differences between statutory and tax reporting. Which condition most affects whether the deferred tax asset can be admitted for statutory purposes?

  1. The number of states in which the insurer is licensed
  2. The level of the insurer's gross premium written in the current year
  3. The size of the insurer's bond portfolio relative to total assets
  4. The likelihood that the insurer will generate sufficient future taxable income to realize the asset Correct answer.

Explanation

Admission of a deferred tax asset depends on the insurer's ability to realize it through future taxable income, subject to prescribed limits and recoverability tests. Portfolio size, licensing footprint, and premium volume are not the determining test. This recoverability principle mirrors the valuation allowance concept in tax accounting.