III IC-92 common mistakes
III IC-92 · Understand the traps and how to avoid them.
Computing a gross premium by applying the expense loading as a percentage of the wrong base - e.g., loading expenses on the net premium when the expense is defined as a percent of gross premium - then reporting the resulting premium without checking it against the balance equation.
Candidates memorize the general shape of the equivalence principle but not which cash flows are proportional to which base. Percent-of-premium expenses create a circular equation that must be solved algebraically, and the algebra is where the error is introduced, not the arithmetic.
What to do instead
Before computing, write the balance equation symbolically with every expense tagged to its base (per-policy, per-1000, percent of premium). Solve symbolically for P, then substitute numbers. Verify by plugging P back into the full profit-test equation and confirming the present value of all outflows equals the present value of premiums.
Mixing premium frequency conventions - quoting a modal premium as if it were annual, or annualizing a modal premium by simple multiplication without reflecting the mode load and the associated lapse/premium-persistence assumption.
Exam questions often give a modal premium and ask for annual-equivalent or vice versa, and the mode loading is small enough that candidates assume it can be ignored. It cannot; the mode load is a designed margin and its omission changes reserves and profitability.
What to do instead
State the frequency convention explicitly at the top of every calculation. When converting, use the stated mode factor (e.g., annual premium = modal premium × number of modes ÷ (1 + mode loading adjustment)) and carry the convention through to the reserve and profit calculations.
Building a profit test with inconsistent timing: premiums assumed at the start of the year but death benefits at the end, expenses split arbitrarily, and the interest discount applied to the wrong period.
Candidates focus on getting the mortality and interest numbers right and treat timing as an afterthought. Under exam time pressure, they adopt the timing of the first formula they recall rather than the timing stated in the question.
What to do instead
Draw a one-year timeline for the first projection year before computing anything, marking each cash flow at its stated time. Adopt one convention (e.g., all cash flows at start of year except the death benefit at mid-year or year-end, per the question) and apply it uniformly. Recompute year 1 by hand and reconcile the sign and discount factor.
Ignoring or mishandling the cash value and reserve interaction on lapse - treating a lapse as simply 'no benefit paid' rather than paying the cash surrender value or releasing the reserve appropriately.
Lapse is often modeled as the residual decrement after mortality, so candidates think of it as a non-event. In reality the lapse decrement carries a cash value outflow and a reserve release that materially affect profitability.
What to do instead
In the decrement model, list every decrement with its associated cash flow: death pays the death benefit, surrender pays the cash value, and in both cases the reserve is released. Check that the sum of decrement probabilities plus the persistency probability equals one and that no decrement is implicitly double-counted.
Treating the pricing interest rate, the valuation interest rate, and the earned rate on assets as interchangeable - using one rate throughout a problem that specifies different rates for pricing, reserving, and asset accumulation.
Many textbook-style problems use a single rate, so candidates develop the habit of one rate fits all. Exam questions deliberately differentiate the rates to test whether the candidate understands that pricing, reserving, and asset modeling are separate exercises with separate assumptions.
What to do instead
At the start of the problem, write a small table listing each rate the question gives and what it applies to (pricing discount, reserve basis, asset return, crediting rate). Refer to the table each time a discount factor is needed, and never carry a rate across a boundary the question defines.
Presenting a profitability result as a single point estimate - a profit margin or IRR - without addressing the sensitivity of that result to the underlying assumptions, even when the question asks about risk or the appropriateness of the pricing.
Candidates treat the calculation as the answer and stop. Product development questions frequently ask for judgment about whether a product is adequately priced, which requires testing what happens when mortality, lapse, or interest assumptions are wrong.
What to do instead
For any profitability question, compute the base result and then at least one adverse scenario (e.g., mortality 10% higher, lapse 20% higher, interest 100 bps lower) and state the direction and rough magnitude of the change. Conclude with whether the margin absorbs the tested adverse scenario.
Confusing the roles of the pricing actuary and the valuation actuary - describing reserves as if they were set by the pricing assumptions, or describing premiums as if they were derived from statutory reserve bases.
The two functions use overlapping mathematics but different purposes, bases, and constraints. Candidates who learn the formulas without the institutional context conflate them.
What to do instead
Anchor the distinction: pricing sets premiums to achieve a target profitability under best-estimate or moderately adverse assumptions; valuation sets reserves under prescribed or prudential assumptions to demonstrate solvency. When a question asks 'which assumption drives X', identify whether X is a pricing output or a reserving output first.
Omitting the cost of capital or the target surplus in a profit measure, reporting a profit margin that ignores the capital the product must hold, and thereby overstating profitability.
Target surplus and cost of capital are add-ons to the basic profit test, and candidates who learned the basic model skip them under time pressure. The result looks complete but is economically wrong.
What to do instead
Include a line for target surplus (or required capital) in every profit-test projection, and where the question implies a return on capital requirement, deduct the cost of holding that capital. If the question does not specify a capital standard, state the assumption you adopt and why.
Failing to reconcile the projected reserve at the end of the projection with the terminal value or release - leaving a residual reserve unaccounted for, so the profit test does not balance.
Candidates project reserves year by year but treat the final year's reserve as if it vanishes. In a proper profit test the terminal reserve is released or carried at its present value, and omitting it distorts the result.
What to do instead
At the end of every projection, explicitly handle the terminal reserve: either release it as a cash flow in the final year or discount it as a terminal value, consistent with the question. Then confirm the profit test balances by checking that the present value of profits plus the present value of the terminal reserve equals the present value of the original capital and surplus commitment.
Answering a product-design question with generic actuarial theory - describing what a reserve is or why mortality matters - instead of addressing the specific design trade-off the question poses, such as the choice between a level premium and a non-level premium structure.
Candidates run short on time and fall back on memorized definitions, or they do not recognize that the question is asking for a design recommendation rather than a calculation.
What to do instead
Read the question's final sentence first to identify the deliverable (calculate, recommend, critique, compare). Structure the answer around that deliverable, naming the specific product features and their consequences - e.g., level premium creates a reserve and lapse risk, while a non-level structure shifts risk to the policyholder - and support each claim with the numbers computed earlier in the answer.