Actuarial Task

Fundamentals of Actuarial Practice: Interim Assessment

Interim Assessment Questions Overview
Assessment Structure
This assessment comprises 16 questions you are to answer. All questions are listed in this
document. Questions are grouped into the following sections:
• Questions 1-6 relate to a group term life insurance scenario.
• Questions 7-11 relate to an individual disability insurance scenario.
• Questions 12-14 relate to an ERM scenario.
• Questions 15-16 are independent of each other and are not linked to a shared scenario.

Your answers to the questions are to be contained in one Microsoft Word document that you will
submit when completed with the Interim Assessment. You must use the template document
IA_template.doc that you downloaded when obtaining this document and the spreadsheets. You
will also submit spreadsheets containing the work you complete for the first scenario. (Further
information about the process for completing the Interim Assessment can be found by clicking the
Interim Assessment FAQ or Interim Assessment Instructions links on the Download Page.)

Important Notes
All information you want to convey to graders must be in your Microsoft Word document. Your
answers should be presented with an 11-point (minimum) font and single-spaced (with double
spacing between paragraphs).

You should not assume that graders will examine the Microsoft Excel spreadsheet you upload.
While graders will have access to your Excel file, they will only review your spreadsheet if they
would like to check your work.
Considerations in Preparing Your Answers For the most part, your answers are not expected to be in memo form and do not need to be in
structured paragraphs. It is acceptable to use outlines and lists where you believe it is
appropriate. However, if the question calls for you to write a memo or document that is intended
for an audience other than the grader, then the communication should be appropriate for that

Your goal should be to answer each question completely and appropriately. You should
effectively and efficiently convey the information that answers each question. Your answers
should average approximately one page (single-spaced).

Your name should not appear anywhere in your submission or in any way identify you as the
author. If you believe you should refer to yourself in the context of an answer, use FAP
Candidate instead of your actual name.

Questions 1–6
You work for Sensible Insurance Company, a mid-sized insurance company whose core product
is group term life. Sensible aims to grow and is trying to gain Mammoth Mart as a client.
Mammoth Mart is a large employer in the U.S., and its addition will almost double the number of
insured lives Sensible covers.

Sensible operates in all states in the U.S., but focuses on small to medium sized businesses
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concentrated in the Eastern U.S. Its current book of business has an average occupation mix of
20% blue-collar/80% white-collar. The average case size is 81 lives with no single group
comprising more than 2% of the insured lives.

The CFO of Sensible is concerned that it may be growing too fast and has asked you to analyze
the effect of adding Mammoth Mart as a client. Your student actuary has sent you the following
information about Mammoth Mart:

1. It has offices nationwide with over 500,000 employees.
2. Approximately 60% of the employees are blue-collar, with the remainder being white-collar.
3. As of today, all of its locations are in the U.S., but it is considering opening some Canadian
locations in the next year or two.
4. It is using a broker to negotiate prices and benefits with insurers.

Mammoth Mart wants a simple plan for its employees–all of them will be covered, and the face
amount will equal the employee’s annual salary. However, instead of a typical one-year rate
guarantee contract with premiums paid monthly, Mammoth Mart would like a three-year rate
guarantee on the premium. It will pay the entire three years’ premium up-front based on its current
workforce and salaries, with monthly adjustments based on increases or decreases to the
covered salary amount.

Ideally, for such a large group we would want to use Mammoth Mart’s own experience to develop
a rate, but this is the first time it has sought life insurance coverage. Therefore Sensible’s rate
manual needs to be used.

A spreadsheet, which can be downloaded by clicking the Excel File Group Term link on the
Download Page, has been prepared to assist you with the questions. Further description of the
spreadsheet will be provided in the questions.
Question 1
(A) Using the existing ratemaking information provided in <Excel File Group Term, tab GT 1A>,
determine the monthly premium per $1000 of covered salary for Mammoth Mart. Show your work
in your answer.

(B) Due to Mammoth Mart’s request for an unusual payment arrangement you decide a monthly
cash flow model should be built to better understand the financial implications. Your student
actuary provides a model that you agree is sufficient for your immediate needs, located in <Excel
File Group Term, tab GT 1B>.

You notice that using the assumed premium from (1A), the profit is greater than 3% of the claims.
Briefly explain why this is and recommend a premium that matches the profit goal.

Premiums for both (A) and (B) (monthly cost / $1000 covered payroll) should be rounded to the
nearest tenth of a cent.

For Questions 2-5, if a premium is needed in your calculations use the premium from 1(B).
Question 2
What are the key external factors that Sensible should consider when determining whether or not
to pursue the Mammoth Mart account? How do these factors apply to this specific situation?
Question 3 Up until this point management has wanted you to use a 3.0% investment income rate. However,
because investment income plays an important role in the case of Mammoth Mart you want to
explore it in more depth. Using the historic data for different asset classes located in <Excel
Group Term File, tab GT 3> recommend an investment strategy and investment income rate
Question 4
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Mammoth Mart has been considering purchasing one of its rivals, Pacific Pro Shopper, and
company officials are estimating the purchase would be effective at the start of month 30 in the
current contract. This purchase would result in an additional $5B of monthly payroll covered for
each of the remaining 7 months. Assume that the premium rate cannot be renegotiated for the
additional payroll.

Using the monthly cash flow model located in <Group Term Life, tab GT 4>, briefly describe the
impact the purchase would have on the premium that is collected by Sensible and the ending
cash position compared to the original assumptions. As a baseline scenario, assume that the
average claims rate remains level throughout the contract period.
Question 5
Before you give your final recommendation to the CFO regarding the Mammoth Mart contract,
you decide it would be best to perform some sensitivity testing. Discuss the assumptions that you
should consider when performing a sensitivity analysis. Explain why each of these assumptions is
important to analyze. Do not perform the sensitivity analysis.
Question 6
Three years have passed and you have been asked to evaluate the Mammoth Mart deal.
Mammoth Mart has expressed interest in a renewal quote.

Mammoth Mart’s experience has been summarized by your actuarial student in <Excel File Group
Term, tab GT 6>. Note that the Canadian expansion has not yet occurred and talks with Pacific
Pro Shopper have been delayed past the 30-month mark initially anticipated. Actual expenses for
Sensible have been equal to those in the original assumptions.

(A) Evaluate Mammoth Mart’s results and profitability for Sensible. Are there any concerns about
the results? Briefly discuss how well the rate guarantee worked for Sensible.

(B) In a memo written to an actuarial student who will be working with this contract going forward
summarize your approach to the renewal using the control cycle as a framework. Include all five
components of the control cycle as they relate specifically to this situation (Professionalism,
External Forces, Define the Problem, Design the Solution, and Monitor the Results) as well as key
renewal rating considerations, recommendations, or concerns you have.

Note: Be sure to save your spreadsheet calculations showing your work for the group term
scenario. You will be prompted to upload this saved spreadsheet when you have completed the
Interim Assessment.

Questions 7–11
Your company, Awesome Benefits Company, sells the following individual disability insurance
• Level annual premiums are paid while healthy and under age 65. Premium rates are
guaranteed and premiums are due at the beginning of the year
• Upon disability, a level monthly benefit is paid while the policyholder is unable to work (a
status that is defined in the policy)
• Benefit payments commence after a 90 day waiting period (also called an elimination
• Benefit payments are 60% of salary and cease when the policyholder turns age 65, dies,
or recovers
• The target market is highly paid professionals (such as doctors and lawyers) and
corporate executives.
• The product is sold through insurance agents.
You have assigned your actuarial student, Joe, to build a pricing model. Joe has built the model in
© 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 3 of 10
Coupon Rate


Price / Face
T-bill N/A 1 Year 990 / 1000
T-Note 2.9% 10 Year 1000 / 1000
Corporate Bond 3.2% 10 Year 1000 / 1000
Corporate Bond 4.1% 30 Year 1000 / 1000

the Excel spreadsheet <Excel File Individual Disability>. Joe has made all of the baseline
assumptions and selected initial premiums. The per-unit premium for each policy is set equal to
the issue age – for example, a 42-year old with a $100,000 salary would pay $4,200 annually
while a 30-year old with a $50,000 salary would pay $1,500 annually. Joe thinks this pricing
scheme will help with marketing the product, because each year a customer delays buying this
policy will lead to an increase in the level premium.

Given the recent economic volatility, Awesome Benefits Company has a conservative investment
strategy. The investment strategy has three priorities; first it is required to hold at least a certain
percent of its portfolio in liquid, short-term assets. The value can be found on the Documentation
tab of the spreadsheet <Excel File Individual Disability>. Next, it wants to duration match assets
and liabilities. Finally, it prefers to invest in United States government securities.

Awesome Benefit Company uses profit as a percent of premium as its primary profit measure.
Using a discount rate of 5%, the required present value of distributable earnings as a percentage
of premium is 10%. Management also desires an IRR greater than 10%.

For this assessment, you can ignore the claims paying ability of the company and any other plan
design features not mentioned in this assessment. You do not have to audit the model.
Question 7
Now that the pricing model is built in <Excel File Individual Disability>, Awesome Benefit
Company’s investment managers have asked you what type of assets should be purchased to
back reserves and capital. You have been asked to assess and comment on its investment

(A) Using an interest rate of 5.0%, and the cash flows in the Model Income Statement tab,
calculate the modified duration using paid claims as the liability cash flows.

(B) Given the available assets below, build an asset portfolio that best meets the requirements
and preferences of the company’s investment strategy. Discuss the characteristics and
implications of the choice of assets.

* Assume coupons are paid once per year, at the end of the year

(C) Senior management has determined that Awesome Benefit Company’s investment strategy
should be even more conservative. You are now required to invest 100% of assets in government
securities. Build a second asset portfolio, which is as close to duration matched as possible.
Discuss the characteristics and implications of the choice of assets and compare it to the first
Question 8
You need to review Joe’s pricing work (recall though that you do not have to audit the model).
Use the <Excel File Individual Disability> model to run the entire population.

(A) Using Joe’s initial assumptions in the cell info tab, discuss the results of the pricing model in
light of the desired profit measures. Recommend changes to the premium schedule if necessary.

(B) Assuming Joe’s premiums are maintained, assess Joe’s premium selection in light of the
model results by age and gender, which are summarized on the Output Summary tab of <Excel
File Individual Disability>. Is setting the per-unit premium proportional to the issue age
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appropriate? Justify your answer. Recommend changes if necessary.

(C) All of Joe’s pricing work has focused on one deterministic scenario. Assuming Joe’s premiums
are maintained, perform a sensitivity analysis by changing key assumptions in the cell info tab
and re-running the entire model. Key assumptions to include in the analysis are incidence,
maintenance expenses, and interest rates. Which assumptions are most/least critical?
Question 9
The new CFO doesn’t understand regulatory reserves and gross premium reserves. You created
the following graph of regulatory reserves and gross premiums reserves by duration for the IDI

Reserve Projection

Total Regulatory


(A) Explain the difference between these two reserves, including the how those differences
produce this pattern of reserves by duration.

(B) Using the model output, calculate the gross premium reserve at the end of year 1 using a
discount rate of 5% and the cash flows in the Model Income Statement tab.

(C) Awesome Benefit Company’s current regulatory reserves are rules-based. Discuss the
differences when compared to a Principles-based valuation.
Question 10
In response to perceived abuse of disability income benefits by insureds, Awesome Benefit
Company decides to offer a new product with a more restrictive definition of disability. This new
definition of disability requires policyholders to be more severely disabled in order to qualify for

Briefly describe the general impact on claim costs / claim administration expenses, litigation costs,
and reinsurance needs. Similarly, briefly list what data you would seek to quantify those effects.

Note: You will not upload the spreadsheet you used for this scenario.
Question 11
Awesome Benefits Company has completed the Failure Modes and Effects Analysis (FMEA)
process. For the individual benefit product the subject matter experts (SME) have identified the
assumptions for each of the 5 scenarios shown below and the likelihood of the scenario
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Risk Scenario Likelihood(%)
Credible worst-case 5
Pessimistic 15
Baseline 60
Optimistic 15
Credible best-case 5

The assumptions for the 5 scenarios were run through the model. After completing the step of
estimating the quantitative impacts, the SME’s were concerned about the results from the
moderately pessimistic and credible worst-case scenarios. Reinsurance was suggested as a risk
mitigation strategy. The ERM team wanted to include the option of reinsurance prior to presenting
results to senior management. An offer for reinsurance was received. The model was adjusted for
reinsurance and re-run.
Risk Scenario No Reinsurance Reinsurance
Credible best-case 1 6
Optimistic 2 7
Baseline 3 8
Pessimistic 4 9
Credible worst-case 5 10

The model income statements have been provided to you in <Excel File Reinsurance> to prepare
for the senior management report. The table above indicates the scenario in the spreadsheet for
the described situation. Generate an executive summary of the data that is easy to understand
and present. Make a recommendation as to whether the reinsurance offer should be chosen.
Justify your recommendation.

Note: You will not upload the spreadsheet used with this question.

Questions 12-14
Warren Peace (WP) winery is a family-owned company which manufactures, markets, and
distributes fine wine. The winery is located on a 60 acre vineyard in Northern California, USA
which is where WP grows grapes and manufactures its products. WP has a history and heritage
of fine winemaking for over 30 years.

WP sells several types of wine produced from its own locally grown grapes. Generally, WP
produces two vintages of wine, a high quality vintage wine which sells at a premium, and a lower
quality brand name wine. From time to time, WP purchases grapes from other vineyards in
Northern California and imports grapes from France, Italy, Argentina, and Canada.

The current Chief Executive Officer is Warren Peace III and the Board of Directors consists of 5
members of the Peace family. The company has 10 total permanent employees.

WP’s company objectives include:
• Produce quality wines at a reasonable price
• Conduct business with integrity and honesty
• Have a passion for wine
• Maximize company value through increasing profit margins

Distributable profits provided by WP over the past few years have ranged from $0 to $1,000,000.
As a result of this volatility, WP is in the process of adjusting the company objectives to include
an increased risk management focus. To help with this task, WP has hired Al Nino to develop a
risk management framework for WP. You are part of a team of actuarial students working for Al.
© 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 6 of 10

Question 12
Warren Peace has asked your team to make a presentation to the Board of Directors to describe
the ERM process. You will hand out a summary of the benefits of ERM. Al has asked you to draft
the handout and to include the following:

• Why should WP implement an ERM process?
• What are the benefits to WP’s major stakeholders (The Peace family, WP’s other
employees, wholesale distributors, business partners, creditors, and customers)?
• Who will be responsible for the ERM process?
• How will a Corporate Value ERM framework assist in WP’s business decision making
• How will an ERM framework address the Board’s concerns?

The handout should be written in bullet point form summarizing the main ideas of your
Question 13
Warren has asked Al to recommend an ERM framework for WP winery. One of your fellow
actuarial students has drafted the following memo and has asked you to review it before sending
it to Al. Suggest five ways to improve the document.

Do not include any grammar, style or punctuation improvements.

Do not submit an entire revision of the document; rather just provide a description of the
suggested improvements.

TO: Warren Peace III

FROM: Al Nino, Risk Consultant

RE: WP Winery Enterprise Risk Management (ERM) Framework
This memo will lay out considerations for the development of an enterprise risk management
strategy for Warren Peace Winery (WP).

The risk management philosophy of WP should:
• Identify and successfully manage risks that present good risk/reward opportunities
• Balance demands of various stakeholders
• Encourage a risk management culture throughout the company
• Quantify risks and strictly manage to an indentified risk tolerance

An understanding of enterprise risk management should be embedded throughout the
organization. The CEO is ultimately responsible for the key risks, but responsibilities will be
delegated to the Chief Risk Officer (CRO) and the ERM committee.

• CRO: responsible for providing the CEO with a written risk report on a quarterly basis,
which includes a status report on risk tolerances and risk appetite. Currently there is no
CRO on staff at WP.
• ERM Committee, which is a subset of the work force and includes equal representation
from manufacturing, marketing, and distribution. This committee is responsible for
reviewing and recommending risk tolerance and risk appetite.

Risks Identified

We have done a comprehensive review of WP’s business processes and global wine market
conditions and have identified the following risks:
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• Competitor risk / loss of key customer – This is the loss of a primary distribution partner
to competing wineries.
• Production risk – This is the loss resulting from unexpected equipment repairs or
• Counterparty credit risk – WP sells its products to various wholesalers throughout the
world. This is the risk of financial loss resulting from counterparty default or delay of
• Market risk – Unexpected changes in external markets impacting the cost of producing
• Product / pricing risk – Unexpected changes in external markets impacting the price of
• Interest rate risk – WP has variable rate loans. This is the risk of increasing interest rates
affecting the financing costs.
• Labor expense risk – This is the risk of adverse changes in the cost of labor.
• Business risk – This is the risk of losses resulting from general business practices and
from political, regulatory, and legislative issues.
• Reputation risk – This is the risk of losses due to negative publicity or failure to uphold a
good reputation.
• Operational risk – This is the risk of losses arising from failures in people, process,
• Weather / suboptimal growing condition risk – This is the risk of losses due to poor
growing conditions leading to poor wine quality and low yields.

Risk Quantification
We are proposing the following framework to manage and monitor the above identified risks.

WP should develop well-defined risk limits and metrics that are regularly and consistently
monitored and enforced. They should also be reviewed regularly for needed updates. The CRO
will be responsible for developing and maintaining appropriate models to manage and monitor
risk. One of the key modeling outputs is distributable cash flow under both deterministic risk
scenarios and more advanced scenario testing such as stochastic simulations.

The baseline company value is the present value of distributable cash flows over a 10-year time
horizon, discounted at the hurdle rate. When assessing the various risks, multiple scenarios are
combined using correlation matrices.

A summary of the key metrics is included in the table below.

Enterprise Risk Metric

Frequency of

Company Value (CV)
Average Present Value of
Distributable Cash Flows

Company Value at Risk
(CVR) from all risks

CV at the 5th

CVR from Standalone
Risk (SCVR)

CV at 10th


Risk Tolerance

In defining WP’s risk appetite, there should be a target risk metric and a maximum risk metric.
• Target risk metric — this is where WP is most comfortable with overall risk/reward
• Maximum risk metric — this is the maximum amount of risk WP is willing to take. If the risk
metric reaches the maximum, then there needs to be action to reduce the exposure.
© 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 8 of 10
Risk Metric Target Maximum

Increase Company Value while
managing to other risk tolerances

CVR 15-25% of Baseline CV 35% of Baseline CV
SCVR 5-10% of Baseline CV 20% of Baseline CV

One of the objectives of WP is to maximize company value through increasing profit margins.
This is accomplished through increasing Company Value while managing to the specified risk

Conclusions and Recommendations
This memo has outlined an enterprise risk management strategy for Warren Peace Winery. This
memo should be updated and reviewed on an annual basis.

Currently, WP has no CRO. In order to embed a risk management culture throughout the
organization, this position needs to be filled as soon as possible. The CRO will be responsible for
organizing the ERM committee.

The company objectives for WP should be adjusted to specifically cite risk management. It is
recommended that an additional objective be added.
Question 14
Several months have passed and WP has adopted a risk management framework based on your
recommendations. Melissa Peace, a member of the Board, is the new Chief Risk Officer (CRO)
and an ERM Committee has been created. The members of the ERM Committee include the
CRO, the General Manager, and the head winemaker.

The ERM Committee has identified the following as the key risks to WP’s CV:

• Competitor risk / loss of key customer
• Weather / suboptimal growing condition risk
• Production risk

The ERM Committee has asked for your assistance in evaluating several proposed risk mitigation
strategies. These have been suggested to align WP’s risks within the limits proposed by the
adopted risk document.

To assist in determining the effectiveness of the suggested strategies, your team constructed a
stochastic model. It was used to identify and quantify the key risks for the Board and incorporates
all aspects of income and expenses.

The risk mitigation strategies include:

Sales Contracts: Enter into a sales contract with your primary distributor. The sales
contract will ensure purchase of a fixed amount of wine in exchange for a
discounted price over the next 10 years.

Diversification: Lease out a portion of WP’s vineyard and use the funds to rent space in
vineyards in other locations. There will be additional costs to transport
grapes from the new vineyards to the main winery in Northern California.

Update Equipment: Invest in new equipment and maintenance workers to reduce the
likelihood of expensive repairs to equipment.

1000 scenarios of the stochastic model were run to determine the risk metrics. The results of the
stochastic model are summarized in the excel worksheet <Excel File Winery ERM>
© 2012-2013 Society of Actuaries | IA 4.0 Scenarios and Questions | Page 9 of 10

Considering the Risk Document adopted by theERM Committee, evaluate the effectiveness and
appropriateness of each of the above risk mitigation strategies.

Note: You will not upload the spreadsheet used with this question.

Questions 15–16
Questions 15–16 are independent of each other and are not linked to a shared scenario.
Question 15
Due to your stellar actuarial work and superior management skills at Great Health Insurance
(GHI), you have just been promoted to Sr. Vice President and have been put in charge of the new
Economic Capital/Risk Management area. You will report directly to the CEO and are expected to
work closely with the Chief Actuary and actuaries from the Pricing and Valuation areas. Your
department has been staffed with several actuarial students from your former team, but you still
have an Actuarial Associate position open.

(A) Write an internal job posting for the Actuarial Associate position. Describe what your area will
do. Your firm has an actuarial student rotation program, so you will need to distinguish your area
from other actuarial areas to attract an internal applicant. Your Human Resources representative
will attach specifics such as educational background, exam level, and years of experience. Your
focus should be describing in general terms what your area will do and how it will interact with
other key areas of the company.

(B) As a public relations initiative, the CEO wants to highlight GHI’s commitment to emerging risk
management strategies. She would like to showcase your department on the company’s external
Web site. Write a description of how your department will benefit GHI’s stakeholders.
Question 16 You are an actuary with Mayhem Consulting. Quality Insurance, a small insurance company that
is a new client, has provided you with detailed policyholder data for a block of universal life
insurance policies and asked you to prepare a reserve estimate using that data. You begin
reviewing the data and notice some irregularities. A sample of the data provided is shown in
<Excel File Universal Life>.

(A) According to ASOP 23, what should you consider prior to using the data? Discuss problems
that you see with the data and how the considerations apply.

You discuss the irregularities with Quality’s Chief Financial Officer (CFO) and he is able to
provide you with an updated data set. However, the CFO says that the policy administration
system automatically assumes all policyholders are male and they haven’t been able to fix the
system to correctly track gender. You continue with your reserve estimate assuming all
policyholders are male because you know that assumption does not conflict with any laws or
regulations. You believe that reserves may be overstated by as much as $2,000,000 due to that

(B) Prepare a disclosure statement regarding data quality that you would include in your

(C) After you have prepared your reserve estimate and disclosu

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