CP1 Actuarial Practice

WHAT IS AN ACTUARIAL CONTROL CYCLE?
The actuarial control cycle is a fundamental tool of risk management which involves the process of analysing, quantifying, mitigating and monitoring risks.

LIST FEW APPLICATIONS OF ACTUARIAL CONTROL CYCLE TO ACTUARIAL WORK.
a) Asset-liability management
b) Model validation
c) Monitoring the effect of investment mismatching
d) Assessing the need for and calculator of provisions.
e) Determining and monitoring mortality, expense and persistency assumptions for use within design of and reserving for contracts or schemes

LIST A FEW CLIENTS TO WHOM ACTUARIES PROVIDE ADVICE TO.
a) Policyholders
b) Employers
c) Insurance company
d) Employees
e) Auditors of insurance companies
f) Sponsors of benefit schemes
g) Banks
h) Members of investment schemes
i) Investment fund managers

DESCRIBE THREE TYPES OF ADVICE GIVEN BY ACTUARY.
a) Indicative advice: giving an opinion without fully investigating the whole issue
b) Factual advice: based on research eg legislation
c) Recommendation: made consistent with requirements

STATE TWO FORMS OF INSURANCE THAT ARE COMPULSORY IN SOME COUNTRIES
Employers’ liability insurance and motor third party insurance.

DEFINE INFORMATION ASYMMETRY.
Information asymmetry is an imbalance between two negotiating parties in their knowledge of relevant factors and details. Typically, that imbalance means that the side with more information enjoys a competitive advantage over the other party.

WHICH FIVE PARTIES ARE THE MAIN PROVIDERS OF BENEFITS?
a) The state
b) Employers or group of employers
c) Individuals
d) Financial institutions
e) Other organisations

DEFINE A DEFINED BENEFIT SCHEME.
A defined benefit plan, more commonly known as a pension plan, offers guaranteed retirement benefits for employees. Defined benefit plans are largely funded by employers, with retirement payouts based on a set formula that considers an employee’s salary, age and tenure with the company.

DEFINE A DEFINED CONTRIBUTION SCHEME.
Defined contribution (DC) schemes are occupational pension schemes where your own contributions and your employer’s contributions are both invested and the proceeds used to buy a pension and/or other benefits at retirement. The value of the ultimate benefits payable from the DC scheme depends on the amount of contributions paid, the investment return achieved less any fees and charges, and the cost of buying the benefits.

DEFINE MICROINSURANCE.
Microinsurance products offer coverage to low-income households or to individuals who have little savings. It is tailored specifically for lower valued assets and compensation for illness, injury, or death.

WHAT ARE THREE TYPES OF INTEREST PAID ON CASH DEPOSITS?
The three types of interest include simple (regular) interest, accrued interest, and compounding interest.
Simple (Regular) Interest- Simple or regular interest is the amount of interest due on the loan, based on the principal loan outstanding.

Example: For example, if an individual borrows ${\$2,000}$ with a $3 \%$ annual interest rate, the loan would require a $\$ 60$ interest payment per year $(\$2,000 * 3 \%=\$ 60)$.
Accrued Interest- Accrued interest is accumulated interest that is unpaid until the end of the period. If a loan requires monthly payments (at the end of each month), interest steadily accumulates throughout the month.

Example: If $\$ 30$ is the interest expense each month, the loan is accruing $\$ 1$ of interest each day that requires payment once the end of the month is reached. In this example, by day 15 , the loan will have accumulated $\$ 15$ in accrued interest (but require payment once $\$ 30$ is reached).
Compound Interest- Compounding interest essentially means “interest on interest.” The interest payments change each period instead of staying fixed. Simple interest is based solely on the principal outstanding, whereas compound interest uses the principal and the previously earned interest.

Example: If a person borrowed $\$ 1,000$ with $2 \%$ interest and has $\$ 100$ of accrued interest, then that year’s interest would be $\$ 22$. It is because the interest is paid on the principal $(\$ 1000)$ and the accrued interest $(\$ 100)$, for a total of $\$ 1100.2 \%$ of $\$ 1100$ is $\$ 22$.

WHAT IS MEANT BY ‘BOND’?
A bond is a fixed-income instrument that represents a loan made by an investor to a borrower (typically corporate or government).Bond details include the end date when the principal of the loan is due to be paid to the bond owner and usually include the terms for variable or fixed interest payments made by the borrower.

WHAT ARE THE MAIN FEATURES OF AN INDEX-LINKED SECURITY?
An index-linked bond is a bond in which payment of interest income on the principal is related to a specific price index, usually the Consumer Price Index (CPI). This feature provides protection to investors by shielding them from changes in the underlying index.

WHAT IS THE RELATIONSHIP BETWEEN REAL AND NOMINAL YIELDS?
Nominal yield= risk-free real yield+ expected future inflation + inflation risk premium, if inflation risk premium is ignored, the difference between nominal and real yields gives an estimate of the market’s expectations for inflation.

WHAT IS THE PURPOSE OF COLLECTIVE INVESTMENT SCHEMES?
A Collective Investment Scheme is an investment scheme where various individuals come together and pool their money in order to invest their whole fund collection in a particular asset.

WHY SHOULD AN INVESTOR CHOOSE AN INVESTMENT FUND SCHEME?
Diversification- Funds typically spread their investment across different companies, asset types and geographical regions, providing a benefit known as ‘diversification’. When one investment is down, another might be up, and you’re not taking a chance on the fortunes of one single asset.
Ease of use- The day-to-day running of your investment is designed to be straightforward. A fund manager invests on your behalf and you’ll receive regular reports on how your money has been invested
Cost- They spread fixed costs, such as the charges for safekeeping of assets across all investors in the fund.
Professional investment management- Investment funds allow you to access the expertise of full‑time, dedicated fund managers and their teams of analysts who have access to market information outside the scope of the average investor.

WHAT ARE TYPES OF COLLECTIVE INVESTMENT SCHEMES?
There are two main types of collective investment scheme – unit trusts and investment trusts. As a closed ended fund, investment trusts have a fixed number of shares in an issue. This allows managers to take a longer-term view because they do not have to sell assets when investors sell their shares. Unit trusts are the most common types of collective investment scheme in the UK and are also referred to as open-ended funds, because they will always accept more cash from investors – they just become bigger to accommodate the demand. On the flip side, if there are more sellers than buyers, the fund will become smaller. This is because it is structured as a company that can create shares for new investors and which will buy shares back from an investor if they wish to sell.

WHAT FACTORS INFLUENCE THE RISK APPETITE OF ANY ORGANISATION?
Risk appetite can vary based on a number of factors, such as:
a) industry,
b) company culture,
c) competitors,
d) the nature of the objectives pursued (e.g. how aggressive they are), and
e) the financial strength and capabilities of the organisation (i.e. the more resources a company has, the more willing it may be to accept risks and the costs associated with them).

GIVE EXAMPLES OF ESG FACTORS AFFECTING RISK APPETITE.
ESG risks are the risks of any negative financial impact on the institution stemming from the current or prospective impacts of ESG factors on its counterparties or invested assets.
For example :
a) Carbon emissions.
b) Air and water pollution.
c) Deforestation.
d) Employee gender and diversity.
e) Data security.
f) Diversity of board members.
g) Political contributions.

PART 1: THE ACTUARIAL CONTROL CYCLE & GENERAL ENVIRONMENT

CAN YOU EXPLAIN THE ACTUARIAL CONTROL CYCLE AND WHY THE FEEDBACK LOOP IS CRUCIAL?
It is a risk management framework with three stages: Specifying the Problem (identifying risks/objectives), Developing the Solution (pricing/modeling), and Monitoring the Experience. The feedback loop is critical because models are simplifications of reality; monitoring actual experience allows actuaries to refine assumptions and re-specify the problem for the next cycle.

WHAT ARE THE FOUR MAIN AIMS OF FINANCIAL REGULATION?
(Mnemonic: GRIP)
Give confidence in the financial system.
Reduce financial crime.
Inefficiencies in the market corrected.
Protect consumers (especially regarding information asymmetry).

WHAT ARE THE POTENTIAL INDIRECT COSTS OF REGULATION?
(Mnemonic: C PAIR)
Competition reduced (barriers to entry).
Professionalism undermined (rules replace judgment).
Alteration of consumer behavior (false sense of security/moral hazard).
Innovation reduced.
Reduced market efficiency.

EXPLAIN “INFORMATION ASYMMETRY” AND ITS TWO MAIN CONSEQUENCES.
It occurs when one party (usually the customer) knows more about the risk than the insurer. It leads to:
Anti-Selection: High-risk people are more likely to buy insurance.
Moral Hazard: Insured people take fewer precautions because they are protected.

WHY DO EMPLOYERS FINANCE BENEFITS FOR EMPLOYEES?
(Mnemonic: PEAP)
Paternalism (desire to look after staff).
Encouragement (or compulsion) from the State.
Attract and retain good quality staff.
Pool expenses and expertise (economies of scale).

PART 2: PRODUCT DESIGN & PRICING (SCENARIO APPLICATIONS)

SCENARIO: YOU ARE PRICING PUBLIC LIABILITY INSURANCE FOR A MUSIC FESTIVAL WITH FIREWORKS. WHAT ARE THE KEY RISKS?
Injury to the crowd (burns, crush injuries).
Property damage (fire spreading to stages/venues).
Cancellation (weather risks).
Operational risks (falling rigs, food poisoning).
Pricing approach: Lack of data is a key issue; use external industry data or reinsurer rates and include significant margins for uncertainty.

SCENARIO: A GOVERNMENT POSTAL SERVICE LOSES ITS MONOPOLY. WHAT IS THE BIGGEST RISK TO THE GOVERNMENT SERVICE?
Anti-Selection (Cherry Picking). Commercial competitors will likely target the profitable urban routes. The government service, usually mandated to deliver everywhere, will be left with high-cost rural routes but without the urban profits to cross-subsidize them, leading to insolvency.

WHAT FACTORS MUST BE CONSIDERED WHEN DESIGNING A PRODUCT?
(Mnemonic: AMPLE DIRECT FACTORS)
Administration systems.
Marketability.
Profitability.
Level of benefits.
Early leaver benefits.
Discretionary benefits.
Interests of customers.
Risk appetite.
Expenses vs Charges.
Competition.
Terms & conditions.
Financing.

WHY MIGHT A COMPANY PRICE A PRODUCT AS A “LOSS LEADER”?
To aggressively gain market share, acquire customer data, or cross-sell more profitable products (e.g., selling cheap car insurance to capture a customer for home or life insurance).

EXPLAIN “NEW BUSINESS STRAIN”.
The immediate depletion of capital when a new contract is written. It occurs because initial cash outflows (commission, marketing, set-up) plus regulatory reserves usually exceed the first premium received.

PART 3: INVESTMENTS & ASSET-LIABILITY MANAGEMENT

WHY WOULD AN INVESTOR HOLD MONEY MARKET INSTRUMENTS (CASH)?
(Mnemonic: POURS)
Protection of monetary value.
Opportunities (liquidity to invest when markets fall).
Unexpected liabilities.
Recently received cashflow (waiting to be invested).
Short-term liabilities.

SCENARIO: A RETAILER ISSUES A BOND IN A FOREIGN CURRENCY TO SAVE ON INTEREST. WHAT ARE THE RISKS?
Currency Risk: If domestic currency depreciates, repayment costs rise, potentially wiping out interest savings.
Mismatch: Unless the retailer has revenue in that foreign currency, assets and liabilities are mismatched.

WHAT DETERMINES THE SHAPE OF THE YIELD CURVE?
(Mnemonic: MILE)
Market Segmentation (supply/demand at different terms).
Inflation Risk Premium (investors demand yield for long-term inflation risk).
Liquidity Preference (investors demand premium for locking money away).
Expectations (market view of future rates).

WHY IS COMMERCIAL PROPERTY A GOOD MATCH FOR PENSION LIABILITIES?
It is a real asset; rental income and capital values tend to track earnings/price inflation over the long term. However, risks include illiquidity, lumpiness (high unit size), and voids (periods with no tenant).

EXPLAIN SYSTEMATIC VS. DIVERSIFIABLE RISK.
Systematic: Market-wide risk (e.g., recession) that cannot be diversified away.
Diversifiable: Risk specific to a single asset (e.g., a CEO resigning) which can be eliminated by holding a broad portfolio.

PART 4: PENSIONS

SCENARIO: A FOOTBALL CLUB HAS A PENSION SCHEME FOR PLAYERS (SHORT CAREER) AND STAFF (LONG CAREER). HOW SHOULD INVESTMENT STRATEGIES DIFFER?
Players: Retire young (e.g., 35). Liabilities are “short duration.” Need liquid assets (bonds/cash) to pay out early. High-risk equities are unsuitable due to the short time horizon.
Staff: Retire later (e.g., 65). Liabilities are “long duration.” The scheme can invest in equities/property to capture long-term growth.

DISTINGUISH BETWEEN DEFINED BENEFIT (DB) AND DEFINED CONTRIBUTION (DC) SCHEMES.
DB: Benefit is guaranteed (e.g., % of final salary). Sponsor bears investment/longevity risk.
DC: Contribution is fixed. Member bears investment/longevity risk (benefits depend on fund performance and annuity rates).

WHAT IS THE “SPONSOR COVENANT”?
The employer’s ability and willingness to support the scheme. If the covenant is weak (employer near insolvency), the scheme must take less investment risk and demand higher contributions to secure benefits.

IF A DB SCHEME IS IN DEFICIT, WHAT OPTIONS DOES THE SPONSOR HAVE?
Increase contributions (cash injection), change investment strategy (seek higher returns), reduce future benefit accrual (e.g., close to new entrants), or offer transfer values to remove liabilities.

HOW CAN “LIFESTYLING” HELP DC MEMBERS?
It automatically switches funds from high-risk assets (equities) to low-risk assets (bonds/cash) as the member approaches retirement, protecting the pot size from market crashes just before benefits are taken.

PART 5: RISK MANAGEMENT

WHAT ARE THE MAIN RISK MANAGEMENT TOOLS?
Transfer (Reinsurance), Reduce/Control (Underwriting), Retain/Accept (Capital buffers), Avoid (Exit market), and Diversify.

SCENARIO: A GOVERNMENT WANTS TO INSURE NUCLEAR POWER. WHY IS THIS HARD FOR THE PRIVATE MARKET?
Capacity: Potential losses (catastrophic liability) exceed private insurers’ capital. Data: Events are rare, making pricing difficult. Correlation: One event triggers multiple lines (property, liability, health). It usually requires a government-backed pool.

EXPLAIN QUOTA SHARE VS. SURPLUS REINSURANCE.
Quota Share: Reinsurer takes a fixed % of every risk. Good for simplicity and capital relief.
Surplus: Reinsurer only takes the part of a risk exceeding a retention limit. Good for increasing capacity to write large risks while keeping profit on small ones.

WHAT IS “OPERATIONAL RISK”?

The risk of loss resulting from inadequate or failed internal processes, people, systems, or external events (e.g., fraud, IT failure, legal compliance, reputational damage).

WHAT IS ENTERPRISE RISK MANAGEMENT (ERM)?
Managing risks holistically across the organization rather than in silos. It allows recognition of diversification benefits (e.g., mortality risk offsetting longevity risk) to optimize capital holding.

PART 6: CAPITAL & SOLVENCY

DIFFERENCE BETWEEN REGULATORY CAPITAL AND ECONOMIC CAPITAL?
Regulatory: Minimum capital required by the regulator to operate legally (often formula-based).
Economic: The company’s own assessment of capital needed based on its specific risk profile and business strategy.

WHAT IS “SUBORDINATED DEBT”?
Debt that ranks below policyholder liabilities in winding up. Regulators often allow it to count as capital (Tier 2) because it acts as a buffer for policyholders.

EXPLAIN “SECURITIZATION” (E.G., CATASTROPHE BONDS).
Transferring insurance risk to capital markets. Investors buy bonds; if a specific catastrophe occurs, the insurer keeps the principal to pay claims. If not, investors get a high yield.

WHY DO COMPANIES HOLD FREE ASSETS?
(Mnemonic: REG CUSHION)
REGulatory requirement.
Cushion against adverse experience.
Unexpected events.
Smooth profits.
Help demonstrate financial strength.
Investment freedom.
Opportunities (acquisitions).
New business strain.

WHAT IS LIQUIDITY RISK FOR AN INSURER?
Being solvent (assets > liabilities) but unable to convert assets into cash quickly enough to pay claims as they fall due without suffering a loss in value (fire sale).

PART 7: VALUATION & DATA

WHAT IS A “MODEL POINT”?
A representative policy used to reduce computing time. Similar policies (e.g., males aged 40 with Term Assurance) are grouped into one Model Point, which is projected and scaled up by the volume of business.

DETERMINISTIC VS. STOCHASTIC MODELING?
Deterministic: Uses one set of assumptions to produce one outcome.
Stochastic: Uses probability distributions for variables and runs thousands of simulations. Essential for valuing options and guarantees.

WHY IS DATA QUALITY CRUCIAL?
“Garbage in, garbage out.” Incorrect data (dates of birth, claims history) leads to wrong pricing and reserves, potentially causing insolvency or reputational damage.

WHAT IS AN “ANALYSIS OF SURPLUS”?
(Mnemonic: DIVERGENE) An analysis breaking down the difference between expected and actual profit into sources (e.g., mortality profit, investment profit, expense loss) to provide feedback to management.

EXPLAIN “BEST ESTIMATE” VS. “PRUDENT” ASSUMPTIONS.
Best Estimate: 50/50 median outcome.
Prudent: Includes a Margin for Adverse Deviation (MAD) to ensure a high probability (e.g., 99.5%) that liabilities can be met even in bad scenarios.

PART 8: EXPERIENCE MONITORING

WHY MIGHT MORTALITY EXPERIENCE BE WORSE THAN EXPECTED?
Random Fluctuation (small data), Catastrophe (pandemic), Trend (worsening health/obesity), or Anti-Selection (poor underwriting standards).

SCENARIO: A ROCK MUSICIAN ASKS YOU TO REVIEW HIS FINANCES. WHAT DO YOU CHECK?
Fees: Are management charges reasonable?
Conflicts: Are managers receiving undisclosed commissions?
Suitability: Are assets liquid enough for tax bills? Is he over-insured for tours but under-insured for long-term health?

HOW DO YOU MONITOR AN INVESTMENT MANAGER?
Compare returns against a benchmark (index/peer group). Analyze attribution—was performance due to market movement (luck) or stock selection (skill)? Check adherence to the risk mandate.

WHAT IS “PERSISTENCY” AND WHY MONITOR IT?
It measures policy renewal rates. High lapses in early years cause losses (acquisition costs not recovered). In later years, lapses remove profitable future cash flows.

YOU FIND A MATERIAL ERROR IN A REPORT THE NIGHT BEFORE A DEADLINE. WHAT DO YOU DO?
(Professionalism check). Do not hide it. Inform senior management immediately. Assess financial impact. Determine if the report can be delayed or submitted with a clear caveat/qualification regarding the error.

PART 9: GENERAL INSURANCE SPECIFICS

WHAT ARE “LATENT CLAIMS”?
Claims arising from causes not realized when the policy was written (e.g., Asbestos). They appear decades later, affecting old policies, and are very hard to reserve for.

EXPLAIN “IBNR”.
Incurred But Not Reported. A reserve for claims that have happened but the insurer doesn’t know about yet. Crucial for “Long-tail” business like Employer’s Liability.

HOW DOES THE “UNDERWRITING CYCLE” WORK?
High profits attract entrants $\to$ competition drives premiums down (Soft Market) $\to$ losses occur $\to$ capital depletes and insurers withdraw $\to$ premiums rise again (Hard Market).

SCENARIO: PRICING INSURANCE FOR A SATELLITE LAUNCH WITH NO DATA.
Use external data (industry stats), reinsurer rates, or first principles (engineering failure risk). Add significant margins for uncertainty and use reinsurance to limit exposure.

WHAT IS A “STOP LOSS” REINSURANCE TREATY?
It protects the insurer’s total annual result. If the total claims ratio exceeds a set % (e.g., 110% of premiums), the reinsurer pays the excess. It protects against volatility in the whole portfolio.

PART 10: STRATEGY

WHY MIGHT AN INSURER CLOSE TO NEW BUSINESS?
Insolvency (regulatory intervention), strategic decision to exit an unprofitable market, or following a merger to consolidate systems.

WHAT IS “FINANCIAL REINSURANCE”?
Reinsurance used primarily for capital management (e.g., smoothing profits) rather than risk transfer. It often involves the reinsurer providing upfront capital (loan) repaid from future profits.

A BANK WANTS TO SELL LIFE INSURANCE (BANCASSURANCE). WHAT ARE THE RISKS?
Cultural clash (transactional vs long-term), Mis-selling risk (pushing products to hit targets), and Concentration risk (reliance on one distribution channel).

HOW DOES INFLATION AFFECT A GENERAL INSURER?
It increases future claims costs (claims inflation), especially in long-tail business (wages/medical costs). If reserves didn’t anticipate this, they will be insufficient.

WHY IS “TREATING CUSTOMERS FAIRLY” (TCF) IMPORTANT?
Financial products are complex and long-term. Customers rely on the provider’s integrity. TCF ensures suitability, clear marketing, and fair claims handling, preventing regulatory fines and reputational ruin.