**BEGINNING OF EXAMINATION**

Morning Session

1. (10 points) Your company is developing a level death benefit universal life product for
sale in the US. The product will be sold with a chronic illness accelerated benefit rider
and a disability waiver rider.

(a) (1 point) Describe the three common chronic illness acceleration rider designs.

(b) (1 point) Describe additional underwriting risk control measures your company
should consider when developing the rider.

(c) (3 points) Assess whether each the following will receive favorable tax treatment
under section 101(g) of the Internal Revenue Code:

(i) Unable to perform at least three activities of daily living due to a loss of
functional capacity.

(ii) The only insurance protection provided under the universal life policy and
chronic illness acceleration rider is coverage of qualified long-term care
services.

(iii) Chronic illness acceleration rider reimburses for all expenses incurred.

Justify your answer.

(d) (5 points) You are given the following information about the proposed UL
product design:

 The guaranteed minimum interest rate applied to the policy account

value is 3%.
 The annual administrative charge is 60 on a current basis and 100 on a
guaranteed basis.
 The premium load is 7%, on both current and guaranteed bases.
 The chronic illness rider qualifies for favorable tax treatment under
section 101(g) of the Internal Revenue Code.

Exam ILALP: Spring 2018 -1- GO ON TO NEXT PAGE

Life Pricing
Morning Session
1. Continued

You are also given the following information for 100,000 policy on a female
insured, age 55:

 The annual deduction for the chronic illness rider is 900, payable until
maturity.
 The annual deduction for the disability waiver rider is 500, payable
until the insured attains age 65.

Interest Rate A55 a55 a55:10

3% 0.436 18.442 8.313
4% 0.345 16.207 7.909
6% 0.225 12.870 7.184

Compute the Guideline Single Premium and Guideline Level Premium under
section 7702 of the Internal Revenue Code.

Show all work.

Exam ILALP: Spring 2018 -2- GO ON TO NEXT PAGE

Life Pricing
Morning Session
2. (9 points) XYZ Life markets various whole life insurance products in the US and
Canada.

(a) (2 points) Describe the principles which should be followed in analyzing the
mortality and persistency experience of XYZ’s whole life insurance block of
business.

(b) (3 points) The most recent experience study showed significant differences in
mortality and persistency experience compared to previous experience studies.
This experience was used to price a new product and filed with the Department of
Insurance. An error was discovered in the data and corrected results now show
minor differences from previous experience studies.

List disclosures required by the Proposed ASOP—Setting Assumptions.

(c) (4 points) XYZ used the Forced Method to end the mortality table at attained age 100.

Calculate mortality rates to age 120 using two alternative methods that are less
conservative than the Forced Method, using the mortality table below:

Age (x) qx
96 0.36
97 0.40
98 0.45
99 0.55
100 1.00

Show all work.

Exam ILALP: Spring 2018 -3- GO ON TO NEXT PAGE

Life Pricing
Morning Session
3. (9 points) MBB Life has been selling term and participating whole life insurance products for
the past ten years. The term life insurance product allows conversion to MBB’s participating
whole life insurance products.

(a) (1 point) Describe a term conversion privilege.

(b) (2 points) Explain two primary ways to cover the cost of anti-selective mortality due to
term conversions.

(c) (5 points) MBB’s prior dividend scale is consistent with the scale that was in place
when MBB began issuing participating business. The following table shows prior and
current dividend scales as of the end of 2017:

Time Prior Scale Current Scale

2017 10 10
2018 12 11
2019 14 12
2020 16 13
2021 12 14

(i) Compare and contrast the following methods for changing a dividend scale:

 Pegging method
 Substitution method

(ii) Calculate the present value of the future dividend scale as of the end of 2018
using the two methods above and an interest rate of 3%. Show all work.

(iii) Recommend a method that MBB should use to change the dividend scale.
Justify your answer.

(d) (1 point) List the four main sources of earnings that drive a dividend scale.

Exam ILALP: Spring 2018 -4- GO ON TO NEXT PAGE

Life Pricing
Morning Session
4. (12 points) IJK Life sells Variable Annuities with Guaranteed Minimum Income
Benefits as well as 10-Year Term Insurance products.

IJK has recently concluded that no changes are needed to their current products because
each product’s Embedded Value meets company benchmarks.

IJK is considering the use of an Economic Value framework to improve their risk profile.

(a) (2 points) List the disadvantages of using Economic Value in the evaluation of
IJK’s products.

(b) (1 point) Explain how a Replicating Portfolio could be used within the Economic
Value Framework.

(c) (6 points) You are given the following information for IJK’s Variable Annuity
product:

Amount (millions)
Total Assets (Beginning of period) 120
Premiums 40
Claims 20
Expenses 2
Economic Liabilities (Beginning of period) 45
Economic Liabilities (End of period) 60
Base cost of capital 9
Risk capital cost 1

Return on invested assets is 10%

Return on replicating portfolio is 5%

Exam ILALP: Spring 2018 -5- GO ON TO NEXT PAGE

Life Pricing
Morning Session
4. Continued

(i) (1 point) Describe the benefits of using a treasury function to measure a

product’s performance.

(ii) (3 points) Calculate the economic profit for each of the following
components:

 Insurance
 Investment
 Treasury

Show all work.

(iii) (1 point) Assess whether product performance is acceptable.

(iv) (1 point) List two ways to increase product performance based on the
calculations above.

(d) (3 points) IJK is also considering moving from traditional pricing methods to risk
based pricing using a market consistent approach.

Assess the effects on profit margin for each of IJK’s products with respect to the
following:

 Investment guarantees
 Asset returns
 Insurance adjustability

Exam ILALP: Spring 2018 -6- GO ON TO NEXT PAGE

Life Pricing
Morning Session
5. (14 points) LWS Life offers a portfolio of life insurance, health insurance and annuity
products.

(a) (1 point) Describe the key risks associated with a standalone Long-Term Care
Insurance (LTCI) product

(b) (11 points) LTCI sales have been declining. LWS is considering offering a LTCI
and annuity combination product.

(i) (2 points) Describe how LTCI combination products reduce risk versus a
standalone LTCI, which provides the same LTCI benefit amount.

(ii) (1 point) Describe the benefits to consumers of LTCI combination

products with extension of benefit riders.

(iii) (4 points) You are given the following sensitivity test scenarios for a
proposed LTCI and annuity combination product:

Scenario Sensitivity
A 80% of Active Life Mortality
B 130% Annual Lapse rate
C 110% LTC Incidence Rates
D 115% Claim Termination Rates

Assess the impact on product profitability for each scenario. Justify your
answer.

(iv) (4 points) Recommend a LTCI and annuity combination product that

minimizes the risk to LWS for each of the following product designs:

A. LTCI and annuity combination with a 2 year acceleration benefits,

without inflation
B. LTCI and annuity combination with a 2 year acceleration benefit
and 4 year extension of benefit rider, without inflation
C. LTCI and annuity combination with a 3 year acceleration benefit
and 3 year extension of benefit rider with inflation

Justify your answer.

Exam ILALP: Spring 2018 -7- GO ON TO NEXT PAGE

Life Pricing
Morning Session
5. Continued

(c) (2 points) The CEO has proposed to stop the sale of critical illness products because the
premium is expensive and LWS also sells disability income insurance.

Critique the CEO’s proposal. Justify you answer.

Exam ILALP: Spring 2018 -8- GO ON TO NEXT PAGE

Life Pricing
Morning Session
6. (6 points)

(a) (2 points) ABC Life’s primary focus is on Term Life insurance and Universal
Life insurance with Secondary Guarantees (ULSG).

(i) Explain three different reserve components and their mechanics under
VM-20.

(ii) Describe the advantages and disadvantages with delayed adoption of VM-
20.

(b) (4 points) ABC recently launched a new term life product sold through its
brokerage channel. You have been asked to conduct an experience study on the
first year lapses.

(i) You are given the following:

 49 of 784 policies lapsed in the first policy year.

 Expected first year lapse rate is 5%

Determine if the first year lapse assumption is appropriate assuming a

95% confidence interval. Show all work.

(ii) Identify two different methods to enhance credibility in setting the lapse
assumption.

(iii) A lapse study shows significant differences from the industry survey.

Explain the possible causes of these differences.

**END OF EXAMINATION**
Morning Session

Exam ILALP: Spring 2018 -9- STOP

Life Pricing
Morning Session
 **BEGINNING OF EXAMINATION**
Afternoon Session
Beginning with Question 7

7. (12 points)

(a) (3 points) A small U.S. life insurance company primarily sells term insurance,
targeting the middle-income market in western states. The underwriting process is
efficient and profits have been excellent.

Assume the following.

 A large eastern state recently passed a law that allows its residents to
deduct a portion of annuity premiums paid from their taxable income.
 The CEO would like to quickly develop an annuity product to take
advantage of this opportunity.

Describe three reasons why the CEO’s strategy may not be successful.

(b) (6 points) An actuary at your company has asked for assistance to prepare the
figures for a nonforfeiture demonstration in accordance with the requirements of
the NAIC Standard Nonforfeiture Law (SNFL) for Individual Deferred Annuities.

The actuary has provided you with the following information for an Individual
Deferred Annuities:

Account(s) Fixed only

Guarantee Rate 0.5%
Contract Loads None
Surrender Charges Percent of Contract Value
Free partial Withdrawals 10% per year, non-cumulative
Market Value Adjustments None
Minimum Nonforfeiture Interest rate 3%
Maturity Date End of contract year 10
Maturity Value of Paid-up Annuity Benefits Account value at maturity

Exam ILALP: Spring 2018 -1- GO ON TO NEXT PAGE

Life Pricing
Afternoon Session
7. Continued

End of Purchase Guaranteed Guaranteed

Contract Payment Account Cash Value
Year Value
1 25,000 25,125 23,090
2 0 25,251 23,433
3 0 25,377 23,778
4 0 25,504 24,127
5 0 25,631 24,478
6 0 25,759 24,832
7 0 25,888 25,189
8 0 26,018 26,018
9 0 26,148 26,148
10 0 26,279 26,279

(i) Determine whether the guaranteed cash surrender value at the end of
contract year 1 satisfies the prospective (present value) test described in
Section 6 of the SNFL.

(ii) Determine whether the guaranteed cash surrender value at the end of
contract year 10 satisfies the retrospective (accumulation) test described in
Section 4 of the SNFL.

(iii) Contrast these guaranteed cash surrender values to those required in Canada.

Show all work.

(c) (3 points) You have been asked to develop and price an Equity Indexed Annuity
with both an indexed and a fixed (non-indexed) option.

Develop a strategy to address pricing considerations for each of the following

potential situations:

(i) The options used to fund the indexed-based crediting become unavailable
in the market.

(ii) Surrenders are well above expected during periods when competitors have
increased the rates offered on new products.

(iii) A period of low or negative nominal interest rates.

Exam ILALP: Spring 2018 -2- GO ON TO NEXT PAGE

Life Pricing
Afternoon Session
8. (9 points) PQR Life, one of the largest term insurance carriers in the market, is pricing a
10-year Term product. The product has level rates for the first 10 years, followed by
Yearly Renewable (YRT) rates, which are significantly higher than the initial level rates.

This product was priced using an ROI target on distributable earnings.

(a) (3 points) You are given the following year 1 information for the new product:

Premium 5,000
Investment Income 100
Death Benefits 321
Increase in Statutory Reserve 450
Surrenders Benefits 535
Commissions 6,500
Acquisition Expenses 2,000
Maintenance Expenses 363
Increase in Target Surplus 1,200

 Tax rate is 35% and premium tax is 2.5%

 Investment return on target surplus is 10%

Calculate the distributable earnings in year 1. Show all work.

(b) (2 points) PQR’s current reserve basis is XXX with AG48 financing of reserves.

(i) Analyze the impact to PQR of the adoption of VM-20

(ii) Recommend actions PQR can take to minimize the impact of VM-20.

(c) (4 points) An inforce block of policies is reaching the end of the initial 10-year
term period.

(i) (3 points) Describe three approaches that would reduce policy lapses after
the initial level term.

(ii) (1 point) Recommend the approach PQR should select. Justify your
answer.

Exam ILALP: Spring 2018 -3- GO ON TO NEXT PAGE

Life Pricing
Afternoon Session
9. (10 points) CBT Life is developing a new Equity Indexed Annuity (EIA) and
considering three index crediting designs:

Design 1 Design 2 Design 3

Index S&P 500 S&P 500 S&P 500
Index crediting 1 year point-to-point 1 year point-to-point Daily average
method 80% participation 100% participation 150% participation
0% floor 0% floor 0% floor
8% cap No cap 6% cap
No margin 1.00% margin No margin

(a) (5 points) The hedging team has produced the following report assessing the
design options:

To: Product Development team

From: Hedging team
Re: EIA index crediting designs

We have completed our analysis of the three EIA index crediting designs.

Design 1: A static hedge program will be easy to implement for Design 1. We will
simply enter into a call spread option with a notional amount equal to 80% of the
premium. The call spread option is comprised of buying an at-the-money call
option and selling a call option with a strike 8% higher than the current index level.

Design 2: We could implement a static hedge by purchasing a call option with a

strike price 1% higher than the initial index level. However, we feel that a
dynamic hedge program is a better option. We will hold a position in futures to
offset the measured delta in the liability portfolio. Based on the daily market
performance over the past year, this strategy will cost 20% less than the
corresponding static hedge. Therefore, for your current pricing, you can assume
80% of the cost we quoted for the static hedge. To make this option even more
attractive, we suggest removing the floor and increasing the participation rate.

Design 3: We will not be able to meet the “Hedged as Required” criteria given
the options readily available in the market today and the Over-the-Counter (OTC)
market is currently cost prohibitive. Therefore, this design should be discarded
because we will not have a reserving method that complies with AG35.

Exam ILALP: Spring 2018 -5- GO ON TO NEXT PAGE

Life Pricing
Afternoon Session
9. Continued

Critique the Hedging team’s report with respect to:

(i) Regulatory concerns

(ii) Expected hedge performance

(b) (5 points) CBT’s Modeling team is proposing a stochastic equity scenario

generation model for the new EIA product. The proposed model uses geometric
Brownian motion to model equity returns and the resulting scenarios are intended
to be arbitrage-free. You have been asked to perform a comprehensive peer
review of the model.

(i) (1 point) Identify the primary areas of consideration when conducting a

peer review according to Stochastic Modeling: Theory and Reality from an
Actuarial Perspective.

(ii) (1 point) Propose a relevant question that you would address in the peer
review for each of the areas of consideration.

(iii) (3 points) Describe the methods you would use to answer each question.

Exam ILALP: Spring 2018 -6- GO ON TO NEXT PAGE

Life Pricing
Afternoon Session
 ILA LP Model Solutions
Spring 2018

1. Learning Objectives:
1. The candidate will understand various insurance products, markets, and
regulatory regimes.

Learning Outcomes:
(1a) Describe insurance product types, benefits, and features including reinsurance.

(1b) Evaluate insurance markets, consumer needs, distribution channels, and

regulatory regimes.

Sources:
Life Insurance and Modified Endowments Under IRC §7702 and §7702A, v2

Life Insurance Acceleration Riders, Filmore - Reinsurance Section, July 2013, pp. 35 –
38

Commentary on Question:
This question tested candidates’ understanding of life insurance acceleration riders, their
associated tax treatments, and required them to calculate guideline premium tests under
section 7702 of the Internal Revenue Code.

Solution:
(a) Describe the three common chronic illness acceleration rider designs.

Commentary on Question:
Candidates generally performed well on this question, however some candidates
described alternate critical illness acceleration rider designs appropriate for
annuity/long term care insurance combinations for which no credit was awarded.

Actuarial discounting of the face amount being accelerated

• A reduced amount of the face amount is accelerated in a given year
• Reduction reflects actuarial discount for time value of money associated with
benefit being paid early as well as foregone premiums related to accelerated
amount

Accelerated benefit through a lien against the death benefit of the policy
• Amount of lien equals cumulative accelerated death benefit plus interest
• Death benefit ultimately paid is reduced by outstanding lien balance

ILA LP Spring 2018 Solutions Page 1

1. Continued

Charge an explicit additional premium at the time the critical illness acceleration
rider is added to the policy

(b) Describe additional underwriting risk control measures your company should
consider when developing the rider.

Commentary on Question:
Candidates generally struggled with this question. Many candidates did not
provide measures specific to underwriting risk and/or did not fully describe their
suggestions. Credit was given for other reasonable underwriting risk control
measures if properly explained.

• Focus on conditions that may result in morbidity associated with activities of

daily living (ADL) losses that may not be included in a typical life insurance
application
• Probe regarding ADL losses or other current disabilities
• Ask questions related to other living benefits coverage inforce (for example:
Long term care, critical or terminal illness acceleration riders)
• Limit issue age at which chronic illness rider can be added
• Only offering rider on policies up to a specified maximum rating
• Requiring an approved licensed healthcare practitioner to confirm the
policyholder is unable to perform ADLs

(c) Assess whether each the following will receive favorable tax treatment under
section 101(g) of the Internal Revenue Code:

(i) Unable to perform at least three activities of daily living due to a loss of
functional capacity.

(ii) The only insurance protection provided under the universal life policy and
chronic illness acceleration rider is coverage of qualified long-term care
services.

(iii) Chronic illness acceleration rider reimburses for all expenses incurred.

Justify your answer.

Commentary on Question:
Many candidates had difficulty with this question and didn’t provide appropriate
justification for their responses.

ILA LP Spring 2018 Solutions Page 2

1. Continued

(i) - A policyholder qualifies for non-taxable benefits if he/she is unable to

perform at least 2 out of 6 activities of daily living (ADLs)
- As it is permissible to have a more stringent benefit trigger, requiring the
policyholder to be unable to perform at least 3 ADLs will receive
favorable tax treatment under section 101(g) of the Internal Revenue Code

(ii) - This meets the definition of a qualified long term care insurance contract
(QLTCI) as defined in section 7702B
- Any chronic illness benefits provided on a periodic, lump-sum, or other
non-reimbursement basis are excludable from income only to the extent of
the per diem limitation of section 7702B
- Benefits received from the insured’s chronic illness will be excludable
from income (i.e. tax-free) and therefore qualify for favorable tax
treatment under section 101(g) of the Internal Revenue Code

(iii) - The primary purpose for the expenses must be related to care required or
needed assistance due to the insured’s chronic illness
- Personal expenses with no relationship to the insured’s needed medical
assistance cannot be reimbursed
- Therefore, Chronic illness acceleration rider reimbursing for all expenses
incurred does not qualify for favorable tax treatment under section 101(g)
of the Internal Revenue Code

(d) Compute the Guideline Single Premium and Guideline Level Premium under
section 7702 of the Internal Revenue Code.

Show all work.

Commentary on Question:
Almost all candidates used the appropriate interest rates for each calculation.
Many candidates were able to correctly compute the Guideline Single Premium
and Guideline Level Premium. Common errors included using the guaranteed
expense charge, including the chronic illness rider, or excluding the disability
waiver rider.

Assumptions required for both calculations:

Per IRS rulings on the reasonable expense charge rule, assume current charges for
contracts providing both current and guaranteed expense charges.
Therefore, annual administrative charge = $60.

Premium load = 7%

ILA LP Spring 2018 Solutions Page 3

1. Continued

The disability waiver rider is a Qualified Additional Benefit (QAB).

Therefore, include disability waiver rider charge of $500 in both Guideline Single
Premium (GSP) and Guideline Level Premium (GLP) calculations.

The chronic illness rider is not a QAB.

Therefore, exclude chronic illness waiver rider charge in both Guideline Single
Premium (GSP) and Guideline Level Premium (GLP) calculations.

Interest rate used for GSP

= maximum (6%, guaranteed minimum interest rate)
= maximum (6%, 3%)
= 6%

Interest rate used for GLP

= maximum (4%, guaranteed minimum interest rate)
= maximum (4%, 3%)
= 4%

GSP = [(Death Benefit * A55, 6%) + (Disability waiver rider charge * ä55:10, 6%) +
(Annual Admin Charge * ä55, 6%)] / (1 – Premium Load)
GSP = [(100,000 * 0.225) + (500 * 7.184) + (60 * 12.870)] / (1 – 0.07)
GSP = 26,864.20 / 0.93
GSP = 28,886.24

GLP = [(Death Benefit * A55, 4%) + (Disability waiver rider charge * ä55:10, 4%) +
(Annual Admin Charge * ä55 ,4%)] / [ä55, 4% * (1 – Premium Load)]
GLP = [(100,000 * 0.345) + (500 * 7.909) + (60 * 16.207)] / [16.207 * (1 – 0.07)
GLP = 39,426.92 / 15.07251
GLP = 2,615.82

ILA LP Spring 2018 Solutions Page 4

2. Learning Objectives:
2. The candidate will understand the relationship between product features, inherent
risks, and the methods and measures to design and price products.

Learning Outcomes:
(2a) Identify, assess, and develop appropriate assumptions to reflect factors such as
product characteristics, risks, policyholder behavior, and company actions.
• Describe and apply the uses of predictive modeling.

Sources:
Experience Data Quality: How to Clean and Validate Your Data

LP-107-07: Experience Assumptions for Individual Life Insurance and Annuities

Proposed ASOP on Setting Assumptions, December, 2016

Commentary on Question:
Commentary listed underneath question component.

Solution:
(a) Describe the principles which should be followed in analyzing the mortality and
persistency experience of XYZ’s whole life insurance block of business.

Commentary on Question:
Overall, students did well. The most common issue was students gave a lot of
detail about Quality of Data, but overlooked discussing the other principles. It is
better to give fewer details about one aspect of the solution but touch on as many
principles as possible, as opposed to writing down everything you know about one
principle and exclude discussing the other principles.

1) Evaluate the credibility of the data

- requires actuarial judgment, need to consider the homogeneity of data and
reasonability of methods and results
2) Evaluate the quality of data
- data which is completely accurate is seldom available
- objective of data cleansing is to have valid and accurate data

- should find and correct common data validity errors first before moving on to
complex data checks
- data validity errors are more common and frequent in inter/intra company
studies than data accuracy errors
- frequently data entry errors are to blame for data validity and accuracy errors
within the source data

ILA LP Spring 2018 Solutions Page 5

2. Continued

3) Use actual (or similar) experience

- experience used should be determinable, available and statistically credible
4) Reflect trends in experience as appropriate
- it is not enough to just look at experience in the last year to set an assumption
- need to evaluate any trends in experience over time, and make a judgment
whether any trends will continue
5) Reflect company and external factors
- review company business practices and reflect them in setting the assumption
- especially true if company practices have changed or are expected to change
- one example is to consider the company's underwriting rules
- mortality rates should reflect the selection criteria for each rating class, the
frequency underwriters make exceptions to the rules, the requirements for
reinstatement, etc.
6) Sensitivity test the assumptions
- actuary should conduct sensitivity tests of the impact of likely deviations in
experience that could have a material impact
- standard statistical tests or historical experience can help establish range of
likely deviation

(b) The most recent experience study showed significant differences in mortality and
persistency experience compared to previous experience studies. This experience
was used to price a new product and filed with the Department of Insurance. An
error was discovered in the data and corrected results now show minor differences
from previous experience studies.

List disclosures required by the Proposed ASOP—Setting Assumptions.

Commentary on Question:
Part b was answered well by the majority of students. One suggestion is to give a
reason for your comment. For example, part marks were given if a student wrote,
“Disclose material assumptions”. But more marks were given if a student said
why material assumptions should be disclosed … ie “to permit another qualified
actuary to assess the reasonableness of the assumptions.”

The pricing actuary (pa) should disclose:

Refer to ASOP #41, Actuarial Communications for the appropriate disclosures
contained therein
Disclose material assumptions in detail to permit another qualified actuary to
assess the reasonableness of assumptions
Description should include a disclosure of any explicit margin for adverse
deviations
Disclose material changes in assumptions since most recent actuarial report
should be communicated, so state that there are differences from previous
reporting but differences were reconciled

ILA LP Spring 2018 Solutions Page 6

2. Continued

According to ASOP 41, state any changes as regards subsequent events or

changes that became known after the information date that would have affected
the assumptions set as of the information date
Material inconsistencies among assumptions and reasons for such inconsistencies
However in case of prescribed assumptions set by law, pa's disclosure may be
limited to identify the possibility of an inconsistency with other assumptions
Use professional judgment when setting assumptions or assessing whether
asumptions used in the experience study are reasonable
Consider to what extent it is appropriate to adjust the assumptions to compensate
for known deficiencies in the data
Consider the reasonableness of the material assumptions and whether it is
reasonable in the aggregate

Disclose any reliance on the other actuaries assumptions used in experience study

(c) XYZ used the Forced Method to end the mortality table at attained age 100.

Calculate mortality rates to age 120 using two alternative methods that are less
conservative than the Forced Method, using the mortality table below:

Age (x) qx
96 0.36
97 0.40
98 0.45
99 0.55
100 1.00

Show all work.

Commentary on Question:
Part c was very well done. Be sure to show your work though. A value for every
single age did not have to be shown, but enough information and values needed to
be provided to indicate what your approach was. It would be a good idea to show
a few q’s …. Say at ages 101-103 and then a few q’s at the end of the table … say
ages 118, 119 and 120. Part marks were given if not enough detail was provided.

Candidate should extend ultimate age to address conservatism concerns.

Blended method: select an ultimate age and blend the rates from some earlier age
to dovetail smoothly into
1.000 at the ultimate age

ILA LP Spring 2018 Solutions Page 7

2. Continued

Pattern method: let the pattern of mortality continue until the rate approaches or
hits 1.000 and set that as the
ultimate age.

Less than one Method: Select an ultimate age but end the table at whatever rate is
produced at that age so that the ultimate rate is less than one.

Blended method: candidate should apply appropriately to a higher ultimate age

(e.g. 120). Could linearly interpolate between .55 at age 99 and 1 at age 120.
Pattern method: candidate should extend using the pattern in the table given
(variety of answers)
Less than one: candidates should select an ultimate age and end the table at
whatever rate is produced at that age (a rate less than one) … variety of answers.

ILA LP Spring 2018 Solutions Page 8

3. Learning Objectives:
1. The candidate will understand various insurance products, markets, and
regulatory regimes.

2. The candidate will understand the relationship between product features, inherent
risks, and the methods and measures to design and price products.

Learning Outcomes:
(1a) Describe insurance product types, benefits, and features including reinsurance.

(2a) Identify, assess, and develop appropriate assumptions to reflect factors such as
product characteristics, risks, policyholder behavior, and company actions.
• Describe and apply the uses of predictive modeling.

Sources:
LP-105-07: Life and Annuity Products and Features

SOA - Society of Actuaries - Product Development Section Newsletter (Product

Matters!), Term Conversions – A Reinsurer’s Perspective, June 2012, pp. 1, 5 – 6
LP

LP-110-07: Policyholder Dividends

Commentary on Question:
Commentary listed underneath question component.

Solution:
(a) Describe a term conversion privilege.

Commentary on Question:
Question sought the definition of a term conversion. Most responses provided
general definition of a conversion. Not many candidates provided the specific
details as outlined below.

A term conversion privilege allows the policyholder of term life insurance

product to convert to any whole life permanent insurance products without
evidence of insurability.
Maximum credit given if it was stated that the same rate class is guaranteed.

(b) Explain two primary ways to cover the cost of anti-selective mortality due to term
conversions.

ILA LP Spring 2018 Solutions Page 9

3. Continued

Commentary on Question:
Candidates received full credit for a response similar to below (ie identifying
where to place the cost and an explanation). About two thirds of the candidates
received full credit. Others received partial credit for just saying “include in term
pricing” and “include in permanent life pricing” with limited explanation.

1. Include in term pricing:

a. Aligns the cost to the product that will experience the increased mortality
2. Include in permanent life pricing:
a. Difficult to determine volume of permanent life sales
b. Difficult to predict utilization rate
c. Term products are price sensitive

(c)

Overall Commentary on Question:

This section tested the understanding of the pegging and substitution methods.
Full credit was given if candidates provided a good definition for each method,
calculated the present values, and justified their recommendation. Some
candidates demonstrated full understanding while others struggled with the
definition of the methods.

(i) Compare and contrast the following methods for changing a dividend scale:

Commentary on Question:
Most candidates understood this question and provided a definition, however,
only about half received credit for providing the correct definition. For the
comparison portion of the question, about one third provided enough information
to receive full credit.

• Pegging method: Pays at least as much as the prior dividend

• Substitution method: Replaces the entire current scale with the prior scale
• Similarities:
o Applies when the current scale of the dividend is less than the prior
dividend scale
o Consider the equity between the block of business
o Slightly improves persistency
o Consider additional cost
• Differences:
o Substitution works best for recent issues while pegging applies broader
o Pegging makes spot changes to the current dividend scale while
substitution replaces the entire dividend scale

ILA LP Spring 2018 Solutions Page 10

3. Continued

(ii) Calculate the present value of the future dividend scale as of the end of 2018
using the two methods above and an interest rate of 3%. Show all work.

Commentary on Question:
The solution to this question varied across candidates. Multiple solutions for the future
dividend scale under the pegging method were accepted. Candidates had to show an
increasing scale, with the initial dividend greater than 10 and not decreasing. On the
contrary, there was only one correct solution for the substitution method. For both
methods, credit was given for the discounting being done correctly even if the scales
were not fully correct.
Credit was also given if the candidate assumed that the 2018 dividend had already been
paid and only 3 years of dividends were discounted.

Below is the most common answer shown for the pegging scale and the only solution
for the substitution scale:

Pegging Scale = 11, 12, 13, 14

PV of scale = 11 + 12/1.03 + 13/(1.03^2) + 14/(1.03^3) = 47.72

Substitution Scale = 12, 14, 16, 12

PV of scale = 12 + 14/1.03 + 16/(1.03^2) + 12/(1.03^3) = 51.66

(iii) Recommend a method that MBB should use to change the dividend scale.
Justify your answer.

Commentary on Question:
The majority of the candidates received partial credit for just making a
recommendation of either method (ie. no justification). Additional credit was
given if a reasonable justification to the recommendation was provided.

Recommend Substitution method:

Scale hasn’t been changed in 10 years, reasonable for the company to make a change
now.

OR

Recommend Pegging method:

Slower impact to policyholders
PV is less costly

ILA LP Spring 2018 Solutions Page 11

3. Continued

(d) List the four main sources of earnings that drive a dividend scale.

Commentary on Question:
A list was sufficient for full credit. Most candidates received full credit on this
question.

1. Investment earnings or interest

2. Mortality experience
3. Expense experience
4. Persistency experience

ILA LP Spring 2018 Solutions Page 12

4. Learning Objectives:
2. The candidate will understand the relationship between product features, inherent
risks, and the methods and measures to design and price products.

Learning Outcomes:
(2b) Assess and critique performance measures, risk measures, and modeling
approaches. Recommend their uses in product management.

(2c) Develop and evaluate a product’s performance, capital requirements, tax and
regulatory requirements, and risk profile.

Sources:
LP-113-09 Economics of Insurance How Insurers Create Value for Shareholders Swiss
Re

Risk Based Pricing—Risk Management at the Point of Sale, Product Matters, June 2009

Commentary on Question:
Commentary listed underneath question component.

Solution:
(a) List the disadvantages of using Economic Value in the evaluation of IJK’s
products.

Commentary on Question:
This question tested a candidate’s knowledge of what problems might be
anticipated when switching from an Embedded Value to an Economic Value
framework.

Most candidates were able to identify that an Economic Value framework

compared to the current Embedded Value framework would have its share of
disadvantages, mainly from a complexity of modelling or explanation to senior
management perspective, but very few identified that there would be very few
disadvantages from a Valuation perspective.

From a valuation perspective, there are no disadvantages in using the Economic

Value framework versus the current Embedded Value framework.

The Economic Value framework is more complicated to explain to Senior

Management. From a modelling perspective, there are disadvantage such as the
need to create a replicating asset.

ILA LP Spring 2018 Solutions Page 13

4. Continued

(b) Explain how a Replicating Portfolio could be used within the Economic Value
Framework.

Commentary on Question:
Many candidates were able to identify the first two points below. However, to
receive full credit candidates had to expand on the value of splitting returns
between the insurance and investment functions.

The following is how a Replicating Portfolio could be used within an Economic

framework:
• The insurer constructs a replicating portfolio that best matches the insurance
liability cashflows.
• The replicating portfolio is used to determine the cost of the liability
cashflows and the required investment return to support the insurance
liabilities.
• The insurance function is deemed to have purchased the replicating portfolio
from the treasury function to minimize its exposure to market risk.
• The treasury function properly allocates investment returns and capital costs
between the underwriting and investment functions based on the replicating
portfolio.

(c)
(i) Describe the benefits of using a treasury function to measure a product’s
performance.

(ii) Calculate the economic profit for each of the following components:

• Insurance
• Investment
• Treasury

Show all work.

(iii) Assess whether product performance is acceptable.

(iv) List two ways to increase product performance based on the calculations
above.

ILA LP Spring 2018 Solutions Page 14

4. Continued

Commentary on Question:
This question tested the candidate’s understanding of why companies use the
Treasury function in determining a product’s Economic Performance.

Candidates generally did well on part (i) but struggled with part (ii). In part (ii),
many candidates struggled to calculate the various components in the
determination of the Economic profit for the Insurance, Investment, and Treasury
functions. In order to receive full credit, the candidate needed to complete the
table as shown below. Candidates that calculated incorrect values in part (ii)
were still given full credit for part (iii) and (iv) as long as the answers were
appropriate in respect to part (ii).

(i) The benefits of using a treasury function to measure a product’s

performance are:
- Explicitly breaks out the product’s insurance and investment
performance so that profitability of each can be analyzed.
- Insurers generally do not invest solely in the replicating portfolio. It is
therefore important to benchmark the actual investment performance with
the theoretical replicating portfolio return.

(ii) Bolded Values in table were given in the question.

General Formulas used in the table:

Economic Profit = Profit from each Department + Capital Cost
Profit from each Department = Premium + Investment Income – Claims –
Expenses – Increase in Liabilities
Capital Cost = Base Cost of Capital + Risk Cost of Capital
Total = Insurance + Investment + Treasury

Income Statement Total Insurance Investment Treasury

a
Premium 40 40
Investment Income 12c -3g 12c 3f
(-1) * Claim -20a -20
(-1) * Expense -2a -2
(-1) * Increase in Liabilities -15a -15
Profit from each Department 15 0 12 3

(-1) * Base Cost of capital -9 0b -6d -3e

(-1) * Risk Cost of capital -1 -1b 0b 0b
Capital cost -10 -1 -6 -3

Economic Profit 5h -1h 6h 0h

ILA LP Spring 2018 Solutions Page 15

4. Continued

a
Values for premium, claim, expense and increase in liabilities are only used in
the calculation of the Insurance profitability.
b
Base Cost of Capital is 0 for Insurance department. The Risk Cost of Capital is
only applicable to the calculation of the Insurance Economic Profit, and is 0 for
both the Treasury and Investment departments.
c
Total Investment Income for the Investment department, which is also the Total
Investment Income for the company, is
= Assets of $120 * Return on invested assets of 10% = 12
d
Investment’s Return of the Replicating Portfolio = Assets of $120 * Rate of
Return of 5% = 6

Note to Candidate: The insurer holds total assets of 120 and the Investment
department earns a return of 10% compared with a return on the replicating
portfolio of 5%. The Investment function receives the total investment return and
is charged with the return of the replicating portfolio.
e
Given the Total Base Cost of Capital is 9 and Investment’ Base Cost of Capital
is 6, as it is charged the return earned on the replicating portfolio, the Base Cost of
Capital for Treasury is 3
f
Treasury is profit neutral. Therefore, Treasury’s Investment Income is 3
g
This then implies that the Investment Income for Insurance is -3
h
Economic Profit = Profit from each Department + Capital Cost

(iii) The product’s performance is unacceptable as there is a $1 million loss on

the Insurance department’s underwriting activities. By splitting the
profitability between Insurance and Investment, it can be seen that the
product’s overall profitability is driven by the Investment department’s
ability to generate improved performance over the amount that could be
earned by the replicating portfolio.

(iv) Given that Insurance department’s performance is causing the overall

profitability to be unacceptable, IJK could increase premiums or decrease
expenses to improve profitability.

ILA LP Spring 2018 Solutions Page 16

4. Continued

(d) IJK is also considering moving from traditional pricing methods to risk based
pricing using a market consistent approach.

Assess the effects on profit margin for each of IJK’s products with respect to the
following:

• Investment guarantees
• Asset returns
• Insurance adjustability

Commentary on Question:
This question tested candidate’s understanding of how product features impact
profitability under a risk based pricing versus a market consistent approach.

Most candidates were able to identify that the Variable Annuity product would
perform worse under the market consistent approach. However, many candidates
struggled with their understanding of the impact of the features for Term.

Note: Under a market consistent approach, some products will perform better
than others. The results will vary depending on the level of guarantees in the
product, the amount of asset risk borne by the insurers, and whether or not the
product allows adjustments to the product at management’s discretion. In other
words, a product with more guarantees, more asset risk, and without management
levers to mitigate adverse experience will be considered a riskier product than a
similar product with opposite characteristics. Therefore, the pricing metric will
be worse in the case of the former versus the latter.

- Term does not have investment guarantees, therefore switching to a risk based
pricing using a market consistent (MC) approach will increase the profit margin.
- The short term asset nature of Term invested in low asset risk classes means
switching to a risk based pricing using an MC approach will increase the profit
margin.
- Term does not have any adjustability levers, therefore switching to a risk based
pricing using an MC approach will decrease the profit margin.

- Variable Annuities (VA) have investment guarantees, therefore switching to a

risk based pricing using a MC approach will decrease the profit margin.
- The long-term nature of the VA product may have increased asset risk which
means switching to a risk based pricing using an MC approach will decrease the
profit margin.
- VAs do not have any adjustability levers, therefore switching to a risk based
pricing using an MC approach will decrease the profit margin.

ILA LP Spring 2018 Solutions Page 17

5. Learning Objectives:
1. The candidate will understand various insurance products, markets, and
regulatory regimes.

Learning Outcomes:
(1a) Describe insurance product types, benefits, and features including reinsurance.

(1b) Evaluate insurance markets, consumer needs, distribution channels, and

regulatory regimes.

Sources:
Quantification of the Natural Hedge Characteristics of Combination Life or Annuity
Products Linked to Long-Term Care Insurance, March 2012

LP-127-13: Product Design of Critical Illness Insurance in Canada

Commentary on Question:
Commentary listed underneath question component.

Solution:
(a) Describe the key risks associated with a standalone Long-Term Care Insurance
(LTCI) product

Commentary on Question:
Many of the candidates received full credit for describing all three of the key risks
associated with standalone LTCI, or partial credit for describing one or two of
the three key risks. Candidates received no credit if they only listed the risk(s)
without supporting description(s), as they were required to show that the
candidate understood why the item is a risk for standalone LTCI.

Below is one possible solution. Credit was also given for other descriptions of
these risks that reasonably demonstrated the candidates understanding of the
risks.

Key risks for standalone LTCI are:

• Persistency – Higher persistency reduces profits because more policyholders
retain coverage into the later durations where the annual premium is
insufficient to cover the claim costs.
• Investment Returns – Standalone LTCI is a level premium product with a
claim cost curve that increases dramatically with age. Excess premiums are
invested in early years to cover the cost of LTCI in later durations.
• Morbidity Risks –higher claim incidence rates and/or lower claim termination
rates than expected will reduce profits.

ILA LP Spring 2018 Solutions Page 18

5. Continued

(b) LTCI sales have been declining. LWS is considering offering a LTCI and annuity
combination product.

(i) Describe how LTCI combination products reduce risk versus a standalone
LTCI, which provides the same LTCI benefit amount.

(ii) Describe the benefits to consumers of LTCI combination products with

extension of benefit riders.

(iii) You are given the following sensitivity test scenarios for a proposed LTCI
and annuity combination product:

Scenario Sensitivity
A 80% of Active Life Mortality
B 130% Annual Lapse rate
C 110% LTC Incidence Rates
D 115% Claim Termination Rates

Assess the impact on product profitability for each scenario. Justify your
answer.

(iv) Recommend a LTCI and annuity combination product that minimizes the
risk to LWS for each of the following product designs:

A. LTCI and annuity combination with a 2 year acceleration benefits,

without inflation
B. LTCI and annuity combination with a 2 year acceleration benefit
and 4 year extension of benefit rider, without inflation
C. LTCI and annuity combination with a 3 year acceleration benefit
and 3 year extension of benefit rider with inflation

Justify your answer.

Commentary on Question:
Part (i):
This part of the question required candidates to describe how LTCI combination
products reduce risk to the company versus a standalone LTCI. Some candidates
described how LTCI combination products reduce risk to the insured; in that case
credit was given, as appropriate, in part (b)(ii).

Credit was given for either LTCI and annuity combination products or LTCI and
life combination products.

ILA LP Spring 2018 Solutions Page 19

5. Continued

Part (ii):
Below is a sample solution which would receive full credit. Credit was also given
for other reasonable answers. Candidates did well on this section.

Part (iii):
Full credit was given to candidates who assessed the impact of the scenarios on
each of the three components of a combination product (i.e. standalone LTCI,
standalone annuity, and the combination product). Partial credit was given to
candidates who assessed the impact of the scenarios on two of the three
components. No credit was given to candidates who only assessed the impact of
the scenarios on a single component.

Many candidates assessed the impact of the scenarios only for the combined
product (no credit was given) or the impact of the scenarios on only the LTC and
combined product (partial credit was given). Many candidates also assumed the
annuity was a payout annuity instead of a deferred annuity (or that the annuity
had death benefits or withdrawal benefits). No credit was given for the impact of
the scenarios on the annuity component of these answers, but it was recognized
that the annuity impact was attempted.

Credit was given to candidates that assessed the impact of the scenarios on the
components of a LTCI and life combination product instead of a LTCI and
annuity combination product.

Part (iv):
Most candidates failed to recommend which one of the three product designs
minimizes the risk to LWS. Candidates often answered by recommending which of
the three approaches for payout structures (tail, coinsurance, or pool) should be
used with each of the three product designs. No credit was given for those
answers. Even those candidates who answered in the correct manner by
recommending one of the three product designs usually chose the wrong product
design.

Of the candidates who answered in the correct manner, many evaluated the risks
of the product features without considering the impact on a LTCI and annuity
combination product. For example, the risks of an inflation rider are significantly
diminished for a LTCI and annuity combination product compared to a
standalone LTCI product.

ILA LP Spring 2018 Solutions Page 20

5. Continued

Part (i):
• LTCI riders commonly pay out monthly long-term care benefits over two to
three years, after which the annuity accumulated value is depleted, maximum
long-term care benefits have been paid, and the entire coverage ends. It
represents a reduction to the risk to the insurance company versus coverage
provided under stand-alone LTCI, since the company would be required to
pay that same dollar amount to the policyholder ultimately via the annuity.
• Some of the pricing factors that normally reduce profit in a standalone annuity
plan have a dampened impact when that same base plan is sold with an LTCI
rider, creating a form of internal hedging effect of risks for the insurance
company.

Part (ii):
• Most combination products are single premium products and provide cash
values for policyholders who discontinue their coverage. This overcomes a
concern for purchasers of standalone LTCI, the risk of never receiving any
benefits from the policy.
• Extension of benefit (EOB) riders provide LTCI protection for an additional
period of time that is often one to two times the length of the acceleration
benefit (AB) period. This provides more comprehensive coverage for
catastrophic LTCI needs.

Part (iii):
Scenario A (80% active life mortality):
• The annuity base plan profits are slightly increased, given that the time over
which acquisition expenses can be amortized is longer.
• The stand-alone LTCI profits are decreased due to decreasing decrements and
increasing long-term LTCI costs.
• The combination product profits are decreased (the losses from the LTCI are
partially offset by the gains on the annuity).

Scenario B (130% annual lapse rate):

• The annuity base plan profits are decreased because deferred annuities are
persistency supported.
• The stand-alone LTCI profits are increased because LTCI is lapse supported.
• The combination product profits are increased (especially at younger ages due
to positive impact of higher lapses on standalone products on LTCI profits is
greatest at the younger ages, with possible increases at later ages) as normal
lapse assumptions for combination plans are much lower than those used for
annuities lessening the negative impact from annuity component.

ILA LP Spring 2018 Solutions Page 21

5. Continued

Scenario C (110% LTC incidence rates):

• The annuity base plan profits are not impacted by an increase in LTC
incidence rates.
• The stand-alone LTCI profits are decreased due to the increase in LTCI
benefit payments.
• The combination product profits are decreased. However, given that policy
holders are cross-funding the first two years of coverage in the combination
plans from their own policy values, the profit sensitivity to incidence rates is
diluted compared to stand alone LTCI, especially for annuity combinations.

Scenario D (115% claim termination rates):

• The annuity base plan profits are not impacted by an increase in claim
termination rates.
• The stand-alone LTCI profits are increased due to the reduction in the time
period during which LTCI benefit payments are made.
• The combination product profits are increased. However, the increase is
diluted compared to stand alone LTCI due to the cross-funding elements of
the LTCI and annuity combination.

Part (iv):
Product design C minimizes the risk to LWS.
• Volatilities are increased for plans with inflation benefits, but greater benefits
are realized by the combination plans due to the internal hedging
characteristics.
• Plans that accelerate over three years with a three-year EOB provision further
dampen the risks of combination plans versus combination plans with a two
year AB + four-year EOB
• For the three-year AB + three-year EOB plan, the policyholder is “cross-
funding” the first three years of coverage and the profit sensitivity to LTCI
incidence rates is even further diluted than under a two-year AB + 4-year
EOB plan. Longer AB has additional profitability benefits.

(c) The CEO of XYZ LWS has proposed to stop the sale of critical illness products
because the premium is expensive and LWS also sells disability income
insurance.

Critique the CEO’s proposal. Justify your answer.

Commentary on Question:
This part of the question required candidates to analyze and respond to the
CEO’s proposal by critiquing the statement that CI premiums are expensive and
by comparing critical illness (CI) and disability income (DI) insurance.

ILA LP Spring 2018 Solutions Page 22

5. Continued

Many candidates misinterpreted the “expensive” rationale as a statement that

critical illness was an expensive product for the company to administer, rather
than a statement that the premiums were high for the consumer. Many candidates
also compared CI to LTC or another product and did not compare CI to DI. Some
candidates suggested that the CEO look at profitability metrics or that the CEO
did not understand the insurance market. These types of answers received no
credit.

An example of a solution which would receive full credit is below. Credit was also
given for other reasonable answers.

• Incidence rates for CI are high so claims are likely and the premiums are high
(especially compared to term life insurance where mortality rates are lower).
• CI is not a substitute for DI. Only 15-20% of those who have both types of
policies could make a claim which qualifies for benefits under both policies.
Many DI claims are for mental/nervous conditions or soft tissue injuries,
neither of which would qualify for CI benefits.

ILA LP Spring 2018 Solutions Page 23

6. Learning Objectives:
1. The candidate will understand various insurance products, markets, and
regulatory regimes.

2. The candidate will understand the relationship between product features, inherent
risks, and the methods and measures to design and price products.

Learning Outcomes:
(1c) Construct, evaluate and recommend product designs that are consistent with
market needs, tax and regulatory requirements, and company business objectives.
• Evaluate the feasibility of proposed designs. Recommend designs.

(2a) Identify, assess, and develop appropriate assumptions to reflect factors such as
product characteristics, risks, policyholder behavior, and company actions.
• Describe and apply the uses of predictive modeling.

Sources:
Impact of VM-20 on Life Insurance Product Development, SOA Research, Nov 2016

LP-107-07 Experience Assumptions for Individual Life

CIA 2014 - Lapse Experience Study for 10-year Term Insurance, Jan 2014, pp. 6 -32

Commentary on Question:
Commentary listed underneath question component.

Solution:
(a) ABC Life’s primary focus is on Term Life insurance and Universal Life insurance
with Secondary Guarantees (ULSG).

(i) Explain three different reserve components and their mechanics under
VM-20.

(ii) Describe the advantages and disadvantages with delayed adoption of VM-
20.

Commentary on Question:
Most of the candidates were able to list the three different reserve components but
only few of them could explain them correctly.
The second part of the question asked for the advantages and disadvantages of
delayed adoption of VM-20; however, some candidates described the advantages
and disadvantages of moving to VM-20 instead.

ILA LP Spring 2018 Solutions Page 24

6. Continued

(i) Net Premium reserve is a seriatim formulaic calculation using specified

CSO mortality tables, prescribed lapses and prescribed valuation interest
rates.
Deterministic reserve is an aggregate gross premium reserve developed as
the present value of pretax liability cash flows at discount rates, using a
prescribed scenario.
Stochastic reserve is an aggregate reserve calculation using an asset
liability model developed as a starting asset amount plus the greatest
present value of accumulated deficiencies over a range of stochastic
scenarios, with the SR set at the 70th conditional tail expectation (CTE).

(ii) The advantage with delayed adoption of VM-20 is to allow more time for
company to develop complex reserve mechanism for VM-20. Also, there
is incentive to delay the adoption of VM-20 to keep the product more
competitive due to reserve advantage from financing. However, an early
adoption gives company more time to develop new concepts to compete
better under VM-20 environment and might bring reserve down by using
company's experience.

(b) ABC recently launched a new term life product sold through its brokerage
channel. You have been asked to conduct an experience study on the first year
lapses.

(i) You are given the following:

• 49 of 784 policies lapsed in the first policy year.

• Expected first year lapse rate is 5%

Determine if the first year lapse assumption is appropriate assuming a

95% confidence interval. Show all work.

(ii) Identify two different methods to enhance credibility in setting the lapse
assumption.

(iii) A lapse study shows significant differences from the industry survey.

Explain the possible causes of these differences.

ILA LP Spring 2018 Solutions Page 25

6. Continued

Commentary on Question:
Candidates overall did better on this part of the question than part (a) and had
relatively more success with the 95% confidence level calculation in (i) and the
explanation in (iii). But many candidates failed to propose the correct method to
enhance credibility in setting the lapse assumption in (ii).

(i) Actual lapse rate: 49/784 = 6.25%

Variance of expected lapse: 784*5%*(1-5%) = 37.24
95% confidence interval of expected lapse:
6.25+/- 1.96 * 37.24^0.5 / 784 = 6.25% +/- 1.53%
The confidence interval is (4.72%, 7.78%). 5% lapse rate assumption is
appropriate under 95% Confidence Level.

(ii) Combine multiple years of issue age together. It is common to group 5-

year or 10-year issue age to group data to get more credible results for
each group. The grouped results would then be smoothed to produce the
final assumption.
Conduct A/E ratio analysis. This ratio is used to track trends over time and
to adjust experience tables for recent experience without creating an
entirely new table.

(iii) Brokerage channel have lower retention than captive/career agents. With
industry study combining all distribution channels, company experience
can be different. Industry study may combine different products in the
same line of business. Mass markets tend to have smaller face amount,
which resulted in higher lapse rates.

ILA LP Spring 2018 Solutions Page 26

7. Learning Objectives:
1. The candidate will understand various insurance products, markets, and
regulatory regimes.

2. The candidate will understand the relationship between product features, inherent
risks, and the methods and measures to design and price products.

3. The candidate will understand actuarial requirements of product governance,

implementation, operations, and management.

Learning Outcomes:
(1a) Describe insurance product types, benefits, and features including reinsurance.

(1b) Evaluate insurance markets, consumer needs, distribution channels, and

regulatory regimes.

(2a) Identify, assess, and develop appropriate assumptions to reflect factors such as
product characteristics, risks, policyholder behavior, and company actions.
• Describe and apply the uses of predictive modeling.

(3b) Apply practices related to product management.

• Describe how to monitor and evaluate actual experience such as benefits,
persistency, and utilization including the use of experience studies and
supplementary data sources.
• Describe and assess practices related to data quality.
• Recommend changes to non-guaranteed elements such as credited rates and
policyholder dividends.

(3c) Design and evaluate product management strategies. Recommend the product
strategy.

Sources:
Life Insurance Products and Finance, Atkinson & Dallas, Chapter 2

LP-121-13: Life Insurance and Annuity Nonforfeiture Practices

LP-123-13: NAIC Standard Nonforfeiture Law for Individual Deferred Annuities

LP-102-07: Equity Indexed Annuities: Product Design and Pricing Considerations

SOA - Modeling Policyholder Behavior for Life and Annuity Products, 2014 pp. 9-16,
23-33, 45-67

SOA – Transition to a High Interest Rate Environment: Preparing for Uncertainty, SOA
Research, July 2015, executive Summary, Sections C, D & E

ILA LP Spring 2018 Solutions Page 27

7. Continued

Commentary on Question:
Commentary listed underneath question component/

Solution:
(a) Describe three reasons why the CEO’s strategy may not be successful.

Commentary on Question:
Candidates did reasonably well on this part of the question. Some candidates did
not receive full credit because they did not describe or provide an explanation,
beyond a single thought or point.

1. Product and company fit

A core competency of the company is underwriting, which will provide no
advantage in the annuity market since it does not use underwriting. The market
likely already has competitors with products that will be available to take
advantage of the new law more quickly. The current distribution system may have
challenges expanding beyond its core western markets.

2. Implementation barriers
Annuity products have very different administrative processes and procedures
than term insurance. Therefore the company will need to invest heavily in new
software and training. Doing this quickly risks costly disruptions to the
company's existing business. It is also possible that the company does not have
the expertise necessary to properly implement the annuity product.

3. Regulatory barriers
While it appears that the company could get regulatory approval for an
annuity product, it may be difficult, expensive, or take longer than desired. This
could be due to the company being less familiar with specific filing requirements
of this eastern state, or accounting/reserving requirements for annuities. Also the
company may need to comply with licensing requirements in order to sell in this
state.

ILA LP Spring 2018 Solutions Page 28

7. Continued

(b)
(i) Determine whether the guaranteed cash surrender value at the end of
contract year 1 satisfies the prospective (present value) test described in
Section 6 of the SNFL.

(ii) Determine whether the guaranteed cash surrender value at the end of
contract year 10 satisfies the retrospective (accumulation) test described in
Section 4 of the SNFL.

(iii) Contrast these guaranteed cash surrender values to those required in

Canada.

Show all work.

Commentary on Question:
Many candidates struggled with part i) of this question, but many candidates also
did very well on part ii).
Some candidates incorrectly used a 3% interest rate on part i), or tried to utilize
the same formula as in part ii). Partial credit was given for part i) that used 3%.
Some candidates did not state the conclusion of whether or not the test was
passed or failed, thus they were only given partial credit.
For part iii), many only stated that Canada had no minimum nonforfeiture law
and did not describe the group equity concept.

i) Prospective test - end of contract year 1

Compare present value of maturity value of paid up annuity benefit discounted at
a rate not greater than 1% over the guaranteed rate. i.e. the rate to use is 1.5%

Prospective non- forfeiture value = 22,983 = 26,279 x (1.005+.01)^-9

This test is satisfied as cash value of 23,090 is greater than the non-forfeiture
value of 22,983.

ii) Retrospective test - end of contract year 10

Accumulate 87.5% of the purchases at the non-forfeiture rate less a $50 annual
expense allowance.

Retrospective non-forfeiture value = 28,808= 29,398 - 590 = 87.5% x 25,000 x

(1.03)^10-50sn10

This test fails, as the cash surrender value of 26,279 is less than the minimum
non-forfeiture value of 28,808.

ILA LP Spring 2018 Solutions Page 29

7. Continued

iii) Canada has no minimum nonforfeiture law for life insurance. Actuaries in
Canada use a concept of “group equity” which means that values from
terminating policies may be used to reduce premiums or raise the level of benefits
for all policyholders.

(c) Develop a strategy to address pricing considerations for each of the following
potential situations:

(i) The options used to fund the indexed-based crediting become unavailable
in the market.

(ii) Surrenders are well above expected during periods when competitors have
increased the rates offered on new products.

(iii) A period of low or negative nominal interest rates.

Commentary on Question:
Candidates did reasonably well on this part of the question. There are a variety of
correct answers for this question. For parts ii) and iii) many candidates took the
approach of answering how these problems could be solved with product
changes, while others considered how to quantify the risk in pricing. Both types of
answers were given credit. To receive full credit, the candidates needed to
provide an explanation for their answers beyond a list or statement.

(i) With the options not being available any longer, we could set up a delta
hedging program using futures instead. As this is a dynamic hedge rather
than a static hedge, this will require frequent rebalancing. As a result, we
will not be able to know the cost in advance, but will only know after the
fact once all of the rebalancing trades are complete.

(ii) This kind of experience would appear to be consistent with a situation

where dynamic policy holder assumptions might be appropriate. In this
situation, it would be appropriate to do an experience study comparing the
time periods when competitors are offering higher vs. lower rates. Then if
we are modelling rates stochastically, implement a dynamic assumption.
Alternatively, could run sensitivity tests in the pricing model with lapses
in the 2 different behavior scenarios.

Some product features that could address this would be higher surrender
charges to discourage lapses, or adding a MVA feature which lowers cash
value when interest rates rise.

ILA LP Spring 2018 Solutions Page 30

7. Continued

(iii) Many interest rate generators have trouble modeling rates that are near
zero or negative. Special scenarios would need to be tested. Would also
want to have a discussion on ALM concerns as minimum guarantees could
be difficult to fund for reinvestment, or funding new inflows.

Some product changes would include lowering the guaranteed rate to the
minimum allowed rate and lowering the indexed floor to 0%. Hedging
costs can be lowered by lowering the index cap, lowering the participation
rate and margin.

ILA LP Spring 2018 Solutions Page 31

8. Learning Objectives:
2. The candidate will understand the relationship between product features, inherent
risks, and the methods and measures to design and price products.

3. The candidate will understand actuarial requirements of product governance,

implementation, operations, and management.

Learning Outcomes:
(2a) Identify, assess, and develop appropriate assumptions to reflect factors such as
product characteristics, risks, policyholder behavior, and company actions.
• Describe and apply the uses of predictive modeling.

(2b) Assess and critique performance measures, risk measures, and modeling
approaches. Recommend their uses in product management.

(2c) Develop and evaluate a product’s performance, capital requirements, tax and
regulatory requirements, and risk profile.

(3a) Describe governance and implementation requirements, principles, and practices.

• Describe and evaluate compliance with illustration regulations.
• Describe operational requirements such as administration, marketing,
reinsurance, and underwriting. Assess their impact on managing products.

(3b) Apply practices related to product management.

• Describe how to monitor and evaluate actual experience such as benefits,
persistency, and utilization including the use of experience studies and
supplementary data sources.
• Describe and assess practices related to data quality.
• Recommend changes to non-guaranteed elements such as credited rates and
policyholder dividends.

(3c) Design and evaluate product management strategies. Recommend the product
strategy.

Sources:
Atkinson & Dallas, Life Insurance Products and Finance, Chapters 11

Impact of VM-20 on Life insurance Product Development, SOA Research, Nov 2016
(exclude appendices)

LP-XXX-16: Evolving Strategies to Improve Inforce Post-Level Term Profitability,

Product Matters, Feb 2015, pp. 23-29

ILA LP Spring 2018 Solutions Page 32

8. Continued

Commentary on Question:
Commentary listed underneath question component.

Solution:
(a) Calculate the distributable earnings in year 1. Show all work.

Commentary on Question:
Candidates did well on this part of the question. Common mistakes included not
using all the correct product cash flows, not applying the tax rate correctly or
assuming a tax rate of zero because the pre-tax income was negative. Candidates
received full credit for bothv including/excluding premium tax in the Distributable
Earnings calculation. Candidates required to show all steps and formulas for full
credit.

The following solution excludes Premium Tax:

Product Cash Flows = Premium - Benefit - Expenses
Product Cash Flows = 5,000 - 321 - 535 – 6,500 – 2,000 - 363 = - 4,719

PreTax Solvency Earnings = Product Cash Flows + Invest Income - Increase In

Stat Reserve
PreTax Solvency Earnings = -4,719 + 100 - 450 = - 5,069

AfterTax Solvency Earnings = Pre Tax Solvency Earnings – Tax

Tax = Pre Tax Solvency Earnings * Tax Rate
AfterTax Solvency Earnings = -5,069 – (-5,069 * 0.35) = - 3,294.85

Distributable Earnings = AfterTax Solvency Earnings - Increase In Target Surplus

+ AfterTax Invest Income On Target Surplus
AfterTax Invest Income On Target Surplus = Target Surplus * Investment return
on target surplus * (1 – Tax Rate)
Distributable Earnings = -3,294.85 - 1,200 + (1,200 * 0.1 * (1- 0.35)) = -3,294.85
- 1,200 + 78 = - 4,416.85

The following solution includes Premium Tax:

Product Cash Flows = 5,000*(1-.025) - 321 - 535 – 6,500 – 2,000 - 363 = - 4,844
PreTax Solvency Earnings = -4,844 + 100 - 450 = - 5,194
AfterTax Solvency Earnings = -5,194 – (-5,194 * .35) = - 3,376.10
Distributable Earnings = -3,376.1 - 1,200 + (1,200 * 0.1 * (1-.35)) = -3,294.85 -
1,200 + 78 = - 4,498.10

ILA LP Spring 2018 Solutions Page 33

8. Continued

(b) PQR’s current reserve basis is XXX with AG48 financing of reserves.

(i) Analyze the impact to PQR of the adoption of VM-20

(ii) Recommend actions PQR can take to minimize the impact of VM-20.

Commentary on Question:
For part (i) many candidates struggled to understand the relationship between
financing the reserves, the tax benefit and how that would change with the
adoption of VM-20. Many were able to identify that VM-20 would change the
level of reserves but were unable to articulate that it would decrease the overall
profitability.

For part (ii) recommended actions should focus on what the company can do to
help increase profitability. Several candidates listed possible actions such as
stochastic modeling that are related to VM-20 but did not address minimizing the
impact of VM-20.

(i) PQR is currently using AG48 financing of reserves due to the higher
reserve requirements of XXX which results in a large tax benefit. If PQR
adopts VM-20, the level of stat reserves will most likely decrease,
however, PQR will lose the ability to finance reserves and thus will lose
the tax advantage. The loss of the tax advantage will decrease the overall
profitability of the product.
(ii) To minimize the impact of moving to VM-20 by trying to increase
profitability back to the original level, the company could increase
premiums or decrease expenses. If PQR is concerned about increasing
premiums due to competitiveness they could accept a lower target
profitability. Other options include reinsurance.

(c) An inforce block of policies is reaching the end of the initial 10-year term period.

(i) Describe three approaches that would reduce policy lapses after the initial
level term.

(ii) Recommend the approach PQR should select. Justify your answer.

Commentary on Question:
Candidates did well on this part of the question and most were able to list and
describe the three approaches to reduce policy lapses after the initial level term.
However, many candidates did not go into enough detail when describing each
approach. Candidates could recommend any of the approaches and earned full
credit for giving valid justification for that recommendation.

ILA LP Spring 2018 Solutions Page 34

8. Continued

Simplified Re-underwriting: The company offers insured the option to answer a

simplified issue underwriting questionnaire as the post-level term approaches. The
carrier uses these answers to determine the insured's risk class. This is a less
arbitrary, more fair approach and appealing to customers and regulators.
However, the questionnaire may alert the insured of the pending premium jump,
possibly causing them to lapse sooner. Also, the implementation could be
challenging.

Graded Approach: Post-level term rates increase at much smaller increments until
a future anniversary, grading to the original YRT schedule at the end of the
graded period. This allows insurers to ease into higher rates that are more
attractive to policyowners than those originally illustrated, while retaining the
right to increase rates up to the ceiling if need be as experience emerges. By
moderating the premium jump, many insureds may be encouraged to retain the
current coverage rather than to go through the ordeal of being re-underwritten for
a new policy.

Class Continuation Approach: The original class structures continue into the post-
level term period, modifying the rate increase based on the insured's select risk
class, where rates may or may not converge to an ultimate rate in later durations.
All policyowners experience a rate increase and move to a YRT schedule,
however the magnitude of jump is dependent on the insured's original risk
classification. This approach rewards the best risks by raising their rates the least.
However, there is a possibility of the underwriting effect wearing off by the end
of the level term period.

Recommendation:
I recommend implementing the Class Continuation Approach as it would decrease
the policy lapses after the level-policy term by decreasing the premium-jump ratio
for each class. This is less expensive to implement than the Simplified Re-
Underwriting approach and it rewards the best risks unlike the Graded Approach.

ILA LP Spring 2018 Solutions Page 35

9. Learning Objectives:
1. The candidate will understand various insurance products, markets, and
regulatory regimes.

2. The candidate will understand the relationship between product features, inherent
risks, and the methods and measures to design and price products.

Learning Outcomes:
(1a) Describe insurance product types, benefits, and features including reinsurance.

(2b) Assess and critique performance measures, risk measures, and modeling
approaches. Recommend their uses in product management.

Sources:
LP-102-07: Equity Indexed Annuities: Product Design and Pricing Consideration

Stochastic Modeling Text - Intro, Sections 1-4, Intro, I - I.B.2, I.E, II.A.1 - II.A.3, III,
IV.A - IV.A.9, IV.B.2-4,IV.B.6,IV.C.3

Commentary on Question:
Commentary listed underneath question component.

Solution:
(a) Critique the Hedging team’s report with respect to:

(i) Regulatory concerns

(ii) Expected hedge performance

Commentary on Question:
Overall, candidates did well on this part of the question. A common error when
addressing the removal of the 0% floor in Design 2 was relating it to the
product’s marketability as opposed to regulatory concerns. Another common
error related to the expected hedging cost of Design 2 was the reasoning that
using only the past one year’s experience is not credible enough and should be
based on more number of years. This often suggested a lack of understanding of
the cost of delta hedging (e.g. not known in advance and driven by market
volatilities). Many candidates also agreed with the conclusion that the cost of a
delta hedging program should be lower than static hedging.

With respect to regulatory concerns, there are two specific items of note in the
Hedging team’s report. The suggestion by the Hedging team to remove the 0%
floor in Design 2 would pose issues in complying with minimum cash surrender
values under the Standard Non-Forfeiture Law.

ILA LP Spring 2018 Solutions Page 36

9. Continued

In Design 3, the “Hedged as Required” criteria under AG35 is only applicable to

Type 1 or Book Value Methods. The company can get around this by opting for a
Type 2 or Market Value Method of valuation.

With respect to expected hedge performance, there are also two specific items to
address in the report. In Design 1, in order to reach the cap of 8%, the index
return would need to exceed 10% due to the 80% participation factor. The
position in the call spread should be based on a strike price that is 10% out of the
money. The current design leaves the amount of index crediting between 6.4%
and 8% unhedged.

The assumption that the delta hedging cost in Design 2 is 20% less than the
corresponding static hedge is flawed. The cost of delta hedging is not known in
advance, but rather depends on the volatility experienced during the period.
Higher volatility suggests more frequent rebalancing, which forces you to buy
high and sell low. This generally results in higher costs. Therefore, it is
inappropriate to base the cost of delta hedging on past experience, which just
happened to indicate a lower cost than static hedging over the past year.
Presumably it could have been the opposite case if realized volatility had been
high enough.

(b) CBT’s Modeling team is proposing a stochastic equity scenario generation model
for the new EIA product. The proposed model uses geometric Brownian motion
to model equity returns and the resulting scenarios are intended to be arbitrage-
free. You have been asked to perform a comprehensive peer review of the model.

(i) Identify the primary areas of consideration when conducting a peer review
according to Stochastic Modeling: Theory and Reality from an Actuarial
Perspective.

(ii) Propose a relevant question that you would address in the peer review for
each of the areas of consideration.

(iii) Describe the methods you would use to answer each question.

ILA LP Spring 2018 Solutions Page 37

9. Continued

Commentary on Question:
Candidates’ performance on this question varied despite the expectation of a wide
range of acceptable responses. A good proportion of the candidates were able to
identify most, if not all of the four primary areas of consideration when
conducting a peer review (formulas, parameters, testing, and validation), and
provide a relevant question to address each area of consideration. In terms of
describing a method to answer the questions posed, many candidates failed to
relate to the specific model (stochastic equity scenario generation model) stated
in the question. The majority of candidates provided some high-level, generic
methodology that further varied in quality. The answers ranged from a clear
demonstration of good practices in a model peer review, to simply restating the
proposed question in a statement format.

Full credit is awarded if the candidate demonstrates a comprehensive

understanding of the four primary areas of conducting a peer review and is able to
relate these concepts specifically to an equity scenario generation model.

The four areas of consideration/categories include formulas, parameters, testing

and validation. Credit is given for simply listing the categories where synonyms
or similar word substitutions are also acceptable. For instance, if a candidate lists
“assumptions” or “data” as a category instead of “parameters”, this was accepted.
However, if a candidate lists “assumptions” and “data” as two separate categories,
credit is only awarded for one category.

The proposed questions in relation to the four categories can vary widely, but they
should further demonstrate the candidate’s understanding of the categories in
relation to the purpose of the peer review process. Illustrative questions for the
four categories are:
1) Formula: Have the formulas been reviewed for accuracy?
2) Parameters: How were the model parameters developed and how were they
calibrated?
3) Testing: Does the model produce reasonable results?
4) Validation: Does the model validate on both a static of dynamic basis?

When describing the methodology to answer the proposed questions, the key
consideration for full credit is the candidate’s ability to correctly and concisely
apply the concepts to an equity scenario generation model. A less relevant
method is awarded partial credit. A repetition of the proposed question with no
further insight or details is awarded no credit. An acceptable method to address
the above illustrative questions are:
1) Formula: Review the documentation of the model to find the specific
stochastic process used (presumably some form of geometric Brownian
Motion). Compare the coding of the formulas to the intended process as
outlined in a textbook or academic literature.

ILA LP Spring 2018 Solutions Page 38

9. Continued

2) Parameters: The key parameters in an equity scenario generation process are

the implied volatilities. A calibrated volatility surface should be calibrated by
term structure. Review the volatility surface across difference strike prices to
see if it exhibits the expected volatility skew.
3) Testing: Run the model with shocks applied to various parameters. Verify
that the modeled cost of an option increases as volatility increases. Verify that
the modeled cost of an option decreases as the risk free rate increases.
4) Validation: Run a liability through the model that can also be modelled with a
simple replicating portfolio. Compare performance of the replicating portfolio
over a recent period against the modeled liability over the same time period.

ILA LP Spring 2018 Solutions Page 39