INSTITUTE OF ACTUARIES OF INDIA

EXAMINATIONS

25th June 2019

Subject CP3 – Communications Practice
Time allowed: 3 Hours 15 Minutes (10.15 – 13.30 Hours)
Total Marks: 100

INSTRUCTIONS TO THE CANDIDATES

1. Please read the instructions inside the cover page of answer booklet and
instructions to examinees sent along with hall ticket carefully and follow
without exception.
2. Mark allocations are shown in brackets.
3. Attempt all questions, beginning your answer to each question on a separate
sheet.

4. Please check if you have received complete Question Paper and no page is
missing. If so, kindly get new set of Question Paper from the Invigilator.

AT THE END OF THE EXAMINATION

Please return your answer book and this question paper to the supervisor separately. You are
not allowed to carry the question paper in any form with you.
IAI CP3 - 0619

Q. 1) You are a consultant to a private ABC trust offering fund management services to corporate
defined contribution schemes in country XYZ. In country XYZ the schemes offer an
accumulation of employer and employee contributions during employment with a particular
company. Post-employment with an employer, an employee can either withdraw his/her
accumulated amount or can transfer to a new employer if the new employer is also associated
with this trust.

Over the years the trust has been able to grow its reputation and several new employers have
associated themselves with the trust.

Years since inception 1 year 2 years 3 years 4 years 5 years

Number of associated employers 5 7 10 20 50
Total AUM (INR cr.) 55 140 250 550 900

There are multiple reasons that have helped the trust grow its reputation which are given
below:

1. Strong asset performance – CAGR – 13% p.a.

2. Prompt administration support and development of online reporting platform for
employees.
3. Flexibility for employers to decide on scheme structure – employers can choose between
varying contribution structures for itself and its employees.
4. Portability of fund between associated employers.

Years since inception 1 year 2 years 3 years 4 years 5 years

Annual Return 12% 14% 15% 13% 12%
CAGR 12% 12.75% 13.25% 13.25% 13%

Trust investment policy

Trust investment policy recommends asset allocation across a variety of investment
instruments:

Financial Instrument Recommended range Current investment

High Quality Corporate Bonds (AA+) 50-60% 55%
Central & State Govt. Bonds 25-35% 25%
Equity 10-15% 15%
Short term Money Market instruments Balance 5%

The policy is revised periodically for strategic and tactical purposes. Over the years the trust
has kept aggressive allocations towards corporate bonds and equity. This drives superior
fund performance. Employers and employees contribute to the trust on a monthly basis. The
trust looks to invest money in available securities as per investment policy. At times it does
take time to invest in suitable securities (as long as 2-3 months). In the meantime, the trust
keeps its investments in the money market.

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The trust usually holds assets for the long term and looks to hold bonds till maturity. It tries
to manage its outflows from the inflows to the funds and any balance by selling securities.
Weighted average duration of trust’s asset investments is about 6 years while its expected
liability duration (redemption of employee accumulation) is expected to be only 3 years.

The Trust credits investment return to account balances on an annual basis at the end of the
year.
Turbulence in Bond market

From the beginning of the year, XYZ country’s bond market started witnessing unusual
turbulence. Combined with interest rate hikes by a large economy and fall in local currency,
demand for country bonds have gone down among Foreign Institutional investors. This has
pushed bond yields to all time high.

Recently a large private infrastructure finance company had failed to service its debt
repayment schedule. This has overnight brought down its bond ratings to nearly default from
existing AA+. It has also caused ripples in other corporate bonds as investors suspect similar
issues with them.

Following tables show credit rating transition matrix for different graded bonds issued by
local companies:

Rating Transition Matrix before financial crisis

AAA+ AA+ A+ Default
(From ↓ To →)

AAA+ 0.90 0.10 0.0 0.0

AA+ 0.10 0.80 0.09 0.01

A+ 0.05 0.15 0.70 0.10

Rating Transition Matrix after financial crisis

AAA+ AA+ A+ Default
(From ↓ To →)
AAA+ 0.75 0.15 0.05 0.05
AA+ 0.05 0.65 0.15 0.15
A+ 0.00 0.15 0.55 0.30

The above tables indicate probability of a bond with a given rating staying at that rating or
moving to another rating in a year. The Trust’s present investment portfolio has about 25%
share invested in local bonds of private companies.

You have received the following email from the Trust’s Investment Committee team asking
for support for upcoming board meeting.

Dear Tom,

You have been advising us on a variety of trust related matters in the past and we continue
to value your support. We need your support again to prepare for an upcoming Board

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meeting. Recent economic developments and turmoil in bond markets have come to the
notice of our Board. One of the trustees has requested us for a discussion on the Trust’s
investment strategy at the upcoming Board meeting.

We need your inputs, preferably as a paper to help us draft suitable material for our Board’s
review. Look forward to your inputs soon.

In this regard attached is a note by the trustee shared with the investment team.

Regards

Thomas

ABC Trust Investment Committee Leader

Trustee Email

Hi Thomas,

In our upcoming Board meeting, I would like you to provide us with information related to
the investment strategy of our trust. We have seen aggressive investments by the trust in past
years and significant exposure to corporate bonds. The bond market has seen significant
turbulence recently. How does the change in market conditions impact us? How can our
investment strategy be shaped to better manage such situations?

Regards

John

i) Draft a paper to the Investment Committee of 650 to 700 words. (45)

ii) Set out three criteria you used for deciding which information to include or exclude
from the paper, giving an example of each. (5)
[50]

Q. 2) You are Shyam, the pricing Actuary in a company which predominantly sells health
insurance both for individual and group clients. Most of the group policies sold by your
company are yearly renewable. The market is very competitive with thin profit margins.
Even though policies are yearly renewable the market practice is to give a soft commitment
to hold the same rates for at least a period of three years. This makes pricing a challenge. Of
late, claim experience has been higher than allowed for and with hardly any margin left for
many schemes. You have been increasing the prices and this has met with some resistance
from the sales team. You have now proposed an increase in premium rates for one of the
group clients. The client is fairly big and the head of sales is particularly unhappy with the
proposal and has written to you as follows.

“Dear Shyam,
I have received your new quote for PQR Company limited and I fear that if we do revise the
rates we may lose the client. In this particular case I checked to see if we are making losses
by comparing premiums with the claims that we have paid and I do not see any losses though

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I do agree that the claims as a percentage of premiums have been increasing. I would like
you to review and see if we can maintain the same rates. In case this is not possible I request
you to help me understand the reasons for the increase. This will help me in my discussion
with the client.
Thank you for your help.

Regards

Ram”

The head of sales has come from financial services background but does not have much
experience in the Insurance industry.

Pricing philosophy

The risk appetite statement approved by the Board has stability of earnings as one of its
agenda. This has been translated into a pricing philosophy which says that contracts should
be written only if there is a reasonable certainty of earning gross margins of 10% of the
premium. Where there is uncertainty the gross margin has to be higher than 10% and
depending on the extent of uncertainty can go upto 20%. Therefore, contracts are usually
priced on best estimates if the experience is credible with a loading of 10%.

Assessment of profitability of ABC Limited

Your team has performed a detailed analysis of the profitability for this client and has
presented you with the following summary.

The scheme has been with the company since Calendar year 2012. (Calendar year and
Financial year are the same). The scheme is renewable in March of each year. The employer
offered health insurance for the first time in 2012 and therefore no experience was available
for the Group at the time of the original pricing. The benefit is reimbursement on
hospitalization up to a maximum of Rs.5 lakhs. Risk rates used for individual products was
the basis for pricing this contract. A margin of 20% had been added on to the priced rates.
The contract charged premiums based on age bands. Therefore the contract does not have
any additional risk of mix by age of the employees being different than expected. A review
of the appropriateness of pricing was carried out earlier in 2015 and it was decided to leave
the rates unchanged.

The details of the premiums and claims as seen in the Financials are presented below.

In millions Premiums Claims

CY12 19.42 8.82
CY13 21.55 16.34
CY14 24.51 19.11
CY15 31.76 24.14
CY16 35.34 29.09
CY17 35.29 31.25
CY18 36.25 31.87

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In the financials the entire premium is shown as revenue. Claims that are reported are shown
as expenses. These include both settled and not settled claims.

An “Unearned premium reserve” is held in respect of the balance of premiums received in

respect of periods of insurance not yet expired. In respect of claims an additional reserve
called the Incurred But Not Reported (IBNR) Reserve is held. This ensures that the
Financials reflect the correct level of profitability.

In order to get a better understanding of actual claims the team has recast the claims based
on the year of issue. The results are as below.

Year of origin of policy Premiums Claims without IBNR Claims with IBNR
In millions `(1) `(2) `(3)
CY12 19.42 14.70 14.70
CY13 21.55 17.43 17.43
CY14 24.51 20.23 20.23
CY15 31.76 26.74 26.74
CY16 35.34 30.65 30.65
CY17 35.29 31.65 31.65

Almost 100% of the claims get reported within a period of 4 to 5 months. Claims for CY12
to CY16 are fully developed. For CY17 an adjustment has been made for IBNR.

Results of experience analysis

The team has separately carried out an experience analysis by breaking down the data into
agewise brackets to see if the experience is very different across these cells. The results are
as below.

Total for
Age bands CY12 CY13 CY14 CY15 CY16 CY17 CY18
all years
<=30 89% 87% 87% 96% 98% 101% 106% 96%
31-35 84% 89% 89% 91% 94% 100% 103% 94%
36-40 84% 94% 97% 94% 97% 99% 104% 97%
41-45 88% 95% 106% 97% 95% 98% 103% 98%
46-50 68% 84% 84% 95% 95% 99% 102% 92%
51-55 83% 99% 97% 84% 108% 107% 100% 98%
>=56 81% 77% 68% 68% 98% 85% 114% 88%
Total across
84% 90% 92% 94% 96% 100% 104% 95%
age bands

 The expected claim payout has been calculated with the same incidence rates for the
all the years.
 The exposed to risk is less for ages greater than 45 years.

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The conclusions of the experience study are as follows.

 Experience is not very different across different age bands especially when seen for
all years together. For ages greater than 45, the experience is not very credible.
However even for these ages experience is not very different as compared to the
other ages.
 Claim experience is showing an increasing trend. There is some volatility at an
individual cell level, however, when the analysis is combined for all ages as seen
from the last row of the table it can be concluded that there is claims inflation. Claims
inflation here is both an account of frequency of claiming and increase in amounts
for certain procedures.
Claims inflation has been calculated as below.

Claims Claims Claim to

Year of origin of Claim
Premiums without with premium
policy inflation
IBNR IBNR ratio
In millions `(1) `(2) `(3) `(4=(3)/(1))
CY12 19.42 14.70 14.70 76%
CY13 21.55 17.43 17.43 81% 6.8%
CY14 24.51 20.23 20.23 83% 2.1%
CY15 31.76 26.74 26.74 84% 2.0%
CY16 35.34 30.65 30.65 87% 3.0%
CY17 35.29 31.65 31.65 90% 3.4%
CY18 36.25 32.01 33.89 94% 4.3%

Average claim inflation 3.6%

Conclusions

The experience across different age bands is not very different. There is no need to revise
the underlying incidence rates due to this. There is definite evidence of Claims inflation. On
an average it is 3.6%. However, it has been increasing.

On a projected basis CY19 will not meet the profitability requirement. Projecting the
experience to CY2020 and onwards by assuming an inflation of 4% and assuming the rates
will be held for about three years we propose an increase of 17% to the incidence rates. This
will ensure a margin of 10% over a three year period.

Premium Claim Claim to premium ratio

CY19 Projected 100.00 97.00 97.0%
CY20 116.83 101.09 86.5%
CY21 116.83 105.13 90.0%
CY22 116.83 109.34 93.6%
Total from CY20 to CY22 350.50 315.56 90.0%

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i) Draft an email to Ram in about 600 to 700 words explaining the necessity of
increasing the premium rates. (45)

ii) Explain how you exercised judgement as to the relevance of information and decide
to exclude information if any from your reply. (2)

iii) Explain how you ensured that your use of language did not contain technical terms or
jargon. (1)

iv) Visual aids such as graphs, tables or charts can be useful for communications.
Comment on your approach to these in your answer to part (i). (2)
[50]

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