QUESTION ONE (1)

A) Actuaries say that, it is possible to operate without principles, but on a temporary and
superficial basis only due to the following observations. To begin with, articulating principles
enables one to sort out the confusion about actuarial terms and definitions used in valuation
methodologies, though principles may have different fundamental uses. They even have the
chance of identifying the common ground of all actuaries around the world. All actuaries
evaluate the financial consequence of risk. Therefore, they must share some common intellectual
foundation.

Principles are a prerequisite for membership in the scientific community; they define the
uniqueness of the actuary's work. With boundaries clearly defined through principles, there is
less danger of other professions laying claim to what is uniquely in actuaries' domain.

Principles are useful in other ways as well. They categorize and inventory the tools available to
the actuary. They provide the skill set for solving the problems of evaluating the financial
consequence of risk.

Principles provide a precise and common language for use in actuarial science. Paul McCrossan
said in a recent article that, "Actuaries share a common language, but are separated by it.'" With
well-articulated principles, that separation should disappear.

Principles can eliminate the confusion caused when actuaries from different disciplines use
different notation and terminology for the same basic ideas. However, it is worth the effort when
the final principle that satisfies all constraints is found. The solution exists it just may be difficult
to find. These important discoveries are the strength of our actuarial profession.

Actually, the principles so discovered do no less than define the profession. The paradigm
describes the true identity of the actuary.

Principles also can help define and guide research efforts. If put together, some holes in the logic
may be discovered that need to be addressed through research. They would also define the
boundaries of the paradigm and show where research might extend those boundaries.

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Principles are the building blocks of the profession. For instance: The current paradigm is
focused on the evaluation of insurance risk, once that boundary is clearly drawn, it becomes
more apparent how to extend the boundary to include the evaluation of all risk. Moreover,
complete set of principles defines the territory of the actuaries' domain. However, it also clarifies
the ways to extend that domain.

Principles can drive the education effort, an understanding of fundamental principles and
methodologies are a crucial part of the education of actuaries.

In a nutshell, these are the basic elements of the general science; they define the tools available
to the actuary and are not expected to change much over time, and they will not change unless
the basic paradigm changes. This point is important to clarify because some worry that strict
adherence to principles could inhibit the research efforts of the learned bodies. Actually,
principles, define what the actuary is capable of doing whilst Standards define what the actuary
should do in light of what he or she is capable of doing.

B) There are some dangers to be avoided when articulating principles. Articulating principles
should be an intellectual process. However, sometimes principles can be misused to substantiate
e.g. political positions. Principles also can be misapplied by the legal profession. Unfortunately,
this must be kept in mind when writing principles. The writers must carefully define the purpose
of principles and their intended application. It is important to make sure that these principles are
not misused or misinterpreted by our profession or the legal profession.

Principles also take a long time to develop fully. This has caused some problems with those who
would like to see them developed more quickly. Furthermore, principles have not been
developed in a timely fashion with respect to standards. Standards should be derived from
principles, but in many cases the standards have been developed before the corresponding
principle. That is just an unfortunate consequence of our rush to get standards in place, but it is
not a good argument for not writing the principles. The worst that can happen is that we might
have to adjust some standards in the future to conform to a principle.

QUESTION TWO (4)

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a) In theory, almost anything is insurable at a price, but in practice there are certain common
characteristics/features among those risks that are acceptable to the market.

 Pure risks: The risk should be what is known as a pure risk. That is, one that results only
in a loss to the insured, such as a fire, flood, collision or illness.
 Speculative risks, those that could result in either a loss or a gain, such as trading risks or
investment, are not usually insurable.
 Determinable: It must be possible to quantify the loss in financial terms, otherwise the
insurer could not calculate a premium and would not know how much to pay as a claim.
 Fortuitous: The risk must be fortuitous, i.e. random, rather than inevitable. Wear and tear
is inevitable and would not usually be insured. The main exception is life assurance.
Assurers take the view that death is inevitable, but the timing is fortuitous.
 Insurable interest: There must be a recognised relationship between the insured and the
loss, e.g. ownership of the property. This is the fundamental difference between insurance
and gambling. Before the concept of insurable interest was introduced, gamblers could
take out policies on the life of the king, or other famous people. Any insurance contract
without insurable interest is unenforceable at law.
 Homogeneity: Preferably there should be a large number of units exposed to similar risk
if the insurer is to be able to create a common pool. One-off risks such as parts of a film
star's anatomy can be insured, but are extremely difficult to price.
 Independence: As far as possible, the risks should be independent of each other, so that a
single event does not affect a large number at the same time, and so give rise to a
catastrophe loss. Examples of this are war risks, terrorism and earthquake in certain
vulnerable regions. In practice, the market may be able to accommodate some catastrophe
risks by reinsurance, that is, the primary insurers transfer part of their risk to other
insurers, so the losses are shared.
 Public policy: It is against public policy that anyone should insure the benefits of a crime.
Such a contract would be declared illegal.

b). Explain the characteristics of actuarial risk classifications?

Another important aspect of insurance systems is the classification of the risk subjects
associated with the actuarial risk. In this context, the term risk is commonly used to refer to

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 risk subjects. For a group of risks associated with a given actuarial
risk, it is possible to identify characteristics of the risks and to establish a set of classes based
on these characteristics so that:

 each risk is assigned to one and only one class; and

 probabilities of occurrence, timing and/or severity may be associated with each
class in a way that results in an actuarial model which, for some degree of
accuracy, is valid relative to observed results for each class or group of
classes having sufficient available data, and potentially valid for every class.
 A set of classes or characteristics or rules for assigning each risk to a class in
such a way that it creates a given group of risks is called a risk classification
system.
 These classes are called risk classes, and the rules used for assigning risks to
risk classes are called underwriting rules.
 A classification system that cannot be associated with an actuarial model that
can be validated relative to observed results when appropriate observed
results are available is not a risk classification system.
 It will reproduce any closely comparable observed values for appropriate
groups of classes within a specified degree of accuracy. For example, if the
insurable event is the occurrence of death within one year and the classes
were determined by: current age, policy year, gender,smoker or non-smoker status,
state of health occupation,

QUESTION SIX (6)

The word “risk” used as a noun expresses the possibility of loss or injury. As a verb, the same
word denotes the exposing of one’s person or property to loss or injury. Within the common
meaning of “risk,” there are thus two distinct elements, the idea of loss or injury, and that of
uncertainty.

In the economic setting within which actuaries work, loss is usually expressed in monetary
terms. Theft, embezzlement, and adverse court judgments cause loss of wealth, and are direct

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forms of economic loss. Death, disability, retirement, and unemployment are various forms of
income loss. Damage to property impairs the value of that property, where value is a measure of
the ability of a property to produce a flow of desired goodsand services. In short, the loss or
injury is often measurable in monetary units. When it is, we use the term “economic loss.”

Though economic loss is seldom certain, neither is it impossible. If the probability of economic
loss is greater than zero but less than one, some party is exposed to the possibility of economic
loss. We here define this exposure as economic risk. When applied to financial markets, this
concept of risk is essentially the same as the “down-side” risk in stocks or bonds, but it is
different from another use of the word “risk,” denoting any uncertainty as to market behavior.

It is almost axiomatic that human beings have an aversion to economic loss, and hence to
economic risk. Some persons are more risk averse than others, but few expose themselves or
their belongings needlessly. There are a few individuals who seem to thrive on taking chances,
even though there seems to be no possibility of gain; but even these must find some satisfaction
that compensates for the possibility of negative economic consequences.

b) Distinguish the usage of the terms insurance and assurance?

Insurance is a contract, represented by a policy, in which an individual or entity receives

financial protection or reimbursement against losses from an insurance company. Insurance
policies are used to hedge against the risk of financial losses, both big and small, that may result
from damage to the insured or her property, or from liability for damages or injury caused to a
third party. The company pools client’s risks to make payments more affordable for the insured.
unlike most other products: it is a conditional promise. In return for a fee (the premium), the
insurer promises to make a payment (referred to as the claim) if an event of a specified nature
occurs (usually referred to as an insured peril) and the insured consequently suffers loss or
damage. As such insurance is a risk transfer mechanism; the basic proposition is that the insured
exchanges the uncertainty of a low frequency, high severity risk (such as a house fire) for the
certainty of a lower cost premium. The insurer holds these premiums in a common pool and pays
the claims of the few from the premiums of the many. This spreads the risk and means that each
insured can pay a premium that is significantly less than their potential loss. Hence, insured’s are

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able to budget and plan with the peace of mind that comes from knowing that they will not have
to face the cost of some unwelcome event

On the contrary, the provision of life assurance is a quite different process from the provision of
non-life insurance. The main distinction is that in life assurance the event being assured is certain
to happen in the case of those policies paying on death, or scientifically calculable in the event of
policies not paying a benefit on death.

The table below further aids to distinguish between insurance and assurance.

Basis of Difference Assurance Insurance

1. Scope
2. Renewal of Policy
3. Element of investment
4. Assurance
5. Amount of Claim
This term is used only in life This term is used for all other
insurance and therefore the types of insurance and
scope is comparatively therefore, the scope is wider.
limited.
The life insurance contract is a It is not certain that the event
continuing contract and it will insured against may happen or
not lapse unless the premium not.
is regularly paid
The element of investment is It lacks the element if
present in assurance since investment since there is no
there is certainly of receiving certainty of receiving
payment either on death or on payment.
maturity of the policy.
The insurer gives assurance to The insurer only promises to
the insured to pay the claim in secure the property in case of
any case, either on maturity or actual loss.
death.
The policy amount is paid to The payment of claim is
the assured in full on the subjected to the element of
maturity or on death along actual loss but not more than
with bonus, etc. announce by the insured sum.
the insurance company from
time to time.

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 6. Insurable Interest
7. Relationship
8. Principle of indemnity
9. Certainty of event
10. Insured Sum
In a life policy, the insurable In indemnity insurance the
interest is one that required by assured is required to have an
law and such interest is not insurable interest in terms of
measurable in terms of money. policy.
The word “Assurance” The word ‘insurance’ only
indicates a relationship with represents the behavior of
principle of insurance. insurance.
Principle of indemnity does Principle of indemnity is the
not apply in life assurance. basis of insurance contracts.
The sum assured is payable
unrespectable of any profit or
loss and the full extent of the
amount insured.
The event is bounded to It is not certain that the event
happen sooner or later. insured against may happen or
not.
Insurance policy for any In insurance, the policy
amount or any number of amount is restricted to market
policies can be taken in this value of assets; not more than
case. that. This is because that
indemnity cannot be more
than the value of asset.

QUESTION FIVE (5)

A) Explain why this is close to the foundations of Actuarial thought?

This concept is very close to the foundations of actuarial thought and it seems obvious to
economists and businessmen of the modern commercial and industrial world that in that money
today is “worth” more than the same amount some time later. The price for this additional value
is “interest;” or perhaps it may be viewed as “rent” (for the use of money), or “investment
return.” Many practical applications arise because money is so widely borrowed, lent, or invested
for profit.

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The theory of interest is still evolving, and is clearly a product of time and place. The charging of
interest and hence its very existence, was once barred as “usury” under Christian canon law, This
is still unacceptable in much of the Islamic world. Whether interest exists in a socialistic
(Marxist) state is still a matter of controversy. The modern version of interest theory has its roots
in the nineteenth century. It attempts to explain what interest is, why it has existed for most of
recorded history, and the influences determining the “interest rate.” It is quite clear that interest
rates, as well as other measures of the time value of money, vary widely over time, place, and
circumstance. Why and how they vary is a matter of considerable importance. This is intended to
not attempt to give a comprehensive description of the various theories as to why interest exists,
but it will outline the best accepted sub-theories: The first of these will be referred to as “time
preference;” the second as “productivity of capital.” A third aspect of the time, value of money
lies in the uncertainty of the future

Time Preference. In large measure, the time value of money arises from the natural human
preference for present goods over future goods. Since kwachas and goods are interchangeable,
Kwachas today are generally preferable to an equal amount of kwachas tomorrow. Kwachas
today can make the present more enjoyable or less onerous, can raise the standard of living (or
reduce the necessity for work), can be exchanged for present goods or present services, or can be
employed for purposes of the future. Kwachas tomorrow have only the last of these desirable
attributes. Future kwachas satisfy present needs only if they can be pledged, borrowed against, or
otherwise moved from the future into the present.

Productivity of Capital. The strong preference for present money may be adequate in itself to
explain consumer borrowing and consumer lending. It also is the basic reason why people
borrow to finance homes or to purchase automobiles. There is another dimension, however, to
loans for business purposes. Businesses large or small require capital goods if they are to
prosper. For instance, a retailer cannot sell merchandise he does not have. A farmer must plant
and cultivate a crop before he can bring it to market. The retailer’s place of business and
inventory, and the farmer’s seed, fertilizer, and machinery represent the capital goods which,
combined with labor, produce business income. In the long run, a business will be successful
only if the return on the capital employed is greater than the rate of interest.

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The Uncertain Future. A third aspect of the time, value of money lies in the uncertainty of the
future. Time preferences are affected by inability to see the future clearly. Humans tend to be
risk averse, and to fear what they cannot predict. Those with a propensity to spend can easily
justify present spending by imagining ways in which money may lose its value. Those with a
tendency to save may be concerned about the safety of their invested funds, or about the future
purchasing power of income deferred. Business lending is also affected by the matter of
uncertainty. Lenders require adequate security, or raise the interest rate, to reflect the risk, that
the loan may not be repaid, or that the loan will be repaid in depreciated kwachas.

The Level of Interest Rates. The foregoing may be an adequate explanation as to why a positive
interest rate exists, but it has little to say about what that interest rate may be, and why and
how it varies from time to time and from place to place. For an analysis of interest rate behavior,
monetary considerations must be taken into account. It is commonly held that the price of
money, like the price of other goods, varies with supply and demand. At least in theory, and if all
other factors are held constant, the prevailing interest rate at any point in time is that rate at
which the supply and demand for loanable funds come into balance, and the money market
“clears.” The supply of money, to some extent controlled by the policies of the central bank,
clearly has an influence, as do expectations of inflation.

B) Comment on its relationship with the uncertain future?

Clearly, any uniqueness that the actuarial profession may claim cannot be based on any special
knowledge of the time value of money. Like any person involved in business, economics, or
finance, the actuary uses the time value concept in his daily work; but the same can be said for
many of those employed in business affairs. Even so, the actuary’s interest in the time value of
money is somewhat more intense, and his knowledge based on a deeper understanding, than the
interest and knowledge of the typical informed business person. There may be two reasons for
the special relationship that actuaries feel with the interest concept.

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