Examination: Subject ST1 Health and Care Specialist Technical

Faculty of Actuaries Institute of Actuaries
EXAMINATION
15 April 2005 (am)
Subject ST1 Health and Care

Specialist Technical
Time allowed: Three hours
INSTRUCTIONS TO THE CANDIDATE
1. Enter all the candidate and examination details as requested on the front of your answer
booklet.
2. You have 15 minutes at the start of the examination in which to read the questions.
You are strongly encouraged to use this time for reading only, but notes may be made.
You then have three hours to complete the paper.
3. You must not start writing your answers in the booklet until instructed to do so by the
supervisor.
4. Mark allocations are shown in brackets.
5. Attempt all 8 questions, beginning your answer to each question on a separate sheet.
6. Candidates should show calculations where this is appropriate.
AT THE END OF THE EXAMINATION
Hand in BOTH your answer booklet, with any additional sheets firmly attached, and this
question paper.
In addition to this paper you should have available the 2002 edition of the
Formulae and Tables and your own electronic calculator.
Faculty of Actuaries
ST1 A2005 Institute of Actuaries
1 Describe the benefits typically available under a UK-type private medical insurance
plan. [5]
2 The following events might lead to personal financial loss or hardship:
A Payment of expenses for medical care where a person s home country has
poor public health facilities.
B The occurrence of sickness or disability after retirement age.
(i) Describe the ways in which each event can lead to hardship and indicate the
range of persons who may be directly, or indirectly, affected. [3]
(ii) Describe, with reasons, a suitable health insurance product that may be
purchased in order to alleviate or prevent the hardship arising from each event
and state whether the product is likely to be traditional non-profit, unit-linked
and/or inflation proofed. [4]
[Total 7]
3 A leading life insurer is considering broadening its individual product range. It is

considering launching income protection, critical illness, private medical insurance
and long term care products. All contracts will be available only on an individual
basis.
Describe the main product specific risks associated with each of these contracts. [7]
4 An insurance company is considering the introduction of an immediate needs annuity

for use by people entering or already in a care home.
(i) Explain why such a product has an appeal to potential purchasers of the
annuity. [4]
(ii) Describe the main considerations that would be taken into account when
determining the assumptions of the pricing basis. [8]
[Total 12]
ST1 A2005 2
5 On 1 January 2005 an insurer has 1000 lives aged 40 next birthday with accelerated
critical illness policies. The average sum assured is £63,000.
You are given the following extract from a mortality/morbidity table:
Age Exact (1) (2) (3) (4) (5)
39 2.3 0.1 1.1 0.55 0.1

40 2.4 0.1 1.2 0.56 0.1
41 2.6 0.1 1.3 0.57 0.1
where:
(1) Incidence rate for critical illness per 1,000.

(2) 28 day mortality rate following critical illness, per 1,000.
(3) Mortality rate from all causes per 1,000.
(4) Proportion of all deaths from critical illness events.
(5) Proportion of policies lapsing per annum.
All the decrements are assumed to operate uniformly over a year.
You are given the following claims information:
Claim amount Date of critical Date of death Date of claim Date of

illness event notification settlement
1 £35,000 3 Mar 2005 6 July 2005 23 Aug 2005

2 £67,000 11 Nov 2004 15 Jan 2005 17 Jan 2005 15 Feb 2005
3 £42,000 7 Jun 2005 5 July 2005 17 Aug 2005
4 £25,000 19 Mar 2004 20 Aug 2005 2 Feb 2006
5 £71,000 3 Feb 2005 19 Feb 2005 19 Mar 2005 27 Apr 2005
(i) Using the life table information above, calculate the expected claim cost for
2005. [5]
(ii) Calculate the actual to expected claim ratio on an amounts basis for 2005. [2]
(iii) Explain why the result calculated above may give an incomplete view of the
claim ratio. [1]
(iv) If all of the policies had been typical stand alone critical illness contracts
indicate, with reasons, whether the experience would be better or worse. [5]
[Total 13]
ST1 A2005 3 PLEASE TURN OVER

6 You are a consulting actuary advising a health and care insurer which is in the process
of purchasing a portfolio of individual income protection business written by a
competitor.
(i) Discuss the methodology that you would apply to assess the profitability of the
portfolio that is being purchased. You should indicate how you would assess
the level of statistical risk. [7]
(ii) Describe the key reasons why the future claims experience of the purchased
portfolio could be very different from the future experience of the existing
portfolio. [7]
[Total 14]
7 You are the pricing actuary of a leading individual critical illness provider. A new
director has recently been appointed and has requested information on how the
company sets its premium bases.
Outline the methodology by which the assumptions needed to set a premium basis
would be determined, indicating the likely key sources of data available. [20]
8 An insurance company is considering entry to the group risks market for a wide range
of health and care contracts.
(i) Describe how medical underwriters seek to manage risk for a UK-type private
medical insurance policy. [4]
(ii) Describe the sources of medical information typically used in underwriting

such a private medical insurance policy. [2]
(iii) Describe how a moratorium clause may be used to manage risk as an

alternative to medical underwriting. [4]
(iv) Describe how the application of medical underwriting for health insurances
differs for group policies as opposed to individual policies. [12]
[Total 22]
END OF PAPER
ST1 A2005 4
EXAMINATION
April 2005

EXAMINERS REPORT
Introduction
The attached subject report has been written by the Principal Examiner with
the aim of helping candidates. The questions and comments are based around
Core Reading as the interpretation of the syllabus to which the examiners are
working. They have however given credit for any alternative approach or
interpretation which they consider to be reasonable.
M Flaherty
Chairman of the Board of Examiners
28 June 2005
Institute of Actuaries
Subject ST1 (Health and Care Specialist Technical) April 2005 Examiners Report
1 Benefits typically available on a PMI plan include:

Hospital costs
In patient costs such as accommodation/private room, nursing care, operating
theatre, diagnostic procedures, surgical dressings, drugs
In-patient physiotherapy
Day patient costs
Accommodation/private room for parent accompanying a child
Specialist fees
Surgeons' and anaesthetists' fees for in-patient or day-care
Physicians' fees
Outpatient fees/costs such as specialist consultations, diagnostic tests
(radiology, pathology), physiotherapy
Radio/chemotherapy/scans
Additional benefits such as private ambulance, recuperative care
Cash for treatment in state system
Benefits may be offered on an indemnity basis or there may be limits to payments or

excesses
Applies only to acute conditions
The question asked for a description of the benefits typically available under a UK PMI plan,
not for an explanation of the purpose of PMI, which some candidates gave. Many candidates
failed to record enough points to gain many marks on this question.
2 (i) Event A may lead to the following:

Loss of income and possibly capital in funding the cost of medical treatment
Hardship to the individual and to persons who are financially independent
Hardship/loss of income to those who have to provide personal care
If extreme, the event could give rise to a catastrophic loss of capital
Event B may lead to the following:

A requirement for capital to fund the costs of institutional care whilst elderly, if the
sickness or disability is sufficiently disabling
A requirement for income over a long period. This might have been taken care of by
a pension.
Without insurance, assets may be depleted due to living a long time in care
There may be costs involved in making adaptations to the home
The individual plus any dependants would be affected together with any providers of
personal care
(ii) A suitable product to cover event A would be medical expenses insurance

which gave the correct level of cover in the domestic context. This would provide
benefits to cover all medical expenses, including primary and secondary care.
This would be a traditional non-profit (short term) contract with an element of

inflation-proofing since the policy provides indemnity benefits.
Page 2
A suitable product to cover event B would be long term care insurance which pays
care fees to elderly in an institutional care facility until death. Long term care
insurance would cover the cost of long term care arising through permanent disability
where individuals are unable to perform specific activities of daily living.
This could have an inflation-proofing element and be either a traditional non-profit or

unit-linked contract. Full inflation-proofing is unlikely because of cost.
If the individual is already in failing health, a special enhanced annuity may be

available taking into account the current poor state of health.
This question was generally well answered, although not all candidates appreciated that
hardship could apply to everyone, not just the poor or old. Few candidates mentioned loss of
income from employment as a possible consequence of event A. Credit up to full marks was
given where a candidate discussed one product which covered both events A and B.
3 Income Protection
The main risk relates to sickness transfer probabilities in the underlying multiple state
model - claim inception and claim termination rates.
Other major risks include:

Anti-selection risk
Withdrawal risk - selective withdrawals
Financial risk on withdrawals where asset share is negative
Critical Illness
The main risk relates to the rates of diagnosis of the critical illness specified in the
contract.

Anti-selection risk
Selective withdrawals
Financial risk on withdrawals where asset share is negative
Private Medical Insurance
The benefit payments are generally determined by individuals over whom the
company has no control (eg increases in fees, increases in cost of treatment).
Claim frequency bound up in GP referrals.
Where the State offers free healthcare, there may be risks arising from lack of sales
and inability to cover expenses which could lead to insolvency
Risk of a single large claim (eg US treatment) or a single incident leading to
accumulation of claims (eg workforce)
Page 3
Long Term Care
The main risk relates to transfer probabilities in the underlying multiple state model
and to claim inception probabilities and transfer probabilities between claim states.

Investment risk
Expense risk
Withdrawal risk - selective withdrawals
Financial loss from withdrawal when asset share is negative
Marketing/reputation risk since policyholders expectations may not be met
This question was generally well answered.
4 (i) An immediate needs annuity can be used to pay care fees on behalf of the care
home/nursing home/retirement home resident. The annuity provides financial
protection both for the care home/nursing home/retirement home resident if
he/she lives longer than expected and the estate of the individual. It also
provides financial protection to the dependants of the individual in that they
will not be required to fund the care home/nursing home/retirement fees if the
individual lives longer than expected.
(ii) Assumptions for the pricing basis include:
Mortality
It is necessary to construct the likely experience of the policy. Reinsurance data

might be available
Underwriting criteria. The effects of changes to past and future underwriting
criteria/strategy need to be considered
Add prudential margin - since survival reduces profits, assume variations in mortality
experience
Expenses
Own data are not available; so compare with existing products.

Assign costs according to policy type/class, initial/ renewal, fixed and variable,
whether per policy or a percentage of premiums.
Include prudent inflation assumption
Allowance for fixed expense contribution depends on future new business (so
consider future sales volume).
Interest
Depends on future investment strategy (which assets are invested in and extent of
matching assets and liabilities)
As non-profit likely to be fixed interest assets
Take a view as to likely returns from fixed interest assets
Page 4
Add prudential margin: depends on extent of reinvestment income (as a proportion of

total future income and profit), as this is much more uncertain
Taxation
Make allowance for future tax incidence at current and/or expected rates
Other factors
Solvency margin and reserving basis

Risk discount rate and profit criteria
Competitors rates
Sensitivity analyses and realignments
In general, this question was reasonably answered, although not all candidates
appeared to have knowledge of an immediate needs annuity. In part (i) few
candidates mentioned the value of a LTC policy to a nursing home providing security
about future payments.
5 (i) Lives aged 40 next so require independent rate for age 39.5 exact
For accelerated critical illness, claim rate = ix + (1 kx) qx
Age 39: Dependent rate = 2.3 + (1 - .55) * 1.1 = 2.795

Independent rate = 2.795 * (1-.1*.5) = 2.655
Age 40: Dependent rate = 2.4 + (1 - .56) * 1.2 = 2.928

Independent rate = 2.928 * (1 - .1*.5) = 2.782
Expected claim cost = (2.655+2.782)/2 * £63,000 = £171,265.50
(ii) Need to include claims where the first of either death or critical illness
occurred within 2005. Date of notification and date of settlement are irrelevant.
Hence claims amount = £35,000 + £42,000 + £71,000 = £148,000
Actual/expected = 148,000/171265.5 = 86.4%
(iii) Would need to allow for claims which have been incurred but not reported.
(iv) For stand alone critical illness contracts the rate is ix * probability survive 28
days (stand alone contracts require a survival period, typically 28 days).
Age 39: Dependent rate = 2.3 * .9

Independent rate = 2.3 * .9 * .95
Age 40: Dependent rate = 2.4 *.9

Independent rate = 2.4 *.9 * .95
Page 5
Age 40 next rate = 2.35 * .9 * .95 = 2.009
Expected claim cost = £63,000 * 2.009 = £126,583
Actual claims to include = £35,000
Actual/Expected = 28%
So result would be much better if all of the plans were stand alone CI contracts
Whilst many candidates realised that lives were aged 39.5 at the start of the year, they
often failed to make the appropriate adjustments to the qx values. Some candidates
also missed the point concerning lapse rates and failed to convert the independent
rates into dependent rates. Many candidates failed to choose the correct claims in
part (ii). In part (iv), although candidates generally realised that stand alone
contracts have a survival period (otherwise it is an accelerated CI plan), many did
not recalculate the expected claims. Credit was given for alternative approaches to
answering parts (i) and (iv), if appropriate.
6 (i) Need to choose model points that are representative of the new portfolio. May
be able to use model points from a previous profitability assessment (perhaps
provided by the portfolio seller) and then update this to allow for new business and
exits (lapses, maturities).
Need to check appropriateness of model points. May be able to do this by, for
example, calculating supervisory reserves using the model portfolio and comparing
this with the actual published portfolio supervisory reserves.
For each model point cash flows would be projected allowing for reserving and
solvency margin requirements on the basis of a set of base values for the parameters
in the model.
The net projected cash flows will then be discounted at a rate of interest, the risk
discount rate, that allows for:
the return required by the company, and
the level of statistical risk attaching to the cash flows under the contract.
Need to consider cost of any options and guarantees.
The level of statistical risk could be assessed:

in some situations analytically, by considering the variances of the individual
parameter values used
by using sensitivity analysis with deterministically assessed variations in the
parameter values
by using stochastic models for some, or all, of the parameter values
Scaling up the results of each model point and totalling these will give the expected
profit.
Page 6
(ii) The experience will differ because of variations in the product design. In
particular:
the definition of disability
the level of guarantees included in the contract
the scope of policy exclusions
the maximum replacement ratio
treatment of any additional benefits
maximum policy duration
The new portfolio may have been underwritten using a different philosophy.
Differences may include:
classification by occupation class
availability of deferred periods
use of individual medical exclusions or application of extra premiums
application of changes in disability definition
maximum replacement ratio offered and the treatment of multiple policies
The new portfolio may cover a different profile of lives and the mix by age, sex,
occupation class, mix between employed and self employed, level of benefit, cease
age, increasing/level benefits may be very different.
There may be a difference in the split between personal cover (including mortgage
cover) and business cover.
Historic lapses and the treatment of past claims may also have an impact on the
existing portfolio mix.
Differences in level of expertise
Premium rates may be higher resulting in greater lapses from healthy lives
Any change in the ownership of a block of business may generate additional lapses
which could be anti-selective.
In general this question was not well answered, with candidates often failing to
provide sufficient points to gain many marks. In part (ii), it was not always
appreciated that if the company purchases the portfolio, there would be no differences
arising from future claims handling etc since this would be carried out by the
purchasing company for both portfolios.
7 Morbidity/Mortality
Analysis of the company s experience over a 3 5 year period - long enough to have
reliable data and short enough to be homogeneous. This would be done for males and
females separately. Allowance would be made for any changes in underwriting
standards.
Page 7
Although a market leader in CI, the company is unlikely to have sufficient data to rely
solely on its own experience. In addition to own data, could look at:
industry data (such as CMI reports in the UK)
data from reinsurer
published tables
data from overseas
Published data will probably need adjustment for the particular circumstances of the
company and its products
Need to consider trends in experience especially for morbidity
For critical illness, would reconsider illnesses and conditions covered. If sufficient
data available, may analyse by specific disease
Rates included in reassurance terms would probably be followed. AIDS projections

are available, but only as industry-wide data.
Data needs to be interpreted with care. Deaths from critical illnesses covered will be
irrelevant, because a claim will already have been paid. Other deaths release reserves
as no benefit is paid. This may be a different situation from the type of policy the
data were collected from.
Comparison of the proposed target market and that in the data is important
Almost certainly likely to use the experience to generate an adjustment to a standard

table
Investment returns
This should reflect the expected return on the underlying investments (net of
expenses)
Expenses
The company should have an analysis of expenses over recent years.
A series of analysis helps to identify trends to use in assessing future rates
Expenses should be split into acquisition, maintenance and claims, and between
contract types. For income protection, the expenses may also be split between claims
inception and claims maintenance. The level of detail will depend on the size of the
company
Need to allow for any specific one-off costs and any expected additional costs (e.g.
regulations).
Expenses might also be analysed into those which are contract size related and those
that are policy related
Page 8
If the company s expense investigation does not provide credible data down to the
particular contract type, broader averages may have to be adjusted. Probably with
input from reassurers
Inflation needs to be allowed for from the date of investigation up to the date the rates
will be used and allowance made for any expected trends in future inflation
assumptions
Assumptions about new business may be needed for spreading fixed costs
Commission
The rates and structure that the company intends to pay can be loaded directly into the
basis
Expense inflation
National data on inflation of prices and earnings
Expected future rates of inflation possibly measured by the difference in returns on

government fixed interest and index-linked securities
The expense inflation rate will be chosen to be consistent with the investment return
assumption
Withdrawals
The company should have an analysis of experience available relating either to this
contract or to broadly similar contracts
Limited industry aggregate data may be available but will have to be adjusted to meet
the particular contract and target market
The analysis may need to be adjusted because it has been affected by unusual
economic circumstances over the period the data were collected. Adjustments may
also be needed if the intended target market or sales channel are different from those
in the data analysed
Analysis by duration
Tax
Suitable assumptions will need to be made taking into account the company s current
and future tax position
Profit
Risk discount rate/profit criteria set according to the company s requirements
Other factors
Page 9
Competitors rate should also be considered

Best estimate assumptions or slightly prudent
Reserving bases
Premium bases may be affected by regulation
Profile of business
This question, which contains quite a lot of bookwork, was generally well answered although
candidates did not always provide sufficient points to gain reasonable marks.
8 (i) Protect company from anti-selection
Protect company from seriously impaired lives where it is impossible to assess risk
accurately
Identify substandard lives to offer special terms
Identify most suitable approach for substandard lives
Identify most suitable premium for substandard lives
Accurate risk classification to ensure fair rating
Try to ensure experience does not deviate from that assumed in pricing of contracts
(ii) Question on the proposal form completed by the applicant

Reports from medical doctor that the applicant has consulted
Medical examination carried out at the request of the insurer
Specialist medical test carried out on the applicant
(iii) Policyholder offered immediate cover
No formal underwriting at point of acceptance
Blanket exclusion on pre-existing conditions - usually defined as conditions that have

received treatment for a specified period prior to application (often 5 years)
Exclusions are waived after a period of time, usually 2 3 years, if policyholder

receives no treatment for condition during that time
Past medical history is examined at the time of claim
(iv) Group policies will often have free cover limits - certain level of benefits
available without individual underwriting. Those looking for benefits above the limit
provide medical information or attend tests
Typically insurer will request that all insured members are actively at work on the day
cover commences or a moratorium is applied, where no claim is paid for short period
after start of cover for new entrant
Page 10
Limited insured information. The following data are often not available:
Numbers of lives
Individual ages
Sex
Benefits
Often the insurer requests a deposit premium. This is adjusted at the end of period
when details are available.
Reduction in anti-selection effect as schemes get larger
Premiums charged may be based on the experience of the group as a whole rather
than as a result of individual medical underwriting this would depend on the size
and credibility of the scheme
For the largest schemes medical history may be disregarded completely
Flex schemes have similar anti-selective characteristics as individual policies, so may

underwrite increases in cover or apply strict limits
Need to consider how to treat new-comers
Need to consider influence of the intermediary. Increased potential for anti selection
and limited supply of information due to increased purchaser knowledge
Dependants underwritten differently
Level of underwriting may depend on assumed take-up rates
Differences may be function of distribution methods
Since it was not clear from the wording of the question whether the initial parts were meant
to relate to individual or group PMI, credit was given for answers which assumed either.
For part (ii), full credit was given if the candidate stated that for group business don't usually
underwrite but apply pre-existing exclusions or moratorium. In general parts (i) and (ii)
were very well answered. In part (iii), not all candidates understood how moratorium
clauses work. Part (iv) was generally poorly answered.
Page 11
EXAMINATION
16 September 2005 (am)

booklet.
supervisor.
question paper.
ST1 S2005 Institute of Actuaries
1 For income protection insurance:
(i) Define with examples the term deferred period. [1]

(ii) Explain with examples the definition of incapacity. [2]
(iii) Define the term activities of daily living . [1]
(iv) Explain the term replacement ratio . [2]
(v) Explain the concept of rehabilitation/partial benefit. [1]
[Total 7]
2 You are the actuary of a leading critical illness insurance provider. Your marketing
director has suggested that the critical illness definitions used should be amended to
differentiate your products from those offered in the market by other companies.
Discuss the marketing issues implied by this suggestion and indicate how they might
be mitigated if such a strategy were followed. [5]
3 The country of Actuaria has no state healthcare provision for the population. A
scheme has been proposed under which an earmarked increase in income tax will be
applied to all citizens of Actuaria to fund a national health system to ensure that all
citizens have access to free medical care.
(i) Outline reasons for implementing such a scheme. [4]
(ii) The finance minister wishes to contain the cost of the scheme by maintaining
an element of self-provision. Describe possible means of doing this. [3]
[Total 7]
4 For a typical non-profit hospital cash (health cash) insurance contract:
(a) Discuss the various criteria which must be met in order for claim benefits to
become payable under the contract.
(b) Describe the ways in which the amount of benefit is determined in the event of
a claim becoming payable under the contract.
(c) State the guarantees which might be provided.

[7]
ST1 S2005 2
5 A proprietary life insurance company writes individual long term care business.
(i) Describe the investigations you would undertake to determine an appropriate

investment strategy. [8]
(ii) The regulatory framework may limit what a company may do in terms of
investment. List the types of restriction that may apply. [3]
[Total 11]
6 A proprietary long term insurance company writes individual critical illness contracts
which have reviewable rates.
(i) List four reasons why the company would wish to monitor claims experience.
[2]
(ii) List the data items you would ideally require to make a full claims experience
analysis. You should include all of the rating factors that are likely to be used
for setting premium rates. [6]
(iii) Describe the other factors you would consider before deciding to change
premium rates for existing business. [4]
[Total 12]
7 A long term insurance company writing individual income protection business is

about to calculate its supervisory reserves for active life business using a gross
premium valuation method.
(i) State the principles that should be used for setting the bases for each of the
following:
(a) Interest rate

(b) Mortality
(c) Morbidity
(d) Expenses
[12]
(ii) Discuss how the basis might relate to that used to price the product. [2]
[Total 14]
ST1 S2005 3 PLEASE TURN OVER

8 XYZ is a country which does not provide any medical or other healthcare benefits for
its citizens. Some of the population receive and pay for medical treatment in other
countries, the remainder are treated by private doctors or in privately owned hospitals
in XYZ.
You are the pricing actuary for the XYZ State Life Insurance Company. This is the
only insurance company that is allowed to offer life and health insurance products to
XYZ citizens.
The company has decided to launch a new conventional non-profit medical expense
insurance policy, under which premiums and benefits are not guaranteed for the
duration of the contract. The company has never before issued conventional medical
expense insurance policies.
(i) List the data sources normally available for pricing this line of business (e.g.
in a developed market) and indicate those which would and would not be
available in the circumstances mentioned above. [5]
(ii) Describe any adjustments that you might make for local use. [4]
(iii) Recent research has shown that the incidence of cigarette smoking in XYZ is
10% of the level in the territory from which the statistics are drawn. Comment
on how you would allow for this factor in the pricing for each of the sources of
data quoted in answer to part (i). [3]
(iv) It has been suggested that the medical expense insurance contract should only
pay benefits to policyholders who receive medical treatment in XYZ.
Comment on the advantages and disadvantages of such a policy provision. [4]
[Total 16]
9 You are the pricing actuary for a well-established long term insurance office that has
been writing income protection business for some years. Your sales director, who has
recently joined the organisation from another industry, has sent you an email in which
he expresses concern at the cost of income protection.
Describe typical means of reducing the premium for income protection and the risks
associated with each. [21]
END OF PAPER
ST1 S2005 4
EXAMINATION
September 2005

EXAMINERS REPORT
Subject ST1 (Health and Care Specialist Technical) September 2005 Examiners Report
1
(i) Deferred periods
the period of incapacity before any benefit is paid

The standard deferred periods 4, 13, 26 and 52 weeks
For certain occupations, minimum deferred periods will be applied
(ii) Definition of incapacity

The condition that must be satisfied to enable a claim to be paid, typically totally
unable through sickness or accident to follow own occupation and not following any
other for profit or reward
Normally applied throughout the duration of the contract
Switch definitions amend the definition of incapacity after a certain elapsed claim
period (2 years).
Reserve the right to apply an alternative definition depending upon the occupation of
the insured.
Some use different definitions of incapacity when cover is offered to housepersons
and where cover is maintained on a restricted basis during a period of unemployment
(iii) Activities of daily living

a number of functional tests against which disability can be measured e.g. eating,
washing etc
(iv) Replacement ratio

The ratio of net (in benefit) income to net pre-disability income
A value significantly less than one is desirable from the insurer s viewpoint, to
provide a financial incentive for the claimant s return to work, especially given that
expenses in disability may be less than those in normal (working) health
(v) Rehabilitation/partial benefit

IP benefit payable when a claimant is no longer totally unable to follow his or her
original occupation and returns to it in a reduced capacity
The amount of benefit is usually reduced in proportion to the relationship that the
gross earnings from the new job bear to those from the occupation against which
disability was being claimed.
This question, which is mainly bookwork, was generally well answered.
2 If different definitions are used from those in the market, the following risks could
arise:
The customer may not understand the product that they are buying; therefore may not
be meeting their reasonable expectations
The distributor may not understand the product.
Any change in conditions to reduce the premium will mean that the coverage is less
comprehensive and therefore claims will not be paid that previously would have been.
Page 2
The claimant may therefore have a real need and expectation of payment but the
benefit will not be paid.
If changes in conditions result in an increase in premiums, will product still be
affordable/seem attractive
Local regulations may require standard set of definitions to be used.
If the product is very different from others in the market, then it may not be sold as it
is a more difficult sale.
The salesmen would be required to explain the differences between this product and
others in the market.
Could add conditions that seem to be worth having but in practice have little cost.
Can the risk be priced?
Will the amended product be seen as good value by potential customers?
How can these mitigated?

The changes in policy conditions must be made clear in the policy literature and the
sales process
The conditions chosen to be excluded should be those for less severe conditions
where there is less likely to be a need for cover.
Conditions may be restricted with resultant impact on premium
Consultation with reinsurers over suggested changes
Undertake market research on what customers want in/out of the coverage list
Move from guaranteed premiums to reviewable
This question was generally not very well answered, with candidates often discussing
aspects which were not really marketing issues.
3 (i) Protecting the nations health

Safeguard healthy workforce
Improve productivity and GDP
Ensure that research is directed so that it benefits the country rather than leaving it to
commercial pressures
Redistribution of wealth
Ensure that the poorest members of society have access to medical care.
Ensure adequate provision of services to the elderly and for children
Political considerations / social culture

Health provision is an emotive issue and likely to be politicised
Government may have made electoral promises
Reasons for earmarked tax levy

Equity: higher earners pay more
Ensure that high costs of healthcare provision are borne by whole economy rather
than those in need.
Page 3
(ii) Introduce mandatory private provision

For certain types of procedure/health provision
For those above a certain income threshold
Incentivise private provision

Restrict public provision and encourage a private healthcare market to act as a top
up
Offer tax incentives for effecting private healthcare eg to individuals, employers
Provide a subsidy to private healthcare providers
Require part payment
This question was usually reasonably answered.
4 Non-profit Hospital Cash (Health Cash)
A claim will become payable if:

Claimant requires medical treatment or services due to sickness or disability
Payment is dependent on the medical treatment or services being included in the
contract, and falling within the definition used
Medical treatment or services has to be medically certified
Policy must have been in force for at least the waiting period before the claim event
occurs
Medical treatment or services must not fall under a policy exclusion
Must not exceed annual maxima
Might not be paid for pre-existing condition
Amount of benefit payable under the contract may be:

a fixed amount e.g. £B p.a.
the care fees
other payments specified by the contract
The amount paid will depend upon the medical expenses claimed, and the internal
limits in the contract
The following may be guaranteed:

benefit level
care level
premium level
reviewable or renewable
Many candidates failed to note the conditions under which a benefit might be payable
and tended to list the types of benefit often found under Hospital cash plan contracts,
which was not what the question was asking for.
Page 4
5 (i) Key principles:

Investments should be appropriate to nature, term and currency of liabilities
Want to maximise overall return subject to level of risk
Need model to project assets and liabilities for a given investment strategy and level
of free capital
Best estimate assumptions
Consider sensitivity
Assets: stochastic model, project income and changes in capital values

Expenses: inflation model
Liabilities: could be linked to investment conditions
Look at difference (assets - liabilities) at each year end using supervisory basis
Need to be 'sufficient'; sufficiency depends on

Investment strategy being considered
Regulatory requirements
Nature of business
Rating agencies/competitors
Extend to stochastic investment model to produce statistical distribution of amounts to

cover level of solvency capital
Calculate probability of insolvency for a particular investment strategy
For proprietary company, extend to look at shareholder earnings
Other factors that may be investigated:

Liquidity requirements
Effect on product development and pricing
Method used for asset valuation
Policyholders' reasonable expectations (PRE
(ii) Type of assets that a company may invest in.

Currency of asset
Amount of any particular type of asset that can be taken into account for the purpose
of demonstration solvency.
The extent to which mismatching is allowed
Custodianship
Method of valuation
Most candidates made a reasonable attempt at this question, especially part (ii).
6 (i) Update assumptions as to future experience for existing business

Monitor changed trends in experience so as to take corrective action.
Provide management information.
Make more informed pricing assumptions for future business
Identify anti-selection
Check effectiveness of underwriting procedures
Page 5
Assess need for reinsurance

Calculate profit share entitlement under an existing reinsurance treaty
(ii) For all records

Type of contract including benefit conditions (accelerated or stand alone)
Policy number or other unique identifier
Date of birth (age)
Sex
Smoker status
Occupation
Single or joint life first event
Policy commencement date (or duration from entry)
Policy status in force, lapse, accepted claim, pending claim.
Date of status change
Rated information (at least sufficient to divide policies between standard and sub
standard risks)
Source of business
Level of and type of original benefit (lump sum or annuity)
Level of current benefit
Basis used to calculate current benefit (indexation/rundown).
Territory/geography/address
For claim record

Cause of claim at least split critical illness or death, ideally by all causes.
Date of claim notification.
Date of acceptance
Date of claim settlement
Date of event
Policy or claim number to link to in force record
(Last date items required to estimate IBNR)
(iii) PRE what has happened at previous reviews?

PRE what does the policy literature suggest?
Policy wordings (contractual restraint)
Impact on market reputation and market position
Need to consider other premium factors:
Interest rate
Lapse experience
Expenses
Capital requirements
Credibility of available data
Future experience expectations, durational effects
Possibility of anti-selective lapses.
Regulatory constraints
Action of competitors
Impact on profits
Impact on reinsurance arrangements
This question was generally well answered.
Page 6
7 A prudent basis, rather than best estimate should be used with appropriate margins for
adverse deviations.
Regulatory requirements need to be taken into account
Interest rate
Take account of currency
Regard to yields on existing assets
Regard to yield on sums to be invested in the future
Credit/default risk
Term of the liabilities
A low rate is prudent
Mortality
Need to consider mortality both pre and post claim.
Pre claim
Take account of sex and age
Underwriting policy
Territory of insurance
A low rate of mortality is prudent.
Post claim
Factors as above:
Definition of disability
Duration of claim (note this is for active lives)

NB: Cause not required as this is for active lives
Source of data eg published statistics
A low rate of mortality is prudent
Morbidity
Need to consider both probability of claim and claim recovery rate
Pre claim
As for mortality
Underwriting policy
Territory of insurance
Occupation class
A high rate of incidence is prudent.
Post claim
As for pre claim

Page 7
Occupation class
Duration of claim (note this is for active lives)

NB: Cause not required as this is for active lives
Source of data eg published statistics
A low rate of recovery is prudent
Expenses
Gross valuation so would look to allow for expenses in line with best estimate plus
margin
Allow for:
Product design features
Territory
Claim costs
Administration costs
Commission
Need to allow for future expense inflation.

Should be based on analysis of recent experience
(ii) In some countries it is standard practice to price using prudent assumptions and then
to use the same assumption for supervisory purposes.
In other countries, it is standard practice to calculate premiums using assumptions that

broadly reflect future experience, with the risks to the company being allowed for
mainly through the risk discount rate. In this case, it would not be appropriate for the
same assumptions to be used for both pricing and reserving.
Pricing basis will include an allowance for initial expenses (including commission)
This question was reasonably answered, although many candidates simply stated that
the mortality or morbidity rates should be set prudently without defining what this
meant (eg a high or a low rate). Also, candidates often did not mention the difference
between pre-and post-claim mortality and morbidity.
8 (i) Availability of data

As it is a new contract the following items would not be available for use:
Internal own price
Claims experience
Competitors prices
Company accounts
Regulatory returns
Local published insurance statistics
Items available for use:

Data on claims incidence and on treatment costs may be available from separate
sources
Page 8
Reinsurer s data, knowledge

Data from actuarial and other consultants
Data from other countries such as USA, UK, other European countries
Other local experience
e.g. data from the XYZ hospital sector
Publicly collected Healthcare experience
(ii) In all cases, may need to adjust for the known differences between XYZ and the data
source. These might include:
Adjust for different lives insured compared to base data
Adjust for different coverages (exclusions, limits, procedures etc.)
Adjust for different propensity to claim (e.g. more prone to do so in US)
Allow for trends
Adjust for any pricing basis or to other unadjusted rates, to include possible margin
for prudence
If available by ratings factors, may need to adjust to proposed ratings factors
Adjust for whether data underwritten or not
Different market conditions e.g. state provision, market definitions, claim acceptance
criteria (in the case of reinsurers data
(iii) Reinsurer's data, knowledge

Data likely to come from major insurance markets; ascertain smoking prevalence in
these territories
Split data in risk segments to identify those most affected by smoking, eg medical
treatment, cost of nursing/doctor care, cost of accommodation, cost of initial
consultation, recuperation/outpatient needs
Adjust the cost to allow for the lower impact of smoking
Apply adjustments to both incidence and severity
Data from other consultants, if available

Data from similar sources to reinsurers
May also have population and case study information; preponderance of smokers
should not be difficult to research; follow same procedures as for reinsurance data
Overseas countries
National statistics should indicate proportion of smokers
May need ot be age-related in order to link to cost of treatment
Apply as for last 3 points for reinsurance data
Hospital information from XYZ

May not know if smoker, but this is own country statistics, so no smoker adjustment
needed
Population healthcare statistics

May need some age adjustment if smoking prevalence varies by age and insurance
does not cover all ages
Adjust data for age differential (frequency and severity separately)
Page 9
Research/Charities/Journals
This is assumed to be XYZ based; as long as underlying population is representative,
no further adjustment needed
If population is representative of all XYZ inhabitants, then adjust as per public health
statistics above
Data may be available separately for smokers and non-smokers, in which case no
adjustments need to be made
(iv) Advantages
Caters for the existing hospitals
Claim control easier with local claims
Single currency only
No additional transport costs
No language/interpretation problems
Different medical protocols possibly abroad
Overseas may be higher tech and more expensive
Disadvantages
Does not cater for the requirements of some likely policyholders
Treatment may be more cost effective in other countries
Introduction of restriction may lose customers, so self insure
Not clear on status of consultations abroad
Disadvantages to providers abroad
In part (i) candidates often provided a list of sources of data availability but dud not
then state which were likely to be available or not. Parts (ii) and (iii) were generally
poorly answered with few points being made about how the data might be adjusted.
Part (iv) was often well answered.
9 Premium reduction mechanism

General point reducing premiums will reduce profit per case
unless accompanied by actual change in practice of company
Change rating structure/target lower risk business

Age / sex / geography / lifestyle / class of product (stand alone / rider etc) /
distribution source / occupation class / anti-selection mortgage purchase
Will complicate and lengthen sales processes may reduce new business sales
despite cheaper premiums for better risks.
Will lose business for which rates rise
Implement more stringent underwriting procedures

May increase decline rates and lengthen sales processes.
Increased cost of underwriting may outweigh benefits of better risk targeting
Reduce anti selection effect / over-insurance cap replacement ratio

May not meet customers needs
Page 10
Reduce anti selection effect multiple policies

Reduce over insurance effect regular policy reviews
Introduces additional costs into process costs may outweigh benefits
Better training of sales teams to reduce anti selection effects / over insurance
Reduce claims outgo

Reduce claims incidence for a given risk
Increase exclusions applied
Implement more stringent claims control processes
Change basis of claims payment from own occupation to own/suited or to any occupation
Decline more claims
Reputational risk
PRE considerations if claims philosophy not in line with policyholders expectations
Reduce claims severity

Increase deferred period
Introduce linked claims clause to encourage return to work
Offer lower expiry age / term
Reduce escalation of claims paid
Limit duration of claims payment
Implement rehabilitation services to help claimants back to work
Implement an early notification scheme to allow early claims intervention
Offer long-term claimants with high reserves a lump sum in lieu of a regular income
Reduce expense loadings

Streamline processes
Redistribute expenses between policies (e.g. apply using percentage of premium basis so that
higher value policies carry higher expenses).
Mismatch of incidence of expenses and allocation between policy sizes. (e.g. risk that
larger number of smaller premium policies sold and expenses not covered).
Reduce profitability loading

Expectation of increased volumes offsetting reduced profit per case
Elasticity of demand not accurately understood. Increases in volume not as expected.
Competitor response to lowering premiums results in volumes not increasing as expected.
Enhance retention and reduce lapse assumption
Implement a no claims discount

High lapse rates following claims
Pay less commission

Insufficient commission to incentivise sales
Increase proportion of commission successfully clawed back
Increased administration costs associated with increasing level of clawback may outweigh
the benefits of doing so
Investment income
Increase investment income from held funds
Investment return mismatch risk if deviate from fixed interest securities
Page 11
Need to consider whether any regulatory risk associated with mismatch
Reinsurance
Make effective use of reinsurance arrangements
Make use of tax / solvency arbitrage between direct office and reinsurer
Risk that taxation position may change
Retain more risk (assume that reinsurers make a profit)
Increased claims volatility from higher retained risk
Guarantees
Remove/reduce the level of guarantees in the policy
Introduce or extend use of reviewable/renewable premiums
Move to unit-linked format

Admin costs likely to increase significantly
Relax underwriting procedures

May lead to 'dodgy' acceptances
Assumptions
Weaken demographic assumptions used in pricing
Risk of pricing assumptions not being borne out in practice
General points
Changes may not meet customers needs
General issue of costs v benefits
This question was generally poorly answered, with many candidates providing insufficient
points to gain many marks (usually in this type of question a valid point will earn half a
mark).
END OF EXAMINERS REPORT
Page 12
EXAMINATION
7 April 2006 (am)

booklet.
supervisor.
question paper.
ST1 A2006 Institute of Actuaries
1 You are an actuary working in the financial projections team within a well-established
insurer that writes both long and short-term classes of health insurance. A junior
actuarial analyst in your team has identified that lapse rates for the organisation have
deteriorated over the last five years.
List the factors by which you would analyse the data in order to investigate this
apparent trend. [4]
2 State the reasons why a health and care insurer would analyse:
(a) the surplus arising over a year on its supervisory basis
(b) the change over a year in the present value of the expected profit from its
existing business
[4]
3 A large health and care insurer writes a pre-funded long term care contract. You are a
consulting actuary and you have been asked to carry out a morbidity experience
analysis. State, with reasons, the information you would request from the insurer to
complete this work. [7]
4 A health insurer writes individual income protection contracts with a deferred period
of 3 months. All benefits are payable monthly in advance.
On 1 January 2005 the insurer purchased reinsurance cover under the following treaty
terms:
Quota share 75% of each risk is ceded.
Maximum retention £1,000 benefit per annum per life.
All risk prior to 1 January 2005 is to be retained by the insurer.
Risk premium rates Reinsurance rates are applied monthly to the sum at risk.
The rate definition is age next birthday at the previous policy anniversary .
You are given the following extract of the premium rate table:
Age next Annual rate per £1,000 annual benefit
39 1.2
40 1.3
41 1.4
42 1.5
ST1 A2006 2
On 1 January 2005 the insurer has 1000 policies aged 40 next birthday under the
above rate definition with the following sum insured profile for each policy:
Number of policies Sum at risk for each policy
800 £3,000 annual benefit

(i) Calculate the reinsurance sum insured. [2]
(ii) Assuming that 10% of the policies lapse uniformly during the year, estimate
the reinsurance premium for 2005, stating any assumptions you use. [3]
You are given the following extract from the insurer s claims records:
Claim Date first sick Date claim notified Date claim Date of recovery Annual
accepted Benefit
A 5 November 2004 12 December 2004 5 January 2005 4 June 2005 £3,000

B 12 December 2004 17 January 2005 26 January 2005 11 July 2005 £4,000
C 7 January 2005 18 February 2005 9 March 2005 6 August 2005 £3,000
D 25 June 2005 13 August 2005 18 August 2005 24 August 2005 £3,000
E 21 November 2005 6 January 2006 12 January 2006 20 March 2006 £3,000
(iii) State, with reasons, whether the reinsurer was required to make payments for
each of the above claims. [2]
(iv) Calculate the total amount of the claim payments made by the reinsurer in
respect of these claims. [2]
(v) State the other factors the reinsurer would need to consider in order to
determine the profitability of this business? [2]
[Total 11]
ST1 A2006 3 PLEASE TURN OVER

5 (i) List the options available to health and care insurers when they receive an
application which is deemed to represent a higher risk than that assumed in the
pricing assumptions. [3]
(ii) Suggest, with reasons, the most appropriate options for the following risks:
(a) An applicant with a history of knee pain applying for income

protection cover.
(b) A female applicant for a stand alone critical illness policy where there
is a family history of breast cancer.
(c) An applicant for an accelerated critical illness contract who is a

professional racing driver.
(d) An applicant for a pre-funded long term care insurance who is

suffering from memory difficulties.
[10]
[Total 13]
6 You are the pricing actuary of a leading individual critical illness provider. Market
research has identified that the critical illness product could be improved by the
addition of the lump sum benefit being paid on the insured being diagnosed with any
permanent mental health condition.
(i) Discuss the advantages and disadvantages of adding the mental health
condition to the contract and whether you would recommend this mental
health benefit should be added to the contract. [8]
(ii) You have been asked to develop the key morbidity and mortality assumptions
to set a premium basis for this suggested addition. Indicate the likely key
sources of data available and the adjustments that would be suitable to the data
for this purpose. [5]
[Total 13]
7 You are a product actuary within a health and care insurer, which is reviewing its
income protection business.
(i) Describe the ways that the insurer can tailor the level and timing of benefits
provided by an individual income protection product to meet an individual
customer s circumstances, including typical values for each and the broad
impact of each feature on the price of the contract. [9]
(ii) Describe how a policyholder s occupation may be relevant in an individual

income protection contract. [5]
(iii) Describe the types of guarantee that might be provided on individual income
protection contracts. [5]
[Total 19]
ST1 A2006 4
8 You are the risk management actuary working in a health and care insurer which
writes income protection, critical illness and private medical insurance products.
Your organisation has just gained approval from your regulator to distribute its
products through Health and Care parties where existing policyholders can hold
annual gatherings of friends and family to sell your products. The party hosts will
guide their guests as to the appropriate forms of cover and will be remunerated on a
commission basis.
(a) Describe the insurance and other business risks to the insurer associated with
this proposal.
(b) For each of the above risks, describe how they can be mitigated. You should
include the monitoring mechanisms the insurer should put in place to enable
these risks to be managed.
[29]
END OF PAPER
ST1 A2006 5
EXAMINATION
April 2006

EXAMINERS REPORT
Introduction
The attached subject report has been written by the Principal Examiner with the aim of
helping candidates. The questions and comments are based around Core Reading as the
interpretation of the syllabus to which the examiners are working. They have however given
credit for any alternative approach or interpretation which they consider to be reasonable.
M Flaherty
June 2006
Comments
Candidates who approached the questions, especially the more substantial elements of each
question, in a methodical and detailed manner were far more likely to satisfy the examiners
and receive a pass in the subject. There was often a lack of sufficient detail in the answers
with candidates failing to realise that each valid point in the answer would normally attract
0.5 marks with the more basic elements e.g. details in a pricing basis such as age and sex,
would attract 0.25 marks.
Candidates should also recognise that whilst reinsurance can play a valuable role in the UK
health insurance market, reinsurance is not a panacea for all evils.
1 Factors by which the data might be analysed to investigate the apparent deteriorating
trend in lapse rates include:
Type of contract (e.g. reviewable/guaranteed, individual/group)

Duration in force
Year of writing
Sales method
Agent
Target market
Premium frequency
Premium size
Premium payment method
Original contract term
Sex/age/smoker status
Claims experience/NCD
Deferred period for IP, LTC
Underwriting
Occupational class/socio-economic class
Location
The data would be needed by time periods such as calendar year to examine trends.
2 (a) To show the financial effect of divergences between the valuation assumptions
and the actual experience, exposing which assumptions are more financially
significant.
To show the financial effect of writing new business.
To provide a check on the valuation data and process, if carried out

independently.
To identify non-recurring components of surplus, thus enabling appropriate

decisions to be made about the distribution of surplus to any with profit
policyholders so entitled or to shareholders.
To provide information on trends in the experience of the company.
(b) To validate the calculations, assumptions and data used.
To reconcile the values for successive years.
To provide management information.
To provide detailed information for publication in the company s accounts or

those of any parent company, in particular the value of any new business taken
on by the company.
Page 2
To identify profitable lines of business.
To assess the yearly return on capital.
3 The question talks about morbidity and for LTC (as with IP) we are interested in both
claim inceptions and claim terminations.
Recoveries will be low but there will be many terminations due to death.
For claim inceptions we require the following to determine the exposed to risk:
Policy commencement date (or duration from entry)

Date of lapse/LTC claim/date of death, if applicable
Level of initial benefit
Basis for calculating current benefit (indexation or level policy)
Single or joint life policy event
For claims we will require:
Date of claim event

Date of notification (to enable IBNR to be calculated)
Cause of claim
We will need to subdivide the results in to homogeneous groups. We will need:
Date of birth
Sex
Rated information (at least sufficient to divide policies between standard and
substandard risk) also used to determine expected claims.
Premium frequency (likely to be monthly, annual, single)
Benefit trigger (2/3 ADLs etc.)
Geography/territory
Source of business
For LTC, pricing is unlikely to depend on smoker status or occupation class.
For a termination analysis we require the following additional exposure information:
Date of claim termination

Cause of termination (recovery or death)
Benefit basis during claim
Date of notification of claim termination (for IBNR terminations)
Additional information that would be required for any analysis:
Full details of the products

An expected basis for incidence and terminations
Policy number to link claims to exposure
Changes in underwriting practices and claims processes
Page 3
4 (i) The reinsurance sum at risk is
800 * £3,000 * .75 + 150 * £4,000 *.75 + 50 * £4,000

(maximum retention bites) = 2,450,000
(ii) To calculate reinsurance premium
Ignoring the lapses:
Policies are age 40 next at outset. Assume that policy anniversaries are spread
uniformly throughout the policy year then the average rate applied is
(1.3 + 1.4)/2 = 1.35
Premium with no lapses is 2,450,000 * 1.35/1,000 = £3,308
Lapses are uniform so, on average, 95% of business in force
Reinsurance premium = 0.95 * £3,308 = £3,142
Assume that premiums are paid on all policies that are in claim
Assume no changes in sum at risk
Assume that lapse rates independent of size of policy/sum at risk
(iii) For claims on which the reinsurer would be required to make payment we are
concerned with date sick during 2005. Date notified, date accepted or date
claim payments commence are irrelevant. Hence we are only interested in
claims C, D and E. Policies have a 3 month deferred period. Claim D has
recovered during the deferred period and should be excluded even though it
has been accepted as a valid claim. So the answer is C and E.
(iv) Reinsurance payment
Reinsurer is responsible for 75% of the risk
Claim C was sick 7 months, so 4 payments

Claim E was sick for 4 months, so 1 payment
(4/12 * 3,000 + 1/12 * 3,000) * .75 = £937.50
(v) Other factors
Claims information may be incomplete because of IBNR.
Reinsurer needs to consider expenses, cost of capital, tax, profit criteria and
investment earnings.
Page 4
5 The available options are:
Load premiums (per mille, % load, age adjustment)

Defer cover
Decline risk
Offer different cover
Offer to reinsurer facultatively with zero retention
Exclude specific perils
Accept as loss leader for business purposes
This part of the question required the candidate to use common sense and should not
require detailed medical knowledge. The question asks for reasons.
(a) Lots of potential policyholder will have a history of knee pain so deferring
cover, declining the risk or offering to reinsurer are unlikely to be good
options.
If the question specified a short deferred period then a longer deferred period
may be appropriate.
Depends on occupation.
Most likely options are load the premium or apply a specific exclusion.
(b) Can t really defer.
Decline likely to be too extreme.
Too common to pass to reinsurer.
Cannot really exclude cancer as it is such a large component of the cost.
Regulation may prohibit use of family history.
This suggests that loading premiums is the only option.
(c) The concern here is the accident risk.
This a rather specialist risk and facultative reinsurance may be the best
approach.
Alternatives are load premiums (charge per mille extra).
Could exclude TPD cover, or change the TPD definition, but other exclusions
likely to be difficult to split the risk.
Exclude deaths from racing accidents.
No obvious other cover.
Page 5
(d) Decline.
This could very easily be Alzheimer s and if this were the case the claim cost
would be substantial.
Depends on claims trigger for memory loss.
It is unlikely (even if possible) to be cost effective to try to determine the

cause of the memory loss.
6 (i) Advantages include
A worthwhile addition valued by customers, giving competitive edge.

Easily identified by the public.
Readily communicable to sales people.
Disadvantages include
Difficult to draft wording for a permanent mental illness addition.

Most mental health problems are chronic with few acute episodes.
so insured is able to work with little loss of income.
Some genetic bias in mental health.
Good relevant morbidity data hard to find.
There will be many potential claims declined.
Mental health problems rise with age.
Prime target market under age 45 so addition less relevant.
Difficulty in underwriting/exclusion.
Leading to anti-selection
especially if no one else is offering it.
Difficulty in approving claims
no independent test.
Might not be able to get reinsurance.
Increased premiums in competitive market.
Expenses of change to claims processing, underwriting etc arising from two
separate contracts.
Marks were given for recommending whether or not the mental health benefit
should be added, provided suitable reasons were given to support the
recommendation made.
(ii) Morbidity/Mortality
Analysis of the company s experience is of no use as this is an addition.
Sources
Industry data (such as CMI reports in the UK) for IP.
Data from reinsurer.
Page 6
More likely to be for IP.
Data from overseas.
Population data
e.g. hospital episode data
Published data will probably need adjustment for the particular circumstances
of the company and its products.
Need to consider trends in experience, especially for morbidity in IP.
Rates included in reassurance terms would probably be followed.
Data needs to be interpreted with care.
Comparison of the proposed target market and that in the data is important.
Almost certainly likely to use the experience to generate an adjustment to a

standard table.
7 (i)
Replacement ratio
Post claim to pre claim ratio

Net of tax
Higher replacement ratio leads to higher claims inceptions and lower claim
terminations
and hence higher premiums
Typical maxima are 60% or 75%
Deferred period
Initial period of sickness during which benefit will not be paid

Commonly 4, 13, 26 and 52 weeks
Lower deferred period results in more claims and hence higher price
May help integration with employer or state benefits
Linked claims clause waive deferred period if recurs within 26/52 weeks
Expiry age/term
Often retirement e.g. 60 or 65

or may be fixed term
E.g. alongside a mortgage
So typical term is 25/20 years
Longer term/older age means higher potential claim amounts and hence
higher premium
Page 7
Escalating premiums and benefit
Benefits can be level e.g. to meet a specified mortgage payment

Increasing benefits more common as link to salary
Fixed percentage or linked to an index
Typical values 5% or RPI (usually capped)
May have different escalation depending on whether in claim or not
Higher escalation means higher premiums
Partial proportionate benefits
GIOs
(ii) Occupational definition
Rating factor
Usually 4 or 5 classes
Direct impact on price
Claim event definition
Occupation dependent (e.g. inability to perform own/any occupation)

(Or inability to perform various tests (PCAs/ ADLs etc.))
More limited definition (own occupation) will result in higher claims (and
hence higher premiums)
May be required to notify all changes to occupation
Need to report occupation changes may be more important for some
occupations than others
Impact on premium unclear as targeting of poor risks and reduction in
selective lapses may be offset by increase in admin costs
Some special IP schemes are occupation dependent
e.g. locum insurance for doctors and dentists
Occupation may impact on the term of contract or expiry age e.g. professional
footballers
Occupation may impact on the availability of GIOs/continuation
options/renewability options
Occupation may necessitate certain work-related exclusions
(iii)
Guaranteed/reviewable rates
May be fully guaranteed or there may be no guarantee

at all
Or often guaranteed for an initial period e.g. first 5 years
Difficult to review in practice because of market pressures
Can also result in selective lapsing
Higher level of guarantee implies higher premium
There may be a maximum increase in premium on review
There may be benefit guarantee (e.g. varying benefits)

Expense charge guarantee
Page 8
Guaranteed insurability
GIO policyholder can increase sum assured, at standard rates, on the

occurrence of certain pre-defined events
Not common on IP as benefit usually linked to salary
May be available if policy linked to a mortgage
Generally more options/guarantees means higher premiums
Term extension guarantee
Guaranteed renewability of contract
Guaranteed convertibility option
8 (a) Key risks associated with this proposal include:
Mis-selling
Key risk is that client does not get appropriate cover.
The insurer s relationship with client is dependent on party host.
There is an overall risk that the party environment is not

conducive to purchase of financial products.
Insufficient time to discuss on a one-to-one basis and hence
no understanding of individuals needs
Peer pressure
Purchases may be induced by alcohol
There may be product bias (commission related)
Inappropriate product host does not understand products
Inappropriate sales message products may be represented
inappropriately (e.g. relating to guarantees)
There may be a high number of regulator complaints
Over selling
Hosts may sell at too high sums assured resulting in higher commission
Less relevant for IP/PMI as usually salary multiple
Mitigation and monitoring points as for mis-selling
Non-receipt of premiums
May not receive premiums from party hosts
Business churn
Annual events so annual resell likely
Anti selection
Party hosts may target friends/family with existing need
Page 9
High rate of policy cancellations
Risk that inappropriate sales lead to policy cancellations as for mis-selling

Risk that host encourages purchase of products followed by subsequent
cancellation once commission has been received
Distribution costs go up due to turnover of hosts
Risk that there will be a high turnover of hosts and significant training costs
will be wasted
Risk that the portfolio of customers will not be diverse
Concentrated on customer profiles that would attend these parties

Anticipated market may be different to actual purchasers
Impact on other distribution channels
Non-disclosure risks
e.g. reluctance of purchasers to disclose medical information to a friend
Risk that distribution approach is not successful
Reputational risk
Risk that regulator withdraws approval at later stage
General points
Risk heightened if no competitors are adopting this approach
(b)
Mis-selling
How this can be mitigated
Party host training

customer healthcare needs
customers ability to pay
products and acceptance procedures
good, clear supporting literature and sales aids
Strict vetting of party host
Ensure appropriate commission, not introducing product bias
Have an employed rep sell products rather than party host
Have cooling off period/use as awareness raising exercise and complete sale
at later date
Page 10
Monitoring keep records of
Volumes by party host

Persistency by party host
Complaints by party host
Over selling
Mitigation and monitoring points as for mis-selling
Non-receipt of premiums
Mitigation
Direct payment from policyholder to insurer

No commission to party host unless premiums received
No cover for policyholder unless premiums received
Business churn
Mitigation/monitoring
Ensure existing business proposition is comparable with new business

proposition
Prohibit annual resell
Do not pay commission where cover is already provided
Anti selection
Mitigation
Underwriting
Training/awareness for party hosts
Increased price for policies sold through this channel
Monitoring
Claims experience by party host

Claims experience for all policies sold through this channel
High policy cancellations
Monitor policy cancellations by host

Apply drip-feed commission
Or claw back if up-front lump sum paid
Distribution costs go up due to turnover of hosts

Monitor turnover rates of hosts
Mitigate by
Targeting profile of hosts with low turnover
Remunerate to encourage low turnover e.g. portfolio based commission
Page 11
Risk that the portfolio of customers will not be diverse or as anticipated
Mitigate by ensuring that this is not sole distribution
Risk that distribution approach is not successful
Monitor profitability of channel as part of regular analysis

Ensure that this is not the sole mechanism of distribution
Reputational risk
Monitor customer feedback

and press/industry comment
Launch under separate brand
Withdraw if adverse comment
Risk that regulator withdraws approval at later stage
Ensure that this is not the sole mechanism of distribution
General risk mitigation points
Undertake post sale compliance checks

Do not pay commission if inappropriate sale
Don t implement this new distribution mechanism
END OF EXAMINERS REPORT
Page 12
EXAMINATION
15 September 2006 (am)

booklet.
supervisor.
question paper.
ST1 S2006 Institute of Actuaries
1 (a) Describe, with examples, three distinct approaches to the definition of
incapacity used in income protection policies.
(b) For each approach give two reasons why the approach is used and give an
example of an occupation or group of people for which the approach would be
suitable. [7]
2 You are an actuary working in the financial projections team within a well-established
insurer that writes both long and short-term classes of health insurance. A junior
actuarial analyst in your team has identified that lapse rates for the organisation have
deteriorated over the last five years.
List the factors by which you would analyse the data in order to investigate this
apparent trend. [4]
3 A non executive director to the long term insurance company for which you work has
proposed that the company should offer income protection insurance with a one-day
deferred period; he suggests that this would have a substantial impact on the level of
new business. Discuss the potential problems with this strategy. [5]
4 An extract of the rates underlying a critical illness table (CIBT06) is shown below:
Age Incidence 28 day mortality Mortality Proportion of

rate per 1,000 rate per 1,000 rate per 1,000 deaths from CI
34 1.1 0.10 0.6 0.25

35 1.2 0.11 0.7 0.25
36 1.3 0.12 0.8 0.25
37 1.4 0.13 0.9 0.25
The insurer only sells accelerated critical illness contracts and uses the following basis
to calculate premium rates:
Claim assumption: 50% CIBT06 with a 20% selection discount

Interest: 4% p.a.
Expenses and profit: 10% loading
Premiums are payable annually in advance and the sum assured is payable at the end
of the policy year of death or critical illness.
(i) Calculate the annual premium for a policyholder aged 35 next birthday at
entry for a sum assured of £50,000 for a policy with a term of one year. [4]
The insurer is considering adding an option to allow a policyholder to effect a new

policy at the expiry of the original policy. The new plan will be offered for a term of
one year and will be based on the new business premium rates in force at that date.
The policyholder does not have to provide any evidence of health on the exercise of
this option.
ST1 S2006 2
(ii) Given the above information, estimate the additional annual premium for the
proposed option. You should state all of your assumptions. [5]
(iii) Estimate the additional annual premium for the option, assuming that 30% of
policyholders will exercise the option and that their experience under the
option policy will be 70% CIBT06. You should state all of your assumptions.
[3]
(iv) Discuss which of the two estimates calculated in parts (ii) and (iii) above is the
most appropriate cost. [2]
(v) Discuss other factors you would consider before introducing this option. [2]
[Total 16]
5 (i) Describe the main distribution channels for health and care products. [8]
(ii) Indicate, with reasons, for each of the channels whether it is an appropriate
form of distribution for each of critical illness, hospital cash and long term
care insurance. [4]
[Total 12]
6 Janet and John, who are both in their 20 s, were recently married and are meeting an
insurance broker to discuss their financial plans. John is self-employed so has no
employee benefits. He earns £30,000 p.a. Janet works for a financial institution
which has an employee benefit package that includes a short-term sick pay scheme
and a Group Income Protection plan. She earns £24,000 p.a.
John is considering the following income protection policy:
Type: Individual income protection policy

Deferred period: Three months
Definition of disability: Unable to follow own occupation
Benefit amount: £1,000 per month
Benefit term: Benefit is paid from the end of the deferred period for a
maximum of 5 years
Expiry age: 60th birthday
Janet is currently a member of her employer s benefit package. The benefits are:
Type: Short-term sick pay plan

Deferred period: None
Benefit amount: 100% of salary for 2 months, 75% of salary for the next
4 months
ST1 S2006 3 PLEASE TURN OVER

Type: Group income protection policy
Deferred period: Six months
Benefit amount: 60% of pre disability salary
Benefit increase: 3% on the anniversary of the income protection benefit
becoming payable
(i) Describe what medical and financial underwriting would be required for
John s income protection plan benefits. [3]
(ii) Calculate what employee and insurance benefits would be payable if Janet and
John were both injured in a road traffic accident and were unable to work for
six years. You should ignore the effect of any income tax that might be
payable. You should set out your answer showing the benefits paid in each of
the years. [7]
(iii) Janet s twin sister, Joan, is about to join Janet s company. Describe the
medical and financial underwriting that would be required for her to join the
same income protection and short-term sick pay scheme. [2]
[Total 12]
7 An overseas company has purchased the assets of a manufacturing company that has
been put into liquidation. The company originally employed 10,000 employees. The
new owners are intending to restart some of the manufacturing activities two months
later and will employ about 2,000 former employees. It is proposed that the health
benefit arrangements of the original employer will be provided for the employees.
The details are:
PMI scheme: Members

PMI benefits: Full coverage for acute conditions
Nil excess, non-contributory scheme for employees
It has been agreed that the insurer of the original PMI scheme will be invited to insure
the scheme for the remaining employees at the restart on the same basis and price as
before.
The insurer is considering their response to this invitation.
(i) Outline the data that the insurer will require from the company to produce
their response. [6]
(ii) Outline the additional items of information that the insurer will need to collect
from internal and other sources. [8]
(iii) Consider what action might be taken by the insurer if the calculation of the
new premium
(a) produces a lower premium than previously quoted

(b) produces a higher premium than previously quoted [5]
[Total 19]
ST1 S2006 4
8 You are a marketing actuary working within a reinsurer. Your organisation has
segmented the insurance market into the following:
Segment A Small new entrants to the health and care insurance market.
Segment B New entrants to health and care insurance that are significant
established insurers for other lines of business.
Segment C Existing health and care insurers whether or not currently reinsured.
(i) Describe the reasons why insurers may choose to reinsure their business,
highlighting where there may be differences between the segments above.
You do not need to consider the different types of reinsurance arrangement as
part of your answer. [10]
Within segment A, a small insurer is considering entering the private medical

insurance market and has asked you to present a potential surplus reinsurance
arrangement to them for their consideration.
(ii) Describe the key features of surplus reinsurance and whether you believe this
is an appropriate form of reinsurance in this context. [3]
(iii) Describe the other forms of reinsurance arrangement available, giving an

indication of their appropriateness in this situation. [12]
[Total 25]
END OF PAPER
ST1 S2006 5
EXAMINATION
September 2006
Subject ST1 — Health and Care

EXAMINERS’ REPORT
Introduction
M A Stocker
November 2006
Comments
½ marks with the more basic elements e.g. details in a pricing basis such as age and sex,
would attract ¼ marks.
Candidates should also recognise that whilst Reinsurance can play a valuable role in the UK
© Faculty of Actuaries
© Institute of Actuaries
Subject ST1 (Health and Care Specialist Technical) — September 2006 — Examiners’ Report
1 Example 1
Most definitions are currently occupational.
Examples are as follows:
• inability to perform own occupation
• inability to perform own occupation and any other suited occupation by
education, status or training
• inability to perform any occupation
• inability to perform own occupation for the first (e.g.) 2 years of claim
followed by inability to perform any occupation
Reasons
Require ability to carry out an occupation, otherwise incapacitated
Matches the risk/needs of the policyholder
Easy for the policyholder to understand
Occupation
Clerical etc.; most employed persons
Example 2
Activities of daily living (ADLs).
The policyholder’s inability to perform a number of normal everyday tasks.
Definitions of these typically include:
feeding, dressing, washing, toiletting, moblity, transfer
A common requirement for the payment of the benefit is the failure of the insured
to be able to undertake, unaided, a given number of the ADLs above, commonly 3
or 4
Reason
An ADL definition can be applied to a wider range of lives.
Less subjective than one based on the ability to perform an occupation.
Occupation
Housepersons
Example 3
Function assessment tests (FATs) or activities of daily working (ADWs) or
Personal Capability Assessment (PCA).
Marks were given for a description of one of ADW, FAT or PCA
Reasons
With these definitions the activities include skills like dexterity, mobility and
communication.
They can be more objective, particularly if the “skills” defined relate to
occupational class.
Page 2
Occupation
E.g. Potter
Alternative definitions include Housebound.
2 Type of contract (e.g. reviewable/guaranteed, individual/group)

Duration in force
Year of writing
Sales method
Commission structure
Agent
Target market
Premium frequency
Premium size
Premium payment method
Original contract term
Sex / age/ smoker status
Claims experience / NCD
Deferred period for IP, LTC
Underwriting
Occupational class/socio-economic class/salary
Location
Need data by time periods such as calendar year to examine trends
3 Volume of claims difficult to administer on system, staff resources.

Volume of claims difficult to appraise medically.
Statistics may not be available to price contract.
Difficulty in obtaining certification.
Difficulty in an unambiguous definition of a claim inception.
Periods of recovery and relapse difficult to ring-fence.
Cost is almost certainly prohibitive to sales
Reinsurance will be difficult to obtain
Pre-existing exclusions may be difficult to enforce
Anti-selection (malingering) rampant: “paid for a day in bed”
Less than maximum period for self-certification of work absence?
Experience likely to be highly seasonal
Experience likely to be subject to latest germ going around e.g. bird flu
Is this insurance? Has p/holder suffered a loss?
Volume of declinatures may shed bad light on insurer.
Page 3
4 (i) Formula for accelerated CI risk: ix + (1 - kx) * qx

where i is the incidence rate, k is the proportion of deaths from CI and q is
the death rate.
35 next so require 34½ exact
CIBT06 rate for 34 = 1.1 +.75 *.6 = 1.55 per 1000

35 = 1.2 + .75 *.7 = 1.725
so rate for age 35 next is 1.6375
Basis 50% with 20% discount in year 1
Premium per 1000 = % table * (1-selection discount) * rate * adj for benefit
at year end * expenses loading
= .5*.8 * 1.6375 * 1/1.04 * 1.1 = 0.693 per mille
Premium for £50,000 = 50 *.693 = £34.65
(ii) Given only the above must use the Conventional method to calculate the
option.
Assumptions
All lives eligible to exercise the option will do so.
The mortality/morbidity experience of those who take up the option will be
ultimate experience which corresponds to the select experience that would
have been used as a basis if underwriting had been completed as normal
when the option was exercised.
The mortality/morbidity basis does not change over time.
Need rate for age 35½ exact

Rate for age 35 = 1.725 (part (i))
Rate for age 36 = 1.3 + 0.75*0.8 = 1.9
Rate 35½ = 1.8125
Normal rate with underwriting at start = % table * (1 – sel adj) * rate * adj
end year * expenses loading
= 5 * 0.8 * 1.8125 * 1/1.04 * 1.1 = 0.7668
Charge for ignoring underwriting = % table * sel adj * rate * discount back
to initial date * expenses loading
= .5 * .2 * 1.8125 * 1/1.04 * 1.1 = 0.1917
No lives at end of 1 year = 1 – % table * (1 – sel) * rate for age 34½

= 1 - 0.5 * 0.8 * 1.6375/1000 = 0.9993
PV cost = SA * no of lives end year * cost at year end * discount to day 1
= 50 * .9993 * 0.1917 * 1/1.04 = £9.21
Page 4
(iii) Now have sufficient information to use the North American method.
Cost = SA * proportion lives exercising option * difference in actual
morbidity and and assumed morbidity in standard premium rate * rate *
lives at end year 1 * benefit payable at end year * discount to day 1 *
expenses loading
= 50 * .3 * (.7 – .5 * .8) * 1.8125 * .9993 * 1/1.04 * 1/1.04 * 1.1
= 8.29
(iv) Looks for a judgement call with reasons. Both methods have their
advantages and there isn’t really a right answer. It depends on how good
your assumptions are.
Under the Conventional method is it reasonable to assume that 100% of
lives exercise the option?
What about lapses?
Under the N American method how confident will we be on the option take
up rate?
How will we know the extra morbidity of those exercising the option?
Both methods rely on assumptions which may be difficult to justify on
day 1.
The company may be able to influence the take up rate by how they
communicate with the policyholder or how the product is sold
(v) We are talking about critical illness so it is not necessarily obvious that the
scope of cover (range of CI events, CI definitions) is still appropriate.
Medical advances may enable greater anti-selection than previously
assumed.
Need to consider the expenses of operating the option,
likely sales impact
and competitor reaction to introduction of this option
Target market and reason for policy
Are these offered to rated policies?
Page 5
5 Insurance intermediaries (brokers)

Independent of a particular insurance company.
Usually remunerated by commission from insurer or fee from client.
Usually client initiates sale although broker may promote themselves to existing
clients.
Generally sells to higher net worth individuals
Products
Able to deal with complicated products and offer market comparisons.
Free to sell any product in the market
Would all generally be capable of selling CI and hospital cash
but LTC may be limited to specialist brokers given the sensitivity of the product and
the likely age of the target market.
Tied agents
Tied to one or several insurance companies.
May be employees of insurance linked organisation (e.g. bank, distribution
company).
Where tied to more than one company products usually mutually exclusive
Typically remunerated by commission.
Often client initiates sale although some agents may actively engage in selling.
Products
Generally able to sell CI and hospital cash.
LTC may require specialist training and so less likely.
Own salesforce
Employees of insurance company so only sell products of that company.
Remunerated by salary and/or commission.
Sales person usually initiates sale.
Products
As with tied agents.
May have a specialist salesforce to handle LTC products
Direct marketing
Mailshots
Telephone selling
Press advertising
Internet
Affinity clubs
Products
Generally require simple products. Hospital cash is an obvious contender.
CI is more complicated and direct channel may be used to generate leads. LTC
unlikely to be sold directly although direct marketing may be used to generate
appropriate leads.
Page 6
Worksite marketing
Broker or insurance rep obtains permission to address the workforce en masse to sell
product.
Intricacy of cover depends on sophistication of staff being targeted.
May be able to offer reduced premium or simplify underwriting process.
There may be expense saving through pay roll deduction.
Products
Can be used for hospital cash and CI.
Unlikely for LTC given complicated product and age of target market.
6 (i) John — may require full underwriting

Depending on the insurer and his state of health.
He will be required to complete a proposal form
An dpossibly undergo a medical examination.
The insurer may obtain a GP report
and possibly other test results
Financial Underwriting — as self employed would need earnings details to
be provided
(ii) John
Year Months Type Amount
1 1–3 Nil
1 4–6 3000
1 7–12 IP 6000
2 IP 12000
3 IP 12000
4 IP 12000
5 IP 12000
6 1–3 IP 3000
Jane
Year Months Type Amount Type Amount Total
1 1–2 100% salary 4000 GIP -
1 3 75% salary 1500 GIP -
1 4–6 75% salary 4500 GIP -
1 7–12 GIP 7200 17200
2 1–6 GIP 7200
2 7–12 GIP 7416 14616
3 GIP 15054.48
4 GIP 15506.11
5 GIP 15971.30
6 1–3 GIP 16450.44
Page 7
(iii) Joan — Group IP

If the group is large enough then free cover will apply.
A short proposal form will be required.
Benefits above free cover will be underwritten as per Individual IP.
If insured, Short-term sick pay scheme will require a short proposal form
Actively at work certificate
7 (i) The employees

The 2,000 employees may or may not have a similar profile to the original
scheme.
The profile may differ by:
Sex
Age
Occupation mix
Location
Stability of in-force
The new scheme

Will there be any medical selection procedure for former employees?
Will there be other local recruitment?
Will other employees have a different level of initial health screening?
What about management from the parent company seconded to this operation?
Employee selection procedures.
What activities are being continued?
What occupations are involved.
(ii) Other details required

Past claims experience from insurer records.
You need full details of:

Exposure past and coming year (movement stats for past and coming year)
Benefit details
Past claims
Calculate the historic burning cost.
You then need information to analyse trends in:

• Inflation
• Legislation
• Recruitment/dismissal
You will need something on employer’s “discretionary” insistence.

Then, for the quote, you will require details on:.
Expenses
Commission
Margins
Cost of capital
Page 8
Profit
Cost of reinsurance
Tax
Medical inflation
Book rates
Competition
(iii) Possible actions to be taken by the insurer
(a) The calculation produces a lower premium than existing

You quote the premium requested, in the hope that any surplus gained
may be used as a reserve to produce a keener quote on a subsequent
occasion when there is competition.
You provide a lower quote or enhance the benefits here in order to
engender customer loyalty.
A lot will depend here on whether there is a broker involved and on the
extent to which the employer regards himself a customer of the broker
rather than the insurer.
(b) The calculation produces a higher premium than existing

You reduce the premium, cutting margins where appropriate, in order to
justify the potential loss.
You hope to regain the deficit over future renewals.
Great care must be taken if such a cut reduces the premium below its
potential burning cost plus direct expenses.
You refuse to quote, writing a polite letter of explanation.
You might give in this letter the extent to which premiums need to be
increased, in your view, to maintain the same level of benefits, and the
extent to which benefits need to be tweaked (reduced) to be funded from
the same level of premium.
You might split the scheme e.g. blue-collar/white-collar or regionally, in
such a way that the “main scheme” can meet the price/benefit criteria.
You might recommend a small contribution from the employees (as
currently non-contributory), such that the price requirement continues to
be met for the insurer.
You might consult with a reinsurer.
If the latter has a keener attitude towards the cost of the risk, a large
quota share with commission compensation for expenses, might enable
you to meet the employer’s criteria.
The commission cost might be negotiated with the broker. This is only
likely to work if all competitor insurers are similarly unable to meet the
premium requirement
Offer profit share
Page 9
8 (i) Limitation of exposure to risk

Where accumulation of risk could materially impact business results of insurer
Health and Care business has volatile claims patterns
Likely to be a requirement for segment A
May also be a requirement for segments B and C
Avoidance of single large losses

Depends on size of free assets
Most likely a requirement for segment A
May also be a requirement for segments B and C
Smoothing of results
Particularly useful when account is immature
So definitely a requirement for A
Potentially also for B
Availability of expertise
Particularly useful when entering new risk areas
Likely to be of benefit for segments A and B
Insurer may choose to reduce reinsurance later on when own expertise has
grown
Increasing capacity to accept risk

Singly
Cumulatively
Can apply to all types of insurer
Financial assistance
New Business Strain
Bolster Free Assets
Particularly relevant to segment A
Tax arbitrage
Solvency arbitrage
Capital arbitrage
All segments
(ii) “Proportional reinsurance”

Insurer selects monetary limit at outset of treaty
Reinsures amount of policy sum above this limit
Can be facultative or obligatory
If facultative, reinsurer must accept all such cases
May have upper limit
May be O/T or risk premium
Insurer is recompensed for costs of writing the business
If on a treaty basis, all policies complying with treaty scope must be ceded
Only used if there is a specified sum assured
So not appropriate for PMI
Page 10
(iii) Proportional reinsurance

Reinsurer covers agreed proportion of each risk
Quota share
Fixed proportion of each risk
Often used in this type of situation
Useful as reinsurer may want to have a significant participation in risk to
compensate for expertise being provided
Original Terms reinsurance

• Premium and claims shared in equal proportion
• Payment of reinsurance commission from reinsurer to insurer
Risk premium
• Office premium not shared
• Reinsurer charges specific premium for risk reinsured
• No commission payable
Non-proportional reinsurance
Reinsurer insures risks over/between limits
Excess of loss
Risk XoL
Reduce exposure to single large claims
Useful here to protect against large (e.g. cancer) claims
Aggregate XoL /Catastrophe XoL

Reduce exposure to poor performing portfolio
From single cause (e.g. single type of claim)
Or single (catastrophic) event
Would be useful, if available
Stop loss
Reduce exposure to poor performing portfolio
From any cause for specified period
Useful here as small portfolio, subject to high fluctuation
Financial reinsurance
Limited risk transfer
Rarely used for PMI
Misc marks
Facultative/obligatory
END OF EXAMINERS’ REPORT
Page 11
EXAMINATION
12 April 2007 (pm)

booklet.
supervisor.
question paper.
ST1 A2007 © Institute of Actuaries
1 Describe the losses which can arise to a health and care insurer if a policy lapses and
suggest ways in which the insurer might limit the risk of policies lapsing. [6]
2 Describe the two claim inception rates, type (a) and type (b), used in CMIR 12. All
symbols that you use should be defined. [5]
3 An insurer is interested in entering the individual private medical insurance market.

Initial market research has indicated that the traditional indemnity-based product is
likely to be too expensive for the proposed target market.
Outline eight alternative medical insurance product designs that the insurer could
consider that may be lower cost and so appeal to a wider distribution. [8]
4 You are the actuary in charge of individual income protection business. A number of
your medical underwriters will be retiring shortly. Replacement staff must be trained
to take their place and you have been asked to produce a short presentation on
underwriting.
List the considerations which would be taken into account when underwriting for
income protection. [8]
5 A customer with a salary of £25,000 per annum wishes to purchase an individual

income protection plan. State disability benefit is £5,000 per annum. Salary and state
disability benefits are taxed at 30%. Benefits payable under an income protection
plan are not subject to tax.
The insurer will offer a maximum net replacement ratio of 90%.
(i) Determine the maximum benefit that can be purchased. [2]
The customer purchases a benefit of £10,000 per annum subject to a three-month

deferred period.
(ii) If he falls sick on 1 May 2007 and remains sick until 31 October 2007,
calculate the amount of benefit which would be received from the insurer. [1]
(iii) Describe with reasons how the benefit received might change if the sickness
were not notified until:
(a) 1 June 2007

(b) 1 October 2007 [4]
ST1 A2007—2
The policy includes a proportionate benefit.
(iv) Calculate the total net income which would be received per month if the
policyholder was only able to return to work on a part time basis and receive
only 40% of salary, assuming that state benefit were no longer payable. [2]
[Total 9]
6 You are the actuary of a large health insurer which provides income protection on
both an individual and group basis. In recent years, there has been a large increase in
the number of psychiatric claims. The managing director has requested that you
investigate the claims experience of this business.
(i) Describe how you would analyse the claims experience for this business and,
in particular, how you would consider the psychiatric claims experience. [11]
The insurer also provides critical illness cover. The managing director has queried
why there has not been a similar increase in critical illness claims.
(ii) Discuss possible reasons for this. [2]

[Total 13]
7 The country of Actuaria is considering the introduction of a State Medical Insurance

Scheme for all individuals of working age up to age 65 who are in full-time regular
employment and their dependant families.
It has been proposed by the government that the structure of the Scheme will be to
create a fund. Contributions by the employer will be paid into this fund. The fund
will pay the cost of all in-patient and out-patient expenses with no limits on what will
be paid by the fund.
(i) List the implications of the proposed State Medical Scheme structure for each
of the following:
(a) the State

(b) employers
(c) employees
(d) the non-working population [5]
On further research by the government of Actuaria, it has been decided that the
amount of medical expenses reimbursed would be too high.
(ii) Describe methods of containing the costs under the scheme. [7]
[Total 12]
ST1 A2007—3 PLEASE TURN OVER

8 For a private medical insurance portfolio,
(i) Describe the different types of reserve that may be held. [7]
(ii) Describe the circumstances under which you would expect:
(a) a statistical approach to be adopted for claims reserving

(b) a case estimate approach to be adopted for claims reserving [3]
(iii) Detail the factors you would take into account in determining a case estimate.
[4]
[Total 14]
9 You are the actuary of a large health insurer, which provides a full range of both
group and individual health products. You have been approached by a pensions
insurer to provide a waiver of premium contract for its defined contribution group
pensions business. The waiver of premium contract would continue to pay
policyholders’ pension contributions until they are 65 if they were unable to work at
their own occupation.
(i) Discuss the key issues in determining whether you would wish to develop this
product. [11]
The pensions insurer has agreed that this product will be offered on a group basis
providing cover for all of those members of the group pensions arrangement.
(ii) Discuss the investigations that you would undertake in determining a suitable
price for this product. [12]
(iii) Describe the key additional considerations if the waiver of premium were
offered on a voluntary basis. [2]
[Total 25]
END OF PAPER
ST1 A2007—4
EXAMINATION
April 2007

EXAMINERS’ REPORT
Introduction
M A Stocker
June 2007
Comments
½ marks whilst the more basic elements e.g. details in a pricing basis such as age and sex,
would attract ¼ marks.
Further comments are also found in the solutions that follow.
Subject ST1 (Health and Care Specialist Technical) — April 2007 — Examiners’ Report
1 Relevant points regarding potential losses if a policy lapses

include the following:
The customer must understand what’s been bought
There is the wastage of the investment in client development
Loss of expenses in customer processing
Possible loss of commission before premiums have been
received to cover this
The potential for reputational damage
The loss of future sales from an existing client.
There will be a loss if surrender value>asset share or asset
share<0
Loss of embedded value
Regulators could enforce the insurer to meet the policyholder’s
expectations (against the insurer’s own intentions) where the
product was missold or other literature was misleading.
Ways of limiting the risk of policies lapsing include:

Proper sales training is paramount
Appropriate commission levels such that sales personnel are
encouraged to recommend “the right policy”
A survey of client understanding can serve the purpose of
ensuring policyholder satisfaction with both the sales process
and the product itself.
Results of this survey, performed as part of an after-sales
service, will be fed back into the literature provided and into
the routines by which products are explained and sold.
Provide a product which meets the needs which the person has
identified as providing grounds for insurance protection.
The more artificial the needs creation through the sales process,
the less likely the policyholder is to maintain the product itself,
let alone purchase further covers from the insurer.
The aim should be to meet needs at an affordable price.
The customer should receive information on a regular basis as
promised
A business retention team may be formed to communicate with
lapsing policyholders and recommend suitable alternatives.
Don't pay surrender values
Monitor lapse rates
Provide no claims discounts or loyalty programme
Ensure income meets outflow of expenses or structure
premiums to reduce negative asset shares
Page 2
2 Two claim inception rates, type (a) and type (b):

ia(x,d) = ca(x,d)/Lx
and
ib(x,d) = cb(x,d)/Lx
where ca(x,d) = the expected number of periods of sickness
which pass through duration d between attained ages x and
x + 1 (sickness commencing between ages x – d and x + 1 - d)
cb(x,d) = the expected number of periods of sickness which

pass through duration d between attained ages x + d and
x + d + 1 (sickness commencing between ages x and x + 1)
Lx = the average number living (healthy and sick) between ages
x and x + 1
These are central rates
Type (a) is claim inception
Type (b) is sickness inception
3 Product designs which may serve to lower cost include:

Outpatient cover only — restrict availability to out-patient
treatment.
Preferred provider — restrict the range of hospitals
MME — lump sum payable on a number of defined events
Waiting list plans — cover only available if waiting time for
State treatment exceeds a defined period
Excess plans — plan only meets cost of cover in excess of a
defined limit
Cash plans — plan pays a defined cash sum rather than
indemnifying policyholder cost
Dental plans — cover restricted to dental costs
Optical plans — cover restricted to optical costs
Personal accident — cover limited to accidental causes and
fixed amount rather than indemnity
Inpatient cover only — restrict availability to in-patient
treatment only
Introduce maximum cap paid per procedure, claim or period
Restrict policy to cover non-medical treatment (e.g.
accommodation, food)
Coinsurance — plan pays percentage of claims
Page 3
4 In answering this question the examiners were expecting

candidates to comment on matters specifically relating to
underwriting income protection products. However, credit
was also given where candidates described a more general
approach to underwriting.
Important considerations when underwriting incomee

protection products include:
Personal factors
Industry
Age and sex
Income
Location
Employment status
Socio-economic class
Occupation
Smoking status
Plan Design
Replacement ratio (net and gross of tax)
Size of benefit
Deferred period
Benefit duration
Individual Underwriting
Medical
Office requirements when considering new proposals
Proposal form
GP report
Medical examination
Special questionnaire
Other tests
Leisure pursuits
Legal restrictions —e.g. use of genetic tests
Page 4
Financial
Employment insecurity can add to UW risk therefore financial
condition must be underwritten
Size of benefit
5(i) Net replacement ratio = income after tax when sick/ income
after tax before sick
0.9 = (X + .7*5000)/(25000*.7) implies
X = 25000*.7*.9 -.7*5000
= £12,250
5(ii) (Months of sickness – deferred period) * monthly benefit

(6 - 3)*10000/12 = £2,500
5(iii) (a) Date of notification is not important provided notification

occurs within a reasonable time of first sick. One month delay
is reasonable. In this case there would be no change in the
benefit.
(b) Policyholder is notifying sickness 5 months after date first

sick which may not be seen as within reasonable time. The
insurer has lost the opportunity to manage the claim. It would
therefore be reasonable to reduce the benefit. A possible
approach is to only pay from date of notification i.e. pay 1
months benefit.
5(iv) Proportionate benefit = 60% IP benefit + 40% salary

IP benefit = 10,000*0.6/12 = 500 per month
Salary = 25,000*0.4*(1 – 30% tax)/12 = 583.33 per month
Total benefit = 1,083.33 per month
6(i) IP Claims Analysis
Morbidity
Check the data
Perform an analysis of own company experience over a suitable
recent period
3–5 years may be suitable depending on volume of data —
credible but homogeneous
Page 5
Split analysis into major different risk groups e.g. male/female,

smoker/non-smoker, location.
Adjust data for other possible influences which will affect its
immediate usage e.g. past changes in underwriting standards or
claims management.
Compare own data with that from other sources over the same
time period, in both the home market and in the overseas
territory such as:
Industry data e.g. from insurers’ associations
Data from reinsurers
Published tables based on insurance experience
Population figures and government health statistics
Assess the adjustment needed to relate any published data,
which may not be underwritten, to the particular circumstances
of the company, its products and target market.
Analyse trends in experience by age, sex, by smoker status.
Analyse claim inception and claim termination rates. If data
permits, investigate by occupational classes and deferred
period.
Analyse data separately by group and individual
Measure actual v expected
adjusting actual or expected for IBNR
Analyse by policy duration
Mortality
Similar analysis to that for morbidity.
Data needs to be interpreted with care
Need to split pre-claim and in-claim mortality
Consider suicide experience and whether relevant
Psychiatric claims
If sufficient data, separate these out separately
Also cover other main causes of claims — back claims etc.
Note issue regarding how good recording of claims is.
Note may extend further back in time.
Discuss with claims team
Look at other sources of data on psychiatric claims (e.g.
reinsurers, health statistics)
Page 6
6(ii) Possible reasons why there was not a similar increase in critical
illness claims include:
Definition of claim event
Critical illness claims relate to specific critical illnesses
May however be increase in PTD element due to this
depending on definition used.
IP — if psychiatric issues result in inability to work then claim
will be paid.
Different target markets
7(i) Implications of the proposed scheme from the point of view of

the State, employers, employers and non-working members of
the population include:
State
May improve productivity of workforce
Will need to ensure treatments available
Will need to administer the fund and claims
Will need to ensure employers contribute
Will need to meet any shortfall
Unrestricted cover will encourage maximum spend by the
employee or provision of unnecessary treatment by providers
Restricting the scheme to those in formal employment and their
families may well make the scheme easier to manage
Employers
May improve staff productivity and minimise time off work
Need to be satisfied about availability of care
Have to pay premiums to fund and may otherwise have to
participate in aspects of administration of the scheme
Increases production costs
Premiums paid may exceed value of benefits - employer may
be subsiding other employees
Employees
Free healthcare
No limit on care - full insurance
If an employee loses his/her job, then cover ceases under this
scheme design
Page 7
Non-working
No cover so must rely on state aid; their children and
dependents are also not covered
May create an underclass
More pressure to get work
7(ii) Possible methods for containing the costs of the scheme

include:
Co-insurance
An excess or a fixed percentage of the claim is paid by the
claimant on each claim.
Claim needs to be defined
Preferred provider
Use of specified medical provider
who has agreed fee schedule with the government
Overall cap
A limit can be placed on each treatment or a course of
treatment
Limiting scope
Exclusions ensure that the scheme covers essential care only
Reduce maximum age of cover
Increase minimum age of cover
No coverage for travel outside of Actuaria
No coverage for hazardous sports
No pre-existing conditions
Use family doctor as gatekeeper
Give hospitals and other medical providers a fixed annual cash
budget
Exclude or limit availability to dependents
Encourage healthier lifestyles
Employees asked to contribute
Encourage opting out of the scheme
Introduce some form of means testing
Page 8
8(i) Different types of reserve include the following:
Unearned premium reserve (UPR)

Reserve in respect of premiums received for periods of
insurance not yet expired
Unexpired risk reserve

Reserve in respect of periods of insurance not yet expired in
excess of UPR where it is felt that the premium basis is
inadequate
Outstanding claims reserve

Reserve in respect of claims notified to the insurer but not fully
settled
Incurred but not reported (IBNR)

Reserve in respect of claims that have arisen but have not yet
been reported to the insurer
Incurred but not enough reported

In respect of claims that have been reported to the insurer but it
is felt that not all detail has yet been submitted and a provision
needs to be established for the remainder
Equalisation / catastrophe reserves

Amounts held back for abnormal events
Claims in transit
Reserve in respect of claims reported but not assessed, or not
recorded
Mismatching reserve
Reserve for extent to which assets do not match liabilities e.g.
by term, currency
8(ii) Statistical approach used where

Claims are homogeneous
If portfolio sufficiently large
And claims are stable
To calculate IBNR
Used if no experienced claims assessors, or insufficient data to
carry out case estimates
Page 9
Case estimate approach used

If the claim is large
Or unusual
If portfolio insufficiently large
Claims are unstable
8(iii) Factors to take into account in determining a case estimate

include:
Procedure type
Procedure cost
In-patient duration and associated costs
Hospital to be used
Surgeon, consultant, other principal — to understand procedure
costs and approach
Policy coverage
Age, sex and medical history
Medical outlook / prognosis
Repatriation costs
Current and anticipated levels of medical inflation
9(i) The key issues are profitability, volumes, market profile, office
strategy
Customer need
Is there a need for this product?
Pension provider
Size of existing opportunity — pension scheme size
How is it distributed?
Existing relationship with provider / broader opportunities
Is there a broader market? — Other pension providers

Potential growth
Product
Compulsory or not
If not compulsory expected take up
Any underwriting — declaration of health
Page 10
Do you offer a similar product?

Premium structure — risk premium or flat
Premium structure — guaranteed or yearly reviewable
Claims
Low amount — Claims process simple
Claimants may not claim
Administration in-house or outsourced to pensions insurer
Existing providers?
If so, is it profitable?
Systems development required
Commission requirements
Is it badged?
Is there a reputational risk?
Reinsurance available
Legal issues
Who holds the policy?
Who pays the premiums?
Any regulatory issues
Other
Fit with overall business plan, company culture and strategy.
How would you price this business — any similar experience?
How are contributions defined?

Company expertise and experience — Is this relevant?
9(ii) If offers product currently then would utilise that experience

If not then look for experience of similar product
Group income protection closest — may also consider Group
Personal Accident
Other markets data — suitably adjusted for market and product
Generally be priced using unit rates as too complex for more

detailed rates.
Page 11
The unit rate calculated based upon the expected experience

using the insurers previous experience of similar products /
schemes.
and allowing for the profile of the pension scheme member
e.g. age, sex, occupation profile.
For particular large pension schemes, might possibly use single

premium costed where rates are calculated for each individual
covered.
The experience analysis will be similar to that for individual.

Specific differences are highlighted below:
Morbidity
Lack of detailed exposure data, detailed claims analysis being
more difficult.
Would analyse their own claims experience of similar schemes.
Potentially use loss ratio analysis.
Adjust data for other possible influences which will affect its
immediate usage e.g. past changes in underwriting standards or
claims management.
Compare own data with that from other sources over the same
time period, such as
Industry data e.g. from insurers’ associations
Data from reinsurers
Published tables based on insurance experience
Population figures and government health statistics
Assess the adjustment needed to relate any published data,
which may not be underwritten, to the particular circumstances
of the company, its products and target market.
Analyse claim inception and claim termination rates. If data
permits, investigate by occupational classes and deferred
period.
Investigate the availability and cost of reinsurance arrangement
of various sorts e.g. risk premium, original terms.
May base premium terms on reinsurance rates, subject to the

above analysis.
Further adjustment needed to align different target market with
that underpinning the base data.
Investment
Note this is a short term contract — this limits the potential for
investment of premiums
Page 12
Expenses
Start with company’s most recent in house expense analysis.
Allow for trends if this is an annual exercise
Allow separately for acquisition (sales, marketing and
underwriting), servicing and claims costs
Claims costs will be split between initial claim validation and
ongoing claim maintenance
Split policy costs into those that are premium related and those
that are per-policy.
Need to understand the extent to which specific one-off costs
(e.g. establishment overheads) and expected additional costs
(e.g. regulation) are to be costed against individual policies.
Related to potential volumes of business for spreading fixed
costs
Degree of detail will depend on size of company and volume of
expense information
Inflation may need to be split between manpower costs, future
equipment costs and others.
Projected inflation may possibly be measured as difference
between government fixed-interest and index-linked securities.
Adopt consistency of assumptions between investment returns
and expense inflation.
Commission
Commission as paid — load directly into premium basis.
Lapses
Analyse experience for Pensions lapse experience
Ensure appropriate to the distribution channel.
Adjust data if target market is different from those underlying
the above researches.
Generally 2 yearly renewable contract.
Tax
Make suitable assumptions as to the insurer’s current and future
tax position.
Profit
Include company profit criteria, commensurate with underlying
risk of venture — risk discount rate, PVFP, pay back period.
Competitors rates if any
Carry out sensitivity analyses
Page 13
9(iii) Additional considerations if the waiver of premium were

offered on a voluntary basis include
Anti-selection
Expected participation rates
Possibly influenced heavily by how the sales process will
work?
Lower volumes so less economies of scale
Underwriting or exclusion of pre-existing conditions
Page 14
EXAMINATION
25 September 2007 (pm)

booklet.
supervisor.
question paper.
ST1 S2007 © Institute of Actuaries
1 An insurer charges a single premium of £12,000 to provide group disability cover
(with a deferred period of six months) from 1 April 2006 to 31 March 2007. During
the scheme year there is only one claim: date of sickness 1 July 2006, monthly benefit
£2000, date of return to work 1 March 2007.
(i) Calculate the earned premium in 2006. [1]
(ii) Calculate the loss ratio for 2006. [2]
(iii) Give two terms that are used to describe the loss ratio if expenses are included
in the numerator. [1]
[Total 4]
2 (i) Outline the regulator’s priorities in assessing a new health product. [2]
A niche health insurer, RudeHealth Insurance, is in the process of designing a new,

limited cover, critical illness plan which bases the level of payout on an assessment of
the impact of the illness on the policyholder. You are an actuary working within the
regulator and you have been approached by RudeHealth for your views on such a
development.
(ii) Outline the key areas on which you would wish to be satisfied in order to
minimise customer detriment. [4]
[Total 6]
3 You are a consultant to a specialist sales team which is contemplating launching its
own health and care insurance company. Both long and short term products are being
considered. You have been asked for a paper covering two aspects of reinsurance:
(a) the use of financial reinsurance

(b) the determination of the retention limit
Discuss the points you would make in the paper, highlighting the issues to be
considered for both long and short term products. [12]
ST1 S2007—2
4 (i) Define what the following terms mean when applied to group healthcare
products.
(a) experience rating

(b) credibility
(c) burning cost
[3]
(ii) Discuss why the past claims experience on an employer’s group disability
contract may not be a good proxy for the future claims experience for the
company. [3]
(iii) Explain why a simple comparison of premiums and claims paid in a calendar
year may fail to give a proper view of the profitability of a group disability
contract. [4]
[Total 10]
5 It is normal for the insurer of an income protection policy to require potential

claimants to notify them of a potential claim at an early stage.
(i) Explain the reasons for this requirement for reporting potential claims. [1]
(ii) State, where the notification of the claim occurs after the end of the deferred
period, six approaches that the insurer may use to treat such an event in
accordance with the policy conditions. [6]
As an insurer of individual income protection policies, your current basis of

notification is that potential claimants must notify you at the end of the deferred
period. No action is taken on a late notification of a claim; the claim is paid. It has
been suggested that you consider using a revised basis that potential claimants must
use to notify the insurer of a potential claim.
(iii) Discuss the general points to be taken into account when consideration is
being given to altering the above approach. [3]
Two alternative bases have been suggested:
Basis 1 The insured is required to notify the company a set time after the incapacity
begins, irrespective of the deferred period.
Basis 2 The insured is required to notify the company at a set time before the end of
the deferred period.
(iv) Comment on each approach. [2]

[Total 12]
ST1 S2007—3 PLEASE TURN OVER

6 You are part of a team which is designing a pre-funded long-term care insurance plan
which is to compete with a number of existing market products. You have been asked
to produce a comparison of the benefit structure of the existing plans in the market.
(i) List the features that you would need to consider and suggest appropriate
values for these, where relevant. [8]
(ii) List the factors that you would need to consider in order to determine the
suitability of a proposed contract design. [5]
(iii) List the incentives that the State could offer to encourage self-provision of
long term care insurance. [2]
[Total 15]
7 You are the pricing actuary working for a health insurance company. You have been
asked to give advice in respect of a UK-type large group hospital cash scheme insured
with the company.
(i) Describe the key features of a typical UK-type hospital cash contract. [4]
You have extracted from the company database the following historical data on the
hospital cash contract for the 2002 to 2006 scheme years.
Scheme Year Written Premium Incurred Losses

£000 £000
2002 150 130
2003 160 145
2004 100 105
2005 120 110
2006 140 130
Rates increased for the 2004 scheme year by 10%. There have been no other rate
changes.
You also know that claims inflation has been running at 1% per annum over this
period for this group scheme.
(ii) Calculate the loss ratio that can be expected for 2007 for this group assuming
that there is no rate increase at the 2007 renewal, based on all of the historical
experience and the rate change and inflation assumptions given above, stating
any assumptions you make. [8]
(iii) Calculate the rate increase required at the 2007 renewal to bring the target loss
ratio for this group for the 2007 scheme year up to 85%. [1]
(iv) State any other information other than claims experience that you would
require in order to determine whether this group scheme can be profitable in
2007. [4]
ST1 S2007—4
Your managing director has realised that the rate of claim inflation on this group since
2002 is substantially less than retail price inflation.
(v) Suggest possible reasons why the claim inflation rate is so low. [3]
[Total 20]
8 You are the marketing actuary for an office writing reviewable accelerated critical
illness. The contract is to be re-launched and you are considering a number of
possible changes to the product.
(i) Suggest a general framework describing the issues that you would consider
before making any change to the product design. [5]
The following three design changes have been proposed.
Option A Include an option to enable the policyholder to increase the sum assured
by 15% each year without the need to provide any evidence of health.
Option B Replace the current reviewable premium rates with rates that are
guaranteed for up to 25 years.
Option C Replace the current underwriting requirements with a pre-existing

condition exclusion clause.
(ii) Evaluate each of the proposals against the framework in part (i) and indicate
any additional constraints that you would impose before introducing the
product change. You should consider each option on its own and not in
conjunction with any other option. [16]
[Total 21]
END OF PAPER
ST1 S2007—5
EXAMINATION
September 2007

EXAMINERS’ REPORT
Introduction
M A Stocker
December 2007
Comments
0.5 marks with the more basic elements e.g. details in a pricing basis such as age and sex,
would attract 0.25 marks.
The mathematical elements of Q1 and Q7 (ii) and (iii) were poorly answered. Candidates
often did not set out the formulae and the items were not defined where required. Candidates
need to be aware that the examiners expect an answer to the best standard of recording used
in the office.
There were instances where candidates did not address the question e.g. Q8. Candidates
often failed to link their answers to part (i) of the question, where they were asked to set out
a framework for evaluation and then in part (ii) use that framework. The conclusion is that
the candidates did not read the question properly.
Comments on individual questions are set out below:
Question 3
Little detail was given by many students on Q3 regarding two aspects of reinsurance
considering the number of marks on offer.
Question 5
Candidates did not realise that both methods set out in question 5 (iii) are less than perfect.
Page 2
1 (i) Proportion of premium in year * written premium

9/12*12000 = £9000
(ii) Incurred claims = sum of payments = monthly benefit * (months of sickness –

deferred period)
= £2000 * (8 - 6) = £4000
Loss ratio = incurred claims / earned premium
= 4000/9000 = 44.4%
(iii) Combined or operating ratio.
2 (i) The insurer remains solvent

Customer detriment is minimised (or that customer needs are met)
Insurer files adequate accurate reports to allow to assess general viability
Probity (or equivalently, honesty, integrity, fitness for purposes)
(ii) Customer Detriment

Benefits must be clearly described
Impact based product, sounds complex
Difficult for customer to understand what they are buying
Use of term “Critical Illness” engenders expectations (in most territories) and
so should be avoided
Value for money — limited benefit so would expect this to be cheaper than
full cover CI
In some territories may wish to be advised of likely premium increases
Sales process should be outlined to ensure that right information is available to
support sale and no undue pressure applied to sales process
Claims administration process
3 (a) Financial reinsurance (short term contracts)
A wide variety of financial reinsurance contracts exist, devised primarily as a

means of improving the apparent accounting position of the cedant.
Involves only a small element, if any, of transfer of insurance risk from the
cedant to the reinsurer.
Similar risks to those that relate to investments.
Many forms of financial reinsurance are, in fact, often viewed as being more
similar to investment than to reinsurance.
Usually the effective “return” that the contracts provide is low in comparison
to conventional investments.
Page 3
Financing reinsurance (long term contracts)
Aim is that the reinsurer relieves the ceding company of part of its new
business financing requirement, eg with regard to solvency, expenses,
commission.
Straightforward loan from the reinsurance company would not achieve this, as
the ceding company would usually have to add the amount of the loan to its
liabilities.
The risk premium reinsurance method is one type of arrangement which can
be associated with a financing arrangement
The “loan” is usually presented as a reinsurance commission related to the
volume of business reinsured.
The “repayments” — spread over a number of years — are added to the
reinsurance premiums.
The reinsurer takes into account the expected lapse experience of the portfolio
of reinsurances in determining the loan repayments.
An alternative approach is to make use of the future profits contained in a
block of new or existing business.
The reinsurer again provides a loan to the direct-writing company, but, as the
repayment of the loan is contingent upon the stream of future profits being
generated by the business, the direct writing company does not need to reserve
for the repayment within its supervisory returns.
This second approach may also be used where a direct writing company needs
to improve its solvency position, for example after a large drop in asset values,
or where it wishes to fund a new project, for example the setting up of a new
subsidiary overseas.
(b) Determination of the retention limit
It is necessary first to estimate the statistical distribution of the risk experience

costs of the portfolio on various assumed retention limits.
One then needs to judge how low a probability should be aimed at for various
degrees of departure from the overall average risk costs.
One approach is to set the retention limit at such a level as to keep the
probability of insolvency below a specified level.
Using a stochastic model for expected claims rates and a model of the
business, expected claims can be projected forward together with the value of
the company’s assets and liabilities.
Using simulation a retention level can then be determined such that the
company stays solvent for 995, say, out of 1,000 runs.
Another possible approach is to consider the total of:
(1) the cost of financing an appropriate risk experience fluctuation reserve,

and
(2) the cost of obtaining reinsurance — the reinsurer naturally incorporates

an expense and profit loading in its reinsurance terms, and the ceding
company incurs administrative expenses
Page 4
As the retention limit increases, (1) will increase and (2) will decrease, and a
retention limit can be adopted which minimises the total (1) + (2).
To calculate (1) the simulation approach discussed above would probably need to
be used to determine the reserve the company needs to hold.
Where financing is involved the reinsurer may set a maximum retention in order
that the reinsurer obtains an adequate level of risk business
Similarly, the local regulator may have rules or limits on retentions for a new
insurer
In many territories there are spin-off advantages in a low proportionate retention
(maybe 50%) which would scale down the solvency margin requirements
A new short term insurer, independent of financing, will want cover for large
individual risks (e.g. life supporting treatment in expensive foreign hospitals) and
thus retention will dependent on availability of free capital and the likelihood of
multiple claims.
Might have low retention limits as new start up and uncertainties involved.
Limits will depend on level of risk aversion
Volatility of results
Absence of data – would use market data from reinsurers, consultants
4 (i) (a) Experience rating — the practice whereby the healthcare premium for
a group contract depends wholly or partially on the past experience of
the group
(b) Credibility — relates to the factor, lies between 0 and 1, which

represents the proportion of the final risk premium which is derived
from past experience, the balance coming from book rates.
(c) Burning cost is the estimated cost of claims in the forthcoming

insurance period, calculated from previous years’ experience, adjusted
for changes in the numbers insured, the nature of cover and medical
inflation. The term can be used to describe the historic cost of claims
only. The burning cost should include estimates of all claims reported
but not settled and claims incurred but not reported.
(ii) Significant changes in personnel

Economic changes
Benefit inflation
Changes of location
Changes of work practices
Changes in cover required
Claim volatility
Political conditions
Unusual large claims
(iii) Premiums need to be earned

Premium may be estimated as full profile not known until end of scheme year
Claims need to be incurred
Must capitalise future claims costs
Need to consider IBNR
Page 5
Incurred but not reported terminations

Claim payment delays
Expenses
Investment return
Tax
Impact of reinsurance on bottom line
Cost of capital (or suitable comment on supervisory reserves)
5 (i) Reasons for reporting potential claims
To ensure valid claims are ready to be paid at the end of the deferred period.
For the purposes of early intervention from a claims management perspective.
(ii) The options are:
Pay an amount commensurate with what would have been expected if the
claim had been properly notified (ie take on trust)
Decline the claim
Reduce the benefit payable
Back date the claim to the end of the deferred period if supporting medical
evidence can be provided
Assume that the commencement of payment to be the date of notification
Assume that the commencement of payment to be the date of notification plus
the deferred period
(iii) - If you introduce a new system you will be running the new and old system
in parallel with likely administration problems
– You cannot change the policy documents but you can change your internal
approach on late notification
+ Consider what is the current market practice
+ Consider what policyholders would expect to happen – reputational risk
You need to advise sales distributors of changes made
You need to advise staff and provide appropriate training on changes made
Regulator’s view to change
May enable lower price to be charged
Need to consider reaction of reinsurers
Could look at numbers and amounts currently missing cut-off to assess effect
(iv) There is a balance, you need to find the middle ground
Basis 1 gives early involvement and hence allows for more claims
management but may have a large number of claims which do not reach the
end of the deferred period
Basis 2 may result in fewer claims being processed but gives less opportunity
for early claims management
Basis 1 would be preferable for longer deferred periods and basis 2 for shorter
deferred periods
Page 6
Hence solution would be to have a basis that varies by deferred period
6 (i) Deferred period — 3 to 12 months

Benefit escalation — level or RPI
Length of benefit payment — lifetime or say 3 years
Maximum initial benefit — consistent with cost of care.
Assistive devices — fixed number of monthly benefits
Respite care
Cash benefits or care only
Independent care advice
Death benefit
Surrender value
Paid up benefit
Benefit trigger — failure of 2/3 ADLs, cognitive impairment
Options and guarantees
Fixed benefit or indemnity
Waiver of premiums
(ii) Profitability
Marketability – meets customer needs
Marketability – sales channels
Competitiveness
Financing requirements
Risk characteristics
Onus of any guarantees
Sensitivity of profit
Extent of cross-subsidies
Administration systems
Consistency with other products of the company
Availability of reinsurance
Regulator’s approval
Underwriting
Claims management
(iii) Tax relief on premiums

Subsidise premiums
Exclude parts of the population from the national welfare scheme
Offer a reduction in general taxation where appropriate insurances are effected
Can reduce cost of care by direct subsidy to providers.
Customer education
7 (i) Cash Plans
Cash Plans are a defined-benefit defined-premium insurance product.
For premiums as low as £2 per week, the subscriber and family are entitled to
a range of specific payouts dependent on certain healthcare related events.
Page 7
These include dental, optical, physiotherapy, maternity, hospitalisation,

recuperation, hearing aids and consultation.
Schedules of benefits are bought in "units" with equivalent levels of

contribution increase.
The purpose of the arrangement is cash in hand as opposed to reimbursement,

thus reducing anti-selection
Limits may apply to ensure that the payout is no more than say 50% of the
medical bill.
(ii) The following gives two possible solutions – marks were given for other
appropriate approaches.
Scheme Inflation Rate Premium Original Original Inflated Inflated Loss Weighted
Year Index Change % Index Premium Losses Premium Losses Ratio
2006 1.01 0 1 1 140 130 140.0 131.3 93.8% 123.141

2005 1.0201 0 1*(1+0) 1 120 110 120.0 112.2 93.5% 104.928
2004 1.0303 10 1*(1+.0) 1 100 105 100.0 108.2 108.2% 117.033
2003 1.0406 0 1*(1+.10) 1.1 160 145 176.0 150.9 85.7% 129.358
2002 1.051 N/A 1.1*(1+0) 1.1 150 130 165.0 136.6 82.8% 113.14
701.0 639.2 91.2% 587.6

Weighted average loss ratio 91.9%
Assumptions
Similar policy conditions/coverages

Incurred losses include IBNR
Years are complete so 2006 losses have not been scaled up from a partial year
figure
No change in business mix
There are no ‘one-offs’ in the data
(iii) Increase needed if actual loss ratio used is 91.2/85 = 1.0728

Increase needed if weighted loss ratio used is 91.9/85 = 1.0815
(iv) Projected volumes of business in 2007 (Written Premium)

Information on unusual exposures, if any
IBNR, particularly for 2006.
Inflation will continue to run at 1% p.a.
Loadings for internal expenses both fixed and variable.
Taxes and any other levies.
Investment income.
For this we need to know payout pattern and premium receipt pattern as well
as investment yields on suitable assets.
Any changes to the product
Impact of reinsurance
Page 8
Economic outlook
Political change
Cost of capital
(v) A typical UK hospital cash contract has heavy coinsurance, low benefits, low
maximum payout so possible reasons are:
Fixed benefits
Low benefits
Low maximum payout in each class
Possible increase in small amounts not being claimed
Good claim control
Cap on overall benefits
Effect of increases in excesses (not raised every year, rounded figures)
8 (i) For each of the possible design changes we need to consider factors like:
How does the change meet customer needs?

How do we price for the benefit?
Impact on sales process — how easy, price
Impact on claims handling
Risk management — opportunity for anti-selection
Administration issues
Impact on valuation/capital needs
Behaviour of competitors
Any regulatory issues?
Impact on reinsurance
Impact on sales process – how easy to describe option
Is the price acceptable to potential customers?
Company strategy/culture
Profitability
Lapse and re-entry risk
(ii) Option A
If policy designed to meet a mortgage then no need for an increase.
If policy designed to meet needs of dependent or business cover then may
need increase at something like RPI and so an increase option would be
valuable.
15% looks a very high increase.
May wish to redefine as RPI with a maximum of 15%.
Need to decide basis for increased premium — either original premium needs
to increase at an agreed percentage or new cover is purchased at the then
premium rate.
Note cost of increase should not be greater than new business rate or risk that
healthy lives would purchase additional cover in the open market.
Lose option if not exercised to manage anti-selection risk.
Impose maximum age for exercise of option.
Impose maximum initial sum assured for option or maximum sum assured
after increases.
Page 9
Impose maximum policy term.

Restrict option to lives accepted at standard terms.
Need to have a clear administration process.
Valuation needs to take account of option.
Option increases price.
Need to agree how increase in cover to be shared with reinsurer if reinsurance
on a surplus basis. Increases should be shared proportionately.
May only offer on certain events in order to reduce selection risk
Option B
Meets customer need of certainty of cost.
Increases premium.
Guarantee charge difficult to quantify and may be too high or too low.
Uncertainty about changes in detection or prevalence of diseases in future —
trend risk.
Need to hold appropriate risk capital
Impose maximum duration of guarantee.
Increased risk so higher profit loading.
May wish to impose maximum level of cover.
May wish to increase proportion of business reinsured
Option C
Simplifies sales process
Reduces cost of policy issue
Increased risk that claim will be denied
Creates uncertainty for customer that claim will not be paid
Risk of litigation
May get high proportion of substandard risks if competitors continue to
underwrite fully
May wish to limit sum assured
Risk that life is substandard increases with age so may wish to limit maximum
age
Danger insurer has already accepted other cover on special terms and so
policyholder may assume insurer aware of pre-existing
In each of the above cases, would need agreement from reinsurer if covered by
a reinsurance agreement.
Page 10
EXAMINATION
15 April 2008 (pm)

booklet.
supervisor.
question paper.
In addition to this paper you should have available the 2002 edition of the Formulae
and Tables and your own electronic calculator from the approved list.
1 (i) Explain why it is often necessary to exclude explicitly certain causes of
disability (or “perils”) from the cover of healthcare insurance contracts. [4]
(ii) List eight common exclusions associated with healthcare insurance. [2]
[Total 6]
2 (i) Outline the approaches taken under the two methods commonly used for
calculating option charges or premiums. [2]
(ii) Compare the relative merits of each method. [2]
A ten year insurance with sum assured of S payable at the end of the year of death or
critical illness event has an option to extend the term for another ten years at expiry.
The premium payable in the extended period will be the then in force standard rate.
(iii) Set out, under each of the two methods in common use, the formula to
evaluate the option premium, defining all the terms used. [6]
[Total 10]
3 The country of Actuaria has recently introduced individual capital adequacy standards
for companies writing insurance business in Actuaria. Under the new rules, insurance
companies are required to hold capital for market risk, default risk, insurance risk,
persistency risk and operational risk. The capital requirement for each risk has to be
individually assessed. These individual capital requirements will then be aggregated
to form the total capital requirement for the company. In aggregating the capital
requirement of these risks, companies are allowed to take credit for diversification
benefits.
It has been decided that the diversification benefits will be included using the square
root of the sum of the squares approach. If all the individual risks are fully correlated,
the total capital requirement will be the sum of all the individual capital requirements.
If all the individual risks are fully independent of each other, the total capital
requirement will be the square root of the sum of the squares of all the individual
capital requirements.
You are the actuary of a healthcare insurance company in Actuaria. You have
calculated the following amount of capital requirements for each individual risk.
Market risk: = £1.5m (Risk 1)

Default risk: = £2.0m (Risk 2)
Insurance risk: = £5.0m (Risk 3)
Persistency risk: = £1.0m (Risk 4)
Operational risk: = £3.0m (Risk 5)
(i) Based on the above individual capital requirements, calculate the maximum
and the minimum amount of total capital that your company would have to
hold. [1]
ST1 A2008—2
The total capital requirement allowing for diversification benefit could be calculated
by using a correlation matrix.
Risk 1 Risk 2 Risk 3 Risk 4 Risk 5

Risk 1 C (1,1) C (1,2) C (1,3) C (1,4) C (1,5)
Risk 2 C (2,1) C (2,2) C (2,3) C (2,4) C (2,5)
Risk 3 C (3,1) C (3,2) C (3,3) C (3,4) C (3,5)
Risk 4 C (4,1) C (4,2) C (4,3) C (4,4) C (4,5)
Risk 5 C (5,1) C (5,2) C (5,3) C (5,4) C (5,5)
The total capital requirement is calculated as:
∑∑ ( Ri * Cij * R j )
i j
where:
Ri is the individual capital requirement of risk i and

Cij is the correlation between risk i and risk j, with
Cij =1 being risk i is fully correlated with risk j and
Cij = 0 being risk i is fully independent of risk j.
(ii) Complete the above table assuming that:
(a) all the risk are fully independent of each other

(b) all the risks are fully correlated
[4]
Realising that individual risks are unlikely to be fully independent nor fully
correlated, your risk management team has derived the following table showing the
correlations of each individual risk.
Market Default Insurance Persistency Operational

Market 1 0.25 0.25 0.25 0.25
Default 0.25 1 0.3 0 0.3
Insurance 0.25 0.3 1 0.25 0.25
Persistency 0.25 0 0.25 1 0.5
Operational 0.25 0.3 0.25 0.5 1
(iii) Calculate the total capital requirement allowing for the appropriate
diversification benefits, using the above individual capital requirements and
the correlation matrix. [6]
(iv) List other means that the regulator might use to constrain a healthcare provider
for the purpose of risk mitigation in addition to the requirement of holding risk
capital. [8]
[Total 19]

4 You are the actuary responsible for a small amount of private medical insurance
business written on an indemnity basis as short term business. For the current
valuation it has been decided that your experienced claims manager will set the
outstanding claims reserves on a case-by-case basis.
(i) Describe the main factors that you would expect to be taken into account in
setting the outstanding claims reserve for reported claims. [6]
(ii) In addition to the outstanding claims reserve, list ten additional reserves that
you might need to consider for PMI business. [5]
(iii) Outline the other factors which should be allowed for explicitly when
assessing possible future claims when setting reserves. [4]
[Total 15]
5 You are the marketing actuary for the health and care area of an insurance company.
Your marketing manager has noted that some insurers rate their immediate annuities
by age, sex and according to the geographical location where the policyholder lives
(postal code rating).
The marketing manager is suggesting that this approach could be applied to rating
immediate care annuities that are currently underwritten on a case-by-case basis.
Discuss the effect of using this revised approach from the point of view of:
(i) the prospective policyholder [2]

(ii) the insurance company [4]
Having discussed this with the pricing actuary, the marketing manager has suggested
the following approaches to allow for the higher mortality rates for impaired life
immediate annuitants in comparison with those assumed for standard life immediate
annuitants:
Option A: multiple of the mortality rates of standard life immediate annuitants
Option B: constant addition to the mortality rates of standard life immediate

annuitants
Option C: decreasing additional mortality loading on the mortality rates of

standard life immediate annuitants
(iii) Discuss the appropriateness of each of the above approaches and suggest two
medical conditions that might be appropriate for each approach. [7]
[Total 13]
ST1 A2008—4
6 (i) Outline the main clauses of a reinsurance contract that might be available to
cover income protection business. [12]
Company ABC is a small insurer writing income protection (IP) locally. It is being
taken over by XYZ, a large bancassurer, that has not sold IP business to date, but
intends to market IP internationally in the future. ABC has a reinsurance treaty in
place on its IP business.
(ii) Describe briefly the areas in which XYZ might want to change or renegotiate
this treaty as a result of the takeover. [2]
[Total 14]
7 You are an actuarial consultant working in the country of Actuaria. In Actuaria, a

monthly benefit is provided to individuals who meet the requirements of the state’s
incapacity tests. These tests are based upon the ability of individuals to perform their
own or any suited occupations. The government is considering changing these
benefits as follows:
• Individuals who are unable to perform their own occupation will be provided with
a monthly benefit of 50% of the existing benefit.
• Individuals who are very severely incapacitated will be provided with a
significantly higher benefit.
The government has agreed that the definition of severely incapacitated will be based
upon the ability of an individual to perform activities of daily living. The government
anticipates that these changes will reduce the amount of money the state pays out on
incapacity benefits.
(i) Describe the government’s objectives in providing healthcare benefits. [3]
(ii) Discuss how well the proposed changes to healthcare benefits would meet
these objectives. [3]
Within Actuaria, there is currently a very successful health insurance market

providing income protection and critical illness business. The government has asked
you to consider the possible implications of the proposed changes on the health
insurance industry.
(iii) Describe the key issues that you would consider in your response. [4]
An insurance company within Actuaria provides only income protection cover and
has not changed its premium rates for several years. Its contracts pay out a maximum
benefit of salary less any state benefits. The insurance company has realised that the
government’s proposals will have an impact on the cost of providing income
protection benefits, and that if these proposals go ahead it would need to reprice its
product.
(iv) Describe the investigations that the company would undertake in order to
reprice its product. [13]
[Total 23]
END OF PAPER
ST1 A2008—5

EXAMINERS’ REPORT
April 2008
Introduction
M A Stocker
June 2008
General comments
and receive a pass in the subject. There was often a lack of sufficient detail in the answers.
In general each valid point in the answer would normally attract 0.5 marks with the more
basic elements e.g. details in a pricing basis such as age and sex, attracting 0.25 marks.
Comments on individual questions
Question 2
Candidates often lost marks in part (iii) through not defining the terms used in their
formulae, as asked for in the question.
Question 5
This was not a straightforward question and many candidates did not score well. In part (ii)
several candidates stated that an annuity paid to an impaired life would be more costly to the
company than the same annuity payable to a standard life of the same age and gender. The
answers to part (iii) were generally very poor, although credit was given for any reasonable
descriptions of the appropriateness of the various approaches and for suggested medical
conditions which might be appropriate for each approach.
Question 6
Several candidates lost marks here by giving a detailed description of the various types of
reinsurance which might be used for income protection business which is not what the
question was asking for.
Question 7
Some candidates lost marks in part (ii) by not linking their answers to the objectives set out
in part (i).
Page 2
1 (i) Reasons for excluding explicitly certain causes of disability from the cover of
healthcare insurance contracts include:
• To avoid anti-selection – e.g. exclude existing conditions. Exclusion
effectively replaces questions on the underwriting form. Waiting period for
cancer claims under a CI policy – again allows underwriting to be reduced
• Moral hazard – because of insurance people may be reckless in their
behaviour so, for example, disability that results from self-inflicted injury,
failure to follow medical advice might be excluded,
• Special risk that is difficult to price – e.g. may exclude disability as a result
of participation in a professional sporting event.
• Cost is likely to be difficult to price because of lack of data – e.g. under a
CI plan the cancer cover will exclude skin cancer. A lot of skin cancer is
not reported and so published statistics will underestimate the risk. Is there
a need for a payment on the diagnosis of skin cancer?
• Cost too high – e.g. a typical IP plan has a deferred period of at least 28
days; this excludes short term claims as a way of reducing the cost.
• Cost is uncertain in the future – uncertain risk like AIDS, war, terrorism.
• It may be unlawful to provide a benefit, for example, if the policyholder is
disabled as a result of committing an illegal act (e.g. committing a terrorist
act).
• Payment received from elsewhere – may exclude claims for which the
policyholder is already receiving compensation (say from an employer or
through a structured settlement).
(ii) Possible exclusions include

• War, terrorism, acts of violence, civil unrest
• Self-inflicted injury or attempted suicide
• Drugs
• Alcohol
• Hazardous past-times or sports
• Aerial activity other than as a fare-paying passenger
• Criminal acts
• Failure to seek or follow medical advice
• Pregnancy
• AIDS/HIV
• Cosmetic surgery
• Accident and emergency treatment
• Pre-existing conditions
• Experimental treatments
• Chronic conditions under PMI
• Preventative treatments
• Treatments not occurring during the insured period
• Effects of exposure to radiation
Page 3
2 (i) North American method

• Double decrement table for lives who have not yet exercised the option
• Decrements include death/disability and exercising the option
• Table (of heavier mortality/morbidity) for lives who have exercised the
option
Conventional method
Assumes that
• All lives eligible to take up the option will do so
• The mortality/morbidity experience of those who take up the option will
be the Ultimate experience
(ii) North American method

• Often difficult to obtain sufficient data to estimate all the decrement rates
• No direct experience for new line of business
• Difficult to estimate take-up rates
Conventional method
• Not possible to use when there are many possible exercise dates
• Not possible to use if there are several alternative options to choose from
• Is 100% take up rate reasonable?
• Question over the appropriateness of using ultimate rates
• More simple to use than North American method
(iii) North American method
Assumptions
• premiums are payable annually in advance

• premiums payable in the extended period are on the same basis as the
original contract
• policyholder is aged x now
• original policy term is 10 years
• a triple decrement table used for lives who have not yet exercised the
option with decrements of mortality/disability and exercising the option
• a mortality/disability table is needed for lives who have exercised the
option
• assurance and annuity factors based on mortality/morbidity for lives who
have exercised the option represented by A′ and a′
• the proportion of those who take up the option is P
Present value of benefits in the extended period:
1
• for new policyholders: S * A
[ x +10]:10
1
• for those who exercise the option = S * A′
x +10:10
Page 4
So present value of premiums in the extended period for those who exercise
the option =
1
A * a′x +10:10
[ x +10]:10
S* .
a[ x +10]:10
Cost of the option at expiry of the original term =
⎡ A 1 * a′x +10:10 ⎤
⎢
S * A′ 1
−
[ x +10]:10 ⎥.
⎢ x +10:10 a[ x +10]:10 ⎥
⎣ ⎦
The proportion of those who take up the option is P.
Option premium payable in addition to the premium of the original policy:
⎡ A 1 * a′x +10:10 ⎤
Dx +10 ⎢ 1 [ x +10]:10 ⎥
* P * S * A′ −
D[ x ] ⎢ x +10:10 a[ x +10]:10 ⎥
⎣ ⎦
a[ x ]:10
Conventional method
• the mortality/morbidity basis used is assumed not to change over time
• so the only data required are the select and ultimate mortality/morbidity
tables used in original pricing basis
Present value of benefits in the extended period:
1
• for new policyholders: S * A
[ x +10]:10
1
• for those who exercise the option: S * A
x +10:10
So present value of premiums in the extended period for those who exercise
the option =
1
A * ax +10:10
[ x +10]:10
S*
a[ x +10]:10
So cost of the option at expiry of the original term =
⎡ A 1 * ax +10:10 ⎤
S *⎢A ⎥.
1 [ x +10]:10
−
⎢ x +10:10 a[ x +10]:10 ⎥
⎣ ⎦
Page 5
Option premium payable in addition to the premium of the original policy =
⎡ A 1 * ax +10:10 ⎤
Dx +10 ⎢ 1 [ x +10]:10 ⎥
*S * A −
D[ x ] ⎢ x +10:10 a[ x +10]:10 ⎥
⎣ ⎦.
a[ x ]:10
3 (i)
• Maximum amount if all the risks are assumed to be fully correlated
• Sum all the capital requirement together = 1.5 + 2 + 5 + 1 + 3 = £12.5m
• Minimum amount if all the risks are assumed to be fully independent
• Square root of the sum of the squares of the capital requirement =
√(1.52 + 22 + 52 + 12 + 32) = £6.4m
(ii) (a) All fully independent

Market 1 0 0 0 0
Default 0 1 0 0 0
Insurance 0 0 1 0 0
Persistency 0 0 0 1 0
Operational 0 0 0 0 1
(b) All fully correlated

Market 1 1 1 1 1
Default 1 1 1 1 1
Insurance 1 1 1 1 1
Persistency 1 1 1 1 1
Operational 1 1 1 1 1
Page 6
(iii)
Market 1.5×1×1.5 1.5×0.25×2 1.5×0.25×5 1.5×0.25×1 1.5×0.25×3
Default 2×0.25×1.5 2×1×2 2×0.3×5 2×0×1 2×0.3×3
Insurance 5×0.25×1.5 5×0.3×2 5×1×5 5×0.25×1 5×0.25×3
Persistency 1×0.25×1.5 1×0×2 1×0.25×5 1×1×1 1×0.5×3
Operational 3×0.25×1.5 3×0.3×2 3×0.25×5 3×0.5×1 3×1×3
Market Default Insurance Persistency Operational Sum

Market 2.25 0.75 1.875 0.375 1.125 6.375
Default 0.75 4 3 0 1.8 9.55
Insurance 1.875 3 25 1.25 3.75 34.875
Persistency 0.375 0 1.25 1 1.5 4.125
Operational 1.125 1.8 3.75 1.5 9 17.175
Sum (Sum) = £72.1m

Square root (72.1) = £8.49m
(iv) May regulate

• Volume of business
• Geographical location in which new business can be written
• Premium rates
• Pricing assumptions
• Commission structure
• Underwriting standard
• Type of business
• Product design
• Policy conditions
• Investment strategy/types of asset can be held
• Claims process
• Corporate governance
• Disclosure of financial positions
• Sales method/distribution channels
• Marketing methods/materials
• Treating customers fairly
• Fact finding of customers
• Quality of advice given to customers
• Minimum level of disclosure at point of sale
• Internal audit
• Independent review by external advisors
• Risk management framework
• Use of reinsurance (e.g. constraints on credit rating/location of reinsurer)
• IT systems and controls
• Mismatching reserves
Page 7
The regulator may

• Approve/authorise individuals
• Approve/authorise firms
• Impose regulatory reporting requirements
• Require custodian for asset
4 (i) A case assessor would firstly consider the medical specialist’s report (this
might be a consultant or a surgeon).
This would provide information on the likely treatment of the medical
condition for which the claim is being made.
The cost of similar procedures carried out previously (possibly by same
surgeon/consultant in same hospital) would be investigated (allowing for
levels of medical costs inflation if the information available is not current).
Hospital (medical centre) to be used – may have special arrangements or limits
on payments.
Name of surgeon, consultant or other medical principal.
These will indicate the cost of the procedure itself
and the likely inpatient duration for accommodation costs.
The feasibility and cost of repatriation if the policyholder were taken ill abroad
might also be investigated.
Would also need to know:

Policy coverage (full indemnity, any excess, limits, recuperation benefit etc.)
This would give information on the potential amounts of claim to which the
insurer is exposed.
Age,
sex and
past claims history of claimant may have some bearing
Reinsurance considerations if calculating net
(ii) Additional reserves that might be considered for PMU business include:
• Unearned premium reserve (UPR)
• Incurred But Not Reported Reserve (IBNR)
• Incurred But Not Enough Reported Reserve (IBNER)
• Catastrophe Reserve
• Reserve for Claims in Transit (Reported, but not assessed or on the
system)
• Claims Equalisation Reserve
• Unexpired Risk Reserve (URR)
• Additional Unexpired Risk Reserve (AURR)
• Premium Deficiency Reserves
• Guarantees/Options Reserve
• Claims Expense Reserve
• Other Expense Reserve
• Mismatching Reserve
• Contingency Reserve
Page 8
(iii)
• Seasonality of claims
• Changes in underlying medical inflation trends
• Changes in underlying provider cost inflation
• Changes in the mix of business over time
• Medical advances affecting diagnosis/claim rates
• Medical advances affecting average cost of claims
• Single high-cost claims e.g. cancer claims
• Catastrophes, e.g. flu pandemics
• Options
• Guarantees
• Impact of reinsurance
• Economic/social environment
• Changes in state provision
• Product changes/changes in policy conditions
• Margins for uncertainty
• Effects of regulation
• Underwriting standards
• Claims management processes
• Purpose of reserves
5 (i) The underwriting process would be less intrusive to the prospective

policyholder (e.g. the need to provide medical data, undergo tests, answer
intrusive questions).
Makes purchase/commencement of policy quicker.
Possibly better annuity rates because of lower expenses.
More transparency.
By changing address I can vary my benefit – is that fair?

Benefit does not vary by state of health – is that fair? A person entering a care
home will be in poor health or disabled.
(ii) Significant savings in the cost of the underwriting process if this method was
adopted.
Easier sale as no underwriting.
No problem of checking medical data.
Anti-selection – the insurer will tend to pick up the better lives, especially if a
rival insurer continues to underwrite on a case by case basis, producing less
mortality profit for the insurer.
This variation in health status is not sufficiently allowed for in geographical
rating.
The regulator may object.
Administration and underwriting systems will need to be changed.
Page 9
(iii) (a)
• assumes that the impairment at outset will continue
• likely to be more suitable for the least severe medical conditions
• this approach is simplistic
• may not be appropriate at older ages as similar medical conditions
may also affect a significant proportion of the standard annuitants
Possible medical conditions include

• diabetes
• hypertension
• Alzheimer’s disease
(b)
• the loading is higher for younger ages
• likely to be more suitable for the more severe medical conditions
• but not the most severe types of medical condition
• medical conditions could include the less aggressive types of
cancer
• or those that could be detected at an early stage

• prostate cancer
• breast cancer
(c)
• assumes high risk of mortality at outset will return to ultimate
levels over time – suggest “kill or cure” type of medical condition
• likely to be suitable for the most severe medical conditions
• it is expected that a significant number of lives will die in the early
years following diagnosis
• which leads to the additional loading to the portfolio reduce rapidly
over time
• medical conditions could include the most aggressive types of
cancer

• Stomach cancer
• Lung cancer
• Liver cancer
• Ovary cancer
• Leukaemia
• Stroke
• Organ transplants
• Replacement kidneys
Page 10
6 (i) Reinsurance contracts

Scope: dates of commencement and (if appropriate) termination of
arrangement
Type of treaty: original terms or risk premium, quota share or surplus or other
Scope: names of contracts to be included (different IP contracts)
Scope: territories of sale to be covered, residence of insured
Scope: maximum and minimum ages at entry/expiry to apply
Scope: maximum and minimum amounts of premium/sums insured to be
covered
Scope: total maximum capacity
Scope: underwriting – limits on degree of policyholder impairment or
occupational class to apply for automatic treaty inclusion
Underwriting authority: limits on premium size, benefit size which can be
accepted without reference to reinsurer
Details of retentions and methods of calculation of sum reinsured and
reinsurance commission
Rules for indexation of limits and other amounts
Administration requirements: frequency of accounts submission, detail of
information, methods of submission, transmission of payments
Details of profit calculation (if appropriate) and method of sharing
Requirement of reinsurer inspection of insurer files
Alternative for facultative treatment of cases outside treaty scope
Service agreement (can be two-way) including response times
Arbitration agreement (in the event of dispute)
Legal jurisdiction of treaty
Procedure for changes to treaty terms (e.g. terminations)
Reviewable/guaranteed premiums
Appendices with schedules of premium rates (office or risk premium)
Signatures of persons capable of committing both parties
Availability and conditions of use of reinsurer software
Details of any financing reinsurance
Claims management and acceptance procedures
(ii) It is likely that XYZ would wish to review and amend the retention limits.
As it is a much larger company, it is likely that retention limits would be
increased.
Similarly there may be a reduced need for financing arrangements.
XYZ may need additional finance (e.g. for solvency purposes or to fund a
takeover)
If XYZ wishes to pursue international markets then the scope of treaty would
need to be extended to cover overseas territories.
Retention limits may stay low for this new international business to reflect the
lack of experience in this market.
XYZ might also wish to agree different general administration arrangements
with the reinsurer.
XYZ may wish to renegotiate risk premium and higher volume limits.
Page 11
7 (i) Protecting the nation’s health – leading to improved productivity and growing
GDP
Subsidising the poor – helping those unable to help themselves
Balancing the budget
Social culture / Political promises
(ii) Both protect nation’s health – own occupation seems a better fit to ensuring
productivity.
Subsidising the poor – benefit recognises that those with more severe
incapacities will require higher levels of benefits.
Balancing the budget – depends on the detail, how much more benefit? What
is the probability of being more severely incapacitated? Likely to be overall
reduction though.
Social culture / political promise – again more socially acceptable to pay more
to severely incapacitated individual but more people will now get less which
might go against social expectations or political promises made in the past.
Lower benefits may encourage quicker return to work and hence help increase
GDP.
Overall reduction may be inconsistent with political ideals.
(iii) Demand for products

Expect to increase as State paying less.
Expected to vary by product.
IP likely to be more demand as linked to employment.
May need to change/increase systems to deal with anticipated increase in
volume of business and changes in lives covered.
Claims experience
The change in the replacement ratio will impact on IP.
Impact on product design

Changes in CI products unlikely but may consider changing definitions to be
consistent with severe definition.
Changes in IP products are likely to be required to reflect the changes in
benefits.
Existing IP claimants
May have to pay out more on existing policies if benefits are defined with a
state benefit offset, and may not be able to increase prices/charges to cover
this additional cost.
(iv) Model points should be set that reflect the expected future profile of new
business.
Then the company needs to project its expected future cashflows, e.g.
premiums, expenses, claims.
The cashflow projections should also take into account supervisory reserving
requirements.
Also need to project forwards the expected levels of state benefit offset.
Page 12
Due to the government proposal, this will require investigation and analysis of
incapacitation rates based on ADLs as well as on “own occupation” tests.
The company will have to clarify or estimate the “significantly higher benefit”
proposed for severely incapacitated lives.
A set of assumptions will be required to perform the profit test investigation;

the starting point is likely to be best estimate.
Morbidity
Perform an analysis of own company experience over a suitable recent period
3–5 years may be suitable depending on volume of data – credible but
homogeneous.
Split analysis into major different risk groups e.g. male/female, smoker/non-
smoker, location.
Adjust data for other possible influences which will affect its immediate usage
e.g. past changes in underwriting standards or claims management.
Allow for possible changes in base experience because of change in state
provision – e.g. may take on different types of lives
Compare actual v expected
Compare own data with that from other sources over the same time period
such as:
• Consultants’ data
• Data from reinsurers
• Published tables based on insurance experience
• Population figures and government health statistics
Assess the adjustment needed to relate any published data, which may not be
underwritten, to the particular circumstances of the company, its products and
target market.
For IP, analyse claim inception and claim termination rates. If data permits,
investigate by occupational classes and deferred period.
Investigate the availability and cost of reinsurance arrangement of various
sorts e.g. risk premium, original terms.
May base premium terms on reinsurance rates, subject to the above analysis.
Need to investigate potential impact of AIDS/HIV
Need to include reserving basis among pricing assumptions, affecting cash
flows.
Will probably use adjustments to a standard table, the adjustments derived
from the above analysis.
Need to allow for deterioration also.
Mortality
Similar analysis to that for morbidity.
For IP, need to split pre-claim and in-claim mortality
Investment
Assess level of potential investment return on the assets backing this portfolio.
Include net of direct investment expenses.
Page 13
Expenses
Start with company’s most recent in-house expense analysis.
Inflate from experience investigation to date of use.
Allow for trends if this is an annual exercise.
Allow separately for acquisition (sales, marketing and underwriting), servicing
and claims costs.
Claims costs will be split between initial claim validation and ongoing claim
maintenance.
Split policy costs into those that are premium related and those that are per-
policy.
Need to understand the extent to which specific one-off costs (e.g.
establishment overheads) and expected additional costs (e.g. regulation) are to
be costed against individual policies.
Degree of detail will depend on size of company and volume of expense
information.
Inflation may need to be split between manpower costs, future equipment
costs and others.
Projected inflation may possibly be measured as difference between
government fixed-interest and index-linked securities.
Adopt consistency of assumptions between investment returns and expense
inflation.
Allow for anticipated changes in new business volumes for spreading fixed
costs.
Commission
Commission as paid. Load directly into premium basis.
May need some adjustment if there are volume-related overrides – thus
dependent on new business forecasts.
Lapses
Analyse experience for IP products by duration.
Ensure appropriate to the distribution channel.
Further adjustment may be needed if past period of data collection was
influenced by unusual economic circumstances, or any other abnormal historic
situation.
Tax
Make suitable assumptions as to the insurer’s current and future tax position.
Options and guarantees
Reinsurance costs
Profit
Include company profit criteria, commensurate with underlying risk of venture
— risk discount rate, PVFP, pay back period.
Possibly increase risk loading in RDR to allow for greater uncertainty about
the experience following the state benefit changes.
The premium rates should then be varied until the profit criterion is met.
Page 14
Consider the extent of cross subsidies between model points, with a view to
minimising new business mix risk.
Sensitivity analysis
Test the sensitivity of the final premiums to adjustments in the individual
assumptions and refine inputs accordingly.
Competitors’ rates
Research competitors’ office premium rates to assess levels of new products –
adjust assumptions then if deemed appropriate.
Page 15
EXAMINATION
23 September 2008 (pm)

booklet.
supervisor.
question paper.
1 The standard benefit of an income protection product is to provide the insured with
regular short- or long-term payments during periods of incapacity.
(i) List the additional benefits that may be added to standard income protection
covers. [2]
(ii) Explain the reasons behind offering benefits in addition to the standard income
protection covers. [4]
[Total 6]
2 You are the valuation actuary of a small company writing only Term Assurance (TA)
and Accelerated Critical Illness (ACI) business. As part of the year end statutory
reporting requirement, you are required to calculate the Capital Requirement for Long
Term Insurance (CRLTI).
For the long-term insurance business, CRLTI is calculated as the sum of the following
components:
Insurance expense risk capital component =

1% of the “Adjusted Mathematical Reserves”
Insurance market risk capital component =

3% of the “Adjusted Mathematical Reserves”
Insurance mortality risk capital component =

0.3% of the “Adjusted Capital at Risk”
where
“Capital At Risk” is calculated as:

Total Sum Assured minus Mathematical Reserves
“Adjusted Mathematical Reserves” is calculated as:

Gross Mathematical Reserves * Reinsurance factor for reserves
“Reinsurance factor for reserves” is calculated as:

Net (of reinsurance) Mathematical Reserves / Gross Mathematical Reserves
(subject to a minimum of 85%)
“Adjusted Capital At Risk” is calculated as:

Gross Capital At Risk * Reinsurance factor for capital at risk
“Reinsurance factor for capital at risk” is calculated as:

Net (of reinsurance) Capital At Risk / Gross Capital At Risk
(subject to a minimum of 50%)
ST1 S2008—2
At the most recent valuation, you have the following information.
Term Assurance
Gross Sum Assured = £20,000m

Gross Mathematical Reserves (excluding Expense & Miscellaneous Reserves) =
£500m
Reinsurance arrangement: 60% Quota Share
Accelerated Critical Illness
Gross Sum Assured = £10,000m

Gross Mathematical Reserves (excluding Expense & Miscellaneous Reserves) =
£350m
Reinsurance arrangement: 80% Quota Share
Global Expense & Miscellaneous Reserves
= £20m
(i) Calculate the total CRLTI for your company based on the above information,
stating all the assumptions you make. (For this purpose, the ACI business will
not be split and is considered to have death risk only.) [6]
Your company has recently purchased the life insurance subsidiary of a bancassurer.
The block consists of ACI business only and there is no reinsurance arrangement. At
the most recent valuation, the total sum assured is £12,000m and the mathematical
reserves are £360m.
(ii) Calculate the CRLTI for this company on its own. [2]
(iii) Assuming that you have decided to hold the same amount of £360m as reserve
for your valuation, calculate the CRLTI for the merged company. [4]
(iv) Explain why your answer in part (iii) is less than the sum of your answer in
part (i) and part (ii). [2]
(v) Apart from the benefits in part (iv), suggest other possible synergies that could
be achieved through this acquisition. [6]
[Total 20]

3 (i) Define the terms gross and net replacement ratio and indicate their impact for
insurance companies writing income protection business. [3]
In Actuaria, the company XYZ provides its working directors and senior staff with the
following health benefits during incapacity.
(a) an income protection benefit of 70% of gross pre-disability salary, plus
(b) an income protection benefit of 15% of gross pre-disability salary in

respect of employees’ contributions to the XYZ Pension Fund
The scheme is insured with the incapacity definition being based on “own
occupation”.
All income protection benefits are paid direct to the employee during claim and are
not subject to tax.
Normal retirement age for XYZ is age 65. Benefits increase at an annual rate of 10%
during claim payment.
(ii) Discuss the effect of the benefit structure on the scheme’s claims experience.
[4]
It has been suggested to XYZ that the benefit structure should stay the same but that
benefits should be paid during incapacity for five years. At that time the income
payments will cease, the employee will leave service and a lump sum of five times the
annual income benefit currently being claimed should be paid to the employee.
(iii) Discuss the effect of the revised benefit structure on the scheme’s claims
experience and the additional considerations for the insurer if they introduce
these changes. [5]
[Total 12]
4 (i) State three ways in which a life insurance company can obtain underwriting
information about a person making an application for a health insurance
contract, and state the information obtained in each case. [6]
(ii) Explain why all three sources of information given in part (i) are not
necessarily obtained for all applicants and how the company will decide upon
which of the three to obtain, both for a particular individual and for its
applicants in general. [3]
(iii) Suggest the underwriting decisions that the insurance company could take on
the basis of the information obtained in (i). [3]
[Total 12]
5 Outline two methods used to provide dental insurance and briefly explain how dental
insurance might be underwritten. [5]
ST1 S2008—4
6 Arcadia, a middle income country has a population that comprises:
(a) a small wealthy elite

(b) a growing and prosperous middle class predominantly involved in government
service, the professions and business, and
(c) a large poorer working class predominately involved in agriculture
In recent years Arcadia has become increasingly prosperous with the traditional
healthy Arcadian diet being pushed aside in favour of imported expensive western fast
foods. At the same time, the incidence of bowel cancer has started to increase. The
Arcadian government has accepted a proposal from an international agency that the
population should be tested in a substantial pilot study using a modern test for
preliminary signs of bowel cancer. It is hoped to determine whether the increase in
bowel cancer is linked to the change in diet.
The Arcadian Life and Health Insurance Company (ALH) is the market leader in the
Arcadian long-term life and health business in Arcadia. ALH has sold two types of
critical illness products in recent years:
Type A: a high sum assured product to the wealthy and the middle classes, and
Type B: a low sum assured product to the working class.
You are a consulting actuary working for an international actuarial consulting group
with responsibilities that include actuarial support for ALH. The actuary of ALH has
written to you requesting a report to be presented to the ALH board of directors
outlining the expected effects of the pilot study on the existing critical illness
portfolio.
(i) Describe the information that:
(a) you would like the actuary of ALH to send you and
(b) you would expect to be able to extract from other data sources
so that you can provide the report. [11]
(ii) Describe the likely effects of the pilot study on the claims experience of the
existing portfolio. [2]
(iii) Describe the likely effects of the pilot study results on the future pricing of
new business of ALH. [2]
In addition, the head of your world-wide actuarial division has written to you asking
for a report of the effect of these new diagnostic tests for bowel cancer on the
reinsurance portfolios of companies reinsuring critical illness written in Arcadia.
(iv) Outline the points you would make in your reply to the head of your world-
wide actuarial division. [2]
[Total 17]

7 (i) State the reasons why a health insurance company may want to analyse the
surplus arising on its supervisory basis over a year. [2]
(ii) State the reasons why the insurer may also analyse the change over a year in
its embedded value. [2]
An actuary could make use of the results of analysing the experience, the surplus
arising and the change in the embedded value to reassess his or her view of the future
with regard to the company.
(iii) Suggest the areas in which the various risks faced by a health insurer could be
controlled as a result of the actuary’s reassessment of his or her view. [6]
You are the pricing actuary of a large health insurer, which provides a wide range of
critical illness, income protection and private medical insurance products. You are in
the process of setting the pricing assumptions for the most recent premium-rating
exercise. You are about to start an analysis of expenses in order to allocate expense
costs correctly between the different classes and rating groups in the portfolio.
Your operations manager suggests that, in place of an expensive in-house analysis, the
company should simply calculate its expense loadings from an average of expenses
published in the accounts for companies writing similar products in your country.
(iv) Discuss the pitfalls of following this approach. [10]
(v) Describe the approach you would adopt in dealing with the following main
items of expense:
(a) salaries and salary related expenses

(b) property costs (rent, property taxes, heating, lighting and cleaning)
(c) one-off capital costs
[8]
[Total 28]
END OF PAPER
ST1 S2008—6

EXAMINERS’ REPORT
September 2008
Introduction
R D Muckart
December 2008
General comments
and receive a pass in the subject. There was often a lack of sufficient detail in the answers.
In general each valid point in the answer would normally attract 0.5 marks with the more
basic elements e.g. details in a pricing basis such as age and sex, attracting 0.25 marks.
1(i) Additional benefits include:

Hospitalisation benefit
Lump sum TPD benefit
Critical illness benefit
Terminal illness benefit
Unemployment waiver of premium benefit
Health waiver of premium benefit
Death benefit
State benefit option
Fatal accident benefit
Some form of maturity guarantee e.g. return of premiums
Increase options/escalating benefits
Unemployment cover
Rehabilitation assistance
Proportionate benefits
Continuation option/guaranteed insurability
Waiver of pension/state health benefit contribution
1(ii) Reasons for offering benefits in addition to the standard income protection benefits
include:
Marketing – enhancing the brand name
Meeting needs
Allays fears
Competitors are offering them
Differentiation from competitors
Statutory requirements
Request from distribution channels
Profitability
Treating customers fairly
To make product more attractive – selling a higher volume
Increase total premium income
Assists return to work
2(i) One possible approach is outlined below. Marks were also given for other
approaches and reasonable assumptions, for example the treatment of the global
reserve of £20m.
Assuming that there is no maximum retention on individual policy

Reinsurance arrangement does not cover miscellaneous reserves
All figures in £m
Term Assurance
Gross reserves = 500
Gross sum assured = 20,000
Net reserves = 500 * (1 – 0.6) = 200
Net sum assured = 20,000 * (1 – 0.6) = 8,000
Page 2
Accelerated CI
Gross reserves = 350
Gross sum assured = 10,000
Net reserves = 350 * (1 – 0.8) = 70
Net sum assured = 10,000 * (1 – 0.8) = 2,000
Global
Gross reserves = 500 + 350 + 20 = 870
Gross sum assured = 20,000 + 10,000 = 30,000
Net reserves = 200 + 70 + 20 = 290
Net sum assured = 8,000 + 2,000 = 10,000
Gross capital at risk = 30,000 – 870 = 29,130
Net capital at risk = 10,000 – 290 = 9,710
Reinsurance factor for reserves = Max (85% , 290/870) = 85%

Reinsurance factor for capital at risk = Max (50% , 10,000/30,000) = 50%
Adjusted mathematical reserves = 870 * 85% = 739.5

Adjusted capital at risk = 29,130 * 50% = 14,565
Insurance expense risk capital component

= 1% * 739.5 = 7.395
Insurance market risk capital component

= 3% * 739.5 = 22.185
Insurance mortality risk capital component

= 0.3% * 14,565 = 43.695
Total CRLTI = 7.395 + 22.185 + 43.695 = 73.275
2(ii) Both reinsurance factors are 100%

Gross capital at risk = net capital at risk = 12,000 – 360 = 11,640
Gross reserve = net reserves = 360
CRLTI = 1% * 360 + 3% * 360 + 0.3% * 11,640 = £49.32m
2(iii) Global
Gross reserves = 870 + 360 = 1,230
Gross sum assured = 30,000 + 12,000 = 42,000
Net reserves = 290 + 360 = 650
Net sum assured = 10,000 + 12,000 = 22,000
Gross capital at risk = 42,000 – 1,230 = 40,770
Net capital at risk = 22,000 – 650 = 21,350
Reinsurance factor for reserves = Max (85% , 650/1,230) = 85%

Reinsurance factor for capital at risk = Max (50% , 21,350/40,770) = 52%
Adjusted mathematical reserves = 1,230 * 85% = 1,045.5

Adjusted capital at risk = 40,770 * 52% = 21,200.4
Page 3
Insurance expense risk capital component

= 1% * 1,045.5 = 10.455
Insurance market risk capital component

= 3% * 1,045.5 = 31.365
Insurance mortality risk capital component

= 0.3% * 21,200.4 = 63.601
Total CRLTI = 10.455 + 31.365 + 63.601 = 105.421
2(iv) Existing reinsurance proportion exceeds maximum reinsurance benefits allowable

Target company does not have existing reinsurance arrangement
Part of the reinsurance benefits which were not allowable prior to the merger could
now be utilised
2(v) Other possible synergies include:

Expense synergy
Tax
Reserving
Investment
Resilience test
Brand name
Distribution
Marketing
Diversification of risk – product
Diversification of risk – geographical
Diversification of risk – business profile
More stable overall profits
Underwriting
Claims process
Credit rating
Capital availability
Lower cost of reinsurance because of higher volumes
Expertise and knowledge sharing
Opportunities for cross selling
3(i) Replacement ratio, in the context of income protection insurance, is the ratio of
post-disability income to pre-disability income.
Post-disability income should include state benefit payments
Gross refers to the replacement ratio being calculated on a ratio of gross income to
pre-disability income.
Net refers to the replacement ratio being calculated on a ratio of net after tax
income to net after tax pre-disability income.
A value less than one is desirable from the insurer’s viewpoint,
to provide a financial incentive for the claimant’s return to work,
especially given that expenses in disability may be less than those in normal
(working) health (although this would not always be the case)
Page 4
3(ii) The total benefit paid by the insurer in the event of a claim is 85% of pre-disability
salary
i.e. the gross replacement ratio is 85%
As income protection benefits are tax free, the net replacement ratio is likely to be
in excess of 100%, depending on the tax rate
The high benefits may produce a higher claims incidence
With a corresponding poor recovery rate to return to work for short term claims
And a very poor recovery rate for long term claims in view of the 10% p.a. benefit
increase during claim
Provided that the RPI or similar inflation rate is modest
If benefits are in excess of free cover, careful medical underwriting will be needed
Own occupation' is a weak definition which may lead to high incidence rates
It is possible that in the event of a claim that the employee will not pay over the
pension fund contributions to the company and this will also be a factor in reducing
the recovery rate (as would how the 15% pension contribution compared to actual
pension contributions)
The claims experience will depend on the health of the employees; if the claims
department is good, the claims experience may not depend on benefit structure
Salary is only one element of remuneration for senior staff, who might also receive
significant bonuses and share options. Hence the impact on inceptions and
terminations may not be as high as it appears. Also, senior management may feel a
moral obligation to return to work.
3(iii) The total benefit paid by the insurer in the event of a claim is the same as before so
no effect on short term claims
However, there may be an impact on the propensity to claim
Claimants who are receiving benefit from about 3 years onwards will be looking to
stretch their claim to five years so that they can receive the lump sum payment
Consequently the recovery rates under this scheme will drop away from 3 years
onwards
However, some people may value their jobs as higher than the lump sum benefit
payable and hence return to work earlier.
The insurer will need to consider whether the incapacity definition for the lump
sum benefit should be on a stricter definition
such as ADLs, FAT etc.
Although the income payments are made for a shorter time, there is the effect of
the lump sum benefit so careful medical underwriting of benefits in excess of free
cover is desirable
If any element of the scheme is reinsured, the reinsurers will need to be consulted
to see if the risk should be accepted
It is not clear whether someone starting to receive benefit over age 60 qualifies for
the lump sum benefit
The lump sum at five times is too generous at older ages
And could be improved at younger ages
The over-generous benefits at high ages may be exacerbated by morbidity rates
increasing with age and /or the profile of those covered (senior management)
Costs may be lower because of loss of the 10% escalation of benefits (counteracted
by no apparent discounting applied).
What is the need being met by such a product design?
Are there any age discrimination issues?
Page 5
May need to change system/administrative processes

There may be tax or regulatory issues.
4(i) Possible ways in which a life insurance company can obtain underwriting
information about a person making an application for a health insurance contract
and the information that might be sought include:
Proposal Form
Applicant has to provide information about (main points):
current health,
medical history
age
sex
height
weight
contract applied for
and size of benefit
lifestyle
e.g. smoking, alcohol consumption, hazardous sports,
family history information (any early deaths of close relatives due to cancer,
heart disease, stroke etc.)
occupation
country of residence
whether special terms have been applied by other insurers
or insurance has been declined
financial information
(e.g. salary)
Medical Attendant’s Report

Confidential report written by applicant’s doctor; gives account of medical history
and an opinion on the applicant’s current health
Medical Examination
Applicant is required to undergo a medical examination by the company’s Chief
Medical Officer (or substitute).
Gives very precise (and unbiased) information about current state of health.
Details of other relevant insurers
[There are other items such as lab tests, Chest X-Ray, ECG for which credit was given]
4(ii) All three are not sought in many cases because it may not be necessary and
therefore leads to an unnecessary expense.
Majority of applicants can be judged as a standard risk from proposal form
information.
The few higher risks, which slip through can be tolerated provided sums assured /
benefits are not too high.
Adverse information given on a proposal form will automatically trigger either or
both a GP report or a medical examination.
A GP report may also trigger a medical examination.
Page 6
Sum assured or benefit higher than the company’s chosen threshold will
automatically trigger a GP report and a medical examination even if proposal form
is clear.
As medical examination is the most expensive item, the threshold for automatic use
is higher than a GP report.
Hassle factor: potential policyholder may give up on the application
Other valid points include:
In general, companies have to decide on their automatic criteria for decision.
Automatic limits will vary by type of product.
May be influenced by reinsurer demands on rating etc.
Regulatory requirements/constraints
If the expected present value of the future extra premiums received from the use of
a lower threshold exceeds the cost of obtaining the extra information, the threshold
should be lowered.
Conversely, with inflation of costs, thresholds generally rise over time. The insurer
will assess whether the loss of future extra premiums for a given rise in threshold is
less than the reduction in cost, then the limit should be raised
4(iii) The options are

could be insured at standard rates
could be offered higher (loaded) premium/reduced benefit
could postpone a decision (e.g. when long-term prognosis is uncertain but should
become clearer at a future date)
could decline insurance (if additional risk is thought to be too high)
could offer a different (less risk intensive) type of policy
could offer to a reinsurer facultatively with zero retention
could apply a claim exclusion for particular causes
5 The principal methods are:

Capitation basis
This is the practice of charging for cover by forecasting the likely claims on an
individual basis
and charging this, adjusted for expenses and profit, as the premium.
In effect, the insurance company “carves out” dental claims and passes this risk
onto the provider,
by giving a proportion of the insurance premium for each person managed to the
dentist up-front rather than an amount per claim.
The dentist estimates the cost for each patient
Risk to the dentist is twofold: the number of patients requiring treatment may be
higher than expected and the cost of treatment increases faster than expected.
Indemnity basis
where the insurer covers pound for pound of treatment delivered
subject to any excess or policy limits
Insurers work closely with dentists to ensure that applicants are screened initially
for pre-existing conditions or imminent treatment,
and to ensure that dental intervention thereafter is in accordance with risk
expectation
Page 7
Pre-existing conditions or imminent treatment may be excluded at outset. (e.g. for

indemnity version)
On a group scheme of sufficient size, dental history may be disregarded
6(i) Details of the pilot study, proportion of the population to be tested by

Sex
Age group
Occupation – socio-economic class
Size of CI portfolio
Details of the ALH CI portfolio split by
Policy type
Sex
Age group
Occupation – socio-economic class
Details of the products covered

Policy documents
Sales literature
Any relevant regulations on paying claims
Are policies reviewable or renewable
What guarantees have been given
Reinsurance terms
Details of the incidence of bowel cancer in the population

Details of the incidence of bowel cancer in the ALH CI portfolio
Details of changes in bowel cancer incidence after similar studies in other
countries, if available
Split by Country
In each case data should be for a period sufficient to be credible eg 3 - 5 years

and split by sex, age group and occupation – socio-economic class, if possible
Forecasts of the increase in incidence of bowel cancer in the population expected

as a result of the pilot study
Split by Sex, Age group and Occupation – socio-economic class
Reinsurers’ data
Other industry data
Details of historic diet and expected future dietary changes
Assessment of accuracy of predictive test
Relationship of bowel cancer and other cancers and between cancers and fast food
diet
6(ii) Claims diagnosis will be brought forward

but unsure how it will impact by sex and age group
Differential impacts can be expected by socio-economic class
Western diet is more expensive and the change in diet is the likely contributory
factor
Page 8
High value policy is likely to be much more affected

If the policy is standalone CI, then the claims numbers will increase as deaths due
to undiagnosed colon cancer within survival period will reduce
May also need to make allowance for any possible government intervention on diet
or dietary advice
6(iii) As claims diagnosis will be brought forward if the pilot study is rolled out to the
entire relevant population
the pricing model will be adjusted by sex, age group and occupation – socio-
economic class
If the link to fast food is proven, then a deterioration of claims experience over the
life of the policy should be factored into the pricing
Differential impacts can be expected if the impact of fast food continues to increase
in the population
With the low value policy becoming affected
Although the price may be expected to increase
actions of competitors will also be a factor
6(iv) Impact on claims experience on proportional business will be the same as for the
direct writer
Impact on claims experience on non-proportional business may be exacerbated
because the higher value business is the most likely to be affected.
This is likely to cause reinsurance premiums to increase.
Depending on the materiality of the increase, this may reduce the amount of critical
illness reinsurance sold.
However, it is possible that companies might increase their levels of reinsurance
due to the uncertainty regarding future bowel cancer trends.
If it writes reinsurance business in countries other than just Arcadia, then the
reinsurer may have more detailed additional information from other countries
which have experienced similar dietary changes, which will help it price more
accurately.
7(i) Show the financial effect of divergences between the valuation assumptions and
the actual experience
Show the financial effect of writing new business
To identify non-recurring components of surplus
To give information on trends in the experience of the company
Provide an independent check on the valuation data and process
7(ii) Validate the calculations, assumptions and data used

Reconcile the values for successive years
Provide management information
Provide detailed information for publication in the company’s accounts
Help set executive remuneration
7(iii) Improving the pricing basis

Establishing/revising the reserving basis
Changing/improving the marketing message
Page 9
Revising training of staff and distributors

Selection of distributors
Revising wording and format of literature
Revising the mechanics of commission payments and clawback
Providing adequate numbers of staff
Revising underwriting processes
Revising claims handling processes
General capital management
Improving the systems and data recording processes
Rewording of policy contracts to remove hidden mistakes in policy design which
have surfaced
Investment strategy
Reinsurance strategy
Lapse/retention management
Expense management/budgeting
General product design
New business strategy (which lines to target)
7(iv) The market average will not represent your mix of business by product and this
will impact expense levels
Your methods of business generation will differ from the market average
In particular expenses will differ significantly between companies selling mainly
through telesales/internet and those generating business otherwise
Your commission levels will differ (unless there are regulation-imposed
commission levels – but even then different business mixes will corrupt the
developed factors)
Numbers in accounts will be out of date by the time published
Market figures may represent differing amounts of business abroad which will
have different expense levels to the home country
There is an obvious difficulty into turning accounting percentages into meaningful
pricing bases (e.g. initial/renewal/claim)
and for splitting per policy/per premium
Difficult to convert to per policy expenses as numbers of policies may not be
published
Companies in the market will have a different split between head office (fixed) and
sales (variable) expenses.
Published figures may not help with need for expense loadings in claims provision
Currency conversions of expenses incurred abroad or by accounts published in
currencies other than the local one will complicate their applicability
Stages of company development will differ – and this will impact their split
between initial and renewal expenses
The size of your company may not reflect market average – thus the balance of
overhead costs may not be reflected in the derived factors
Your ability to recover commission on lapses (and your agreement/rules for so
doing) may be different from the market average
You may have younger staff (lower paid) than the average
You may have fewer professionals e.g. actuaries than the average
You may have special pay scales
You may have schemes for home working which reduces staffing costs
Your normal pension contributions may be lower than the average
Page 10
Accounting rules may mean that some companies’ pension deficit recovery
payments are treated as staffing costs which is a problem which your company
does not share
Expense cost per premium may be reduced by outsourcing and/or call centres in
some companies which will distort the relevance of averages
The cost of computer systems may vary significantly between companies and
averages may not help/level of automation of processes
Your products may have features which are less or more expense intensive than
those of the market.
Your products may require less or more claims management e.g. insurer
intervention in claims approval or settlement quantification
Your company may have special deals with energy suppliers which are not
reflected in the market average
The location of offices (particularly HQ) will impact staff salaries
The location of offices (particularly HQ) will impact rental costs whether imputed
or actual
There will be differences in your salesmen remuneration depending on whether
they are salaried or commission-rewarded and this may not reflect the market norm
Different levels of initial underwriting (this can be quite a significant component of
costs)
Published expenses are unlikely to be split by product, so will not be able to derive
differentiated loadings for pricing purposes
Not all one-off costs may be identified separately
7(v) (a) Salaries and salary-related expenses

Large part of expenses are staff-related
In the short term, much of this may remained fixed in real terms
In the longer term, this will vary to meet changing levels of new and existing
business
Staff can be split into
Staff whose work relates to one single cell of the analysis can be directly
allocated to the appropriate cell
Staff whose work relates to more than one cell, time-sheets can be used to split
their salaries between the appropriate cells
Other staff, split in proportion to overheads and direct expenses
Typical cells may be
The whole business of the insurer
The whole business of a particular accounting fund
Each main product line of the insurer
If none of the above are available, other pragmatic approaches could be used
(b) Property costs

If the company owns, as an asset of its long-term fund any of the buildings it
occupies
a notional rent charged to the relevant departments
Rent, plus property taxes, heating costs etc., can be split by floor space
occupied between departments
And then allocated in accordance to salaries
Page 11
(c) One-off capital costs

These need to be amortised over the expected useful lifetime of the item
purchased
The amortised cost may then be treated as part of the overheads
Some items can be treated as an asset of the long-term fund, e.g. a new head-
office building
In which case, a charge, e.g. a notional rent would usually be made instead of
amortisation
Exceptional items, which are not likely to recur, would be excluded
completely from the analysis
Page 12
EXAMINATION
30 April 2009 (pm)

booklet.
2. You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
supervisor.
5. Attempt all six questions, beginning your answer to each question on a separate sheet.
question paper.
1 A large health insurer is reviewing the rating basis for members of group PMI
schemes. Currently, its pricing basis has different ratings for Single Members, Single
Parent Members, Married Members (with no children) and Family Members.
Describe the data that would be required in order to check whether the above rating
system is reasonable. You can assume that all relevant data are available. [4]
2 In Actuaria, there are a number of care homes offering differing levels of residential
and nursing care. You are a consulting actuary practising in Actuaria. One of your
clients in the health insurance industry has asked you to produce a report setting out
the possible impact of a new drug taken daily to delay the impact of full blown
clinical symptoms on people suffering from the initial stages of Alzheimer’s Disease.
It is thought that if the drug trials are successful, the effect will be a delay of two
years before the sufferer needs institutional care. It is not thought that there will be an
overall impact on life expectancy.
(i) Discuss the potential impact on the following markets if the drug trials are
successful and the drug becomes widely available:
(a) the immediate needs annuity market

(b) the pre-funded long-term care insurance market
[5]
It is forecast that mx male lives at age x and fx female lives at age x in Actuaria will
contract Alzheimer’s in the next year and will take the drug.
(ii) Outline a simple formula to estimate the impact of the new drug on total
medical and care costs for these lives, determining the present value of the
cost savings and defining all items in the formula. You may assume that all
data are or will become available. [6]
[Total 11]
3 (i) Describe the process of investigating the expense experience of a health and
care insurer. [10]
A small health and care insurer has been experiencing fluctuating new business
volumes and increasing expenses for a number of years. The finance director has
suggested the possibility of outsourcing the administration and client servicing
functions to an external provider.
(ii) Discuss this suggestion. [8]

[Total 18]
ST1 A2009—2
4 A small health insurance company writes accelerated critical illness, stand alone
critical illness and income protection business.
(i) Explain why initial underwriting would be used by this company for the
purpose of risk management. [5]
An applicant is normally required to disclose any significant change in personal

circumstances between the policy application date and the risk commencement date.
Failure to disclose this information will result in the health insurance company not
paying a claim and cancelling all cover under that policy.
(ii) List six personal circumstances that are likely to be included under this
requirement. [3]
The company’s current underwriting limit at which a medical examination is

automatic is in line with general market practice. With the aim of making a
significant reduction in underwriting costs, the marketing manager has proposed
increasing the underwriting limit of the accelerated critical illness and stand alone
critical illness business. The proposed increase is substantial.
(iii) Discuss the factors to consider relating to this proposal. [9]
Under the current underwriting model, sales advisers gather all the risk information
directly from the applicant and then pass it to the underwriting department. Your
underwriting manager has proposed that instead of using sales advisers to gather the
risk information, a dedicated team of trained nurses will interview applicants over the
phone to gather risk information. The current level of sales remuneration will be
maintained.
(iv) Discuss the merits of this proposal from the point of view of:
(a) Sales advisers

(b) Company
(c) Customers
[9]
[Total 26]

5 A health and care insurer writes accelerated critical illness, stand alone critical illness
and income protection products. It is well established in the critical illness market but
it is relatively new to the income protection market.
(i) Describe the reasons why this insurer might use reinsurance. [8]
(ii) Describe the approaches that can be used for the determination of an
appropriate retention limit. [4]
Reinsurance cover has been purchased for each product under the following treaty
terms:
Accelerated Critical Illness (ACI) & Stand Alone Critical Illness (SACI)
Retention — 25% of the sum insured of each policy, subject to a maximum of

£100,000 retention for any one life. For joint life policies, the retention shall be
calculated on the basis of the life with the highest aggregate sum insured across all
critical illness policies held.
Income Protection (IP)
Retention — 30% of the sum insured of each policy, subject to a maximum of

£10,000 retention per annum per life.
(iii) Calculate the total amount of reinsurance claims between 1 January 2008 and
31 December 2008 for each of the following claims.
(a) Claim A
Claimant: Mr A
Type of claim: Death
Date of death: 05/06/2008
Date of notification: 08/07/2008
Policies:
1. Joint Life First Event ACI with Mrs A; Sum insured £75,000
2. SACI for Mrs A; Sum insured £50,000
3. IP for Mr A; Sum insured £6,000 per annum; Deferred period 26
weeks
ST1 A2009—4
(b) Claim B
Claimant: Mr B
Type of claim: Sickness
Date of first sickness: 17/11/2007
Type of claim: Death
Date of death: 12/10/2008
Policies:
1. ACI; Sum insured £80,000

2. IP; Sum insured £7,000 per annum; Deferred period 26 weeks
(c) Claim C
Claimant: Mr C
Type of claim: Critical Illness
Date of diagnosis: 15/10/2008
Policies:
1. Joint Life First Event ACI with Mrs C; Sum insured £500,000
2. IP for Mr C; Sum insured £30,000 per annum; Deferred period 13
weeks
[8]
[Total 20]

6 In the country of Actuaria a new regulatory regime is being considered. Under the
current regime, reserves for long term insurance business are calculated using a
prospective methodology and a prescribed basis. The new regime would involve a
new method of calculating reserves which would be specified by the regulator, and
each insurance company would set their own basis.
Before moving to the new system, the regulator wishes to determine the impact of the
proposed changes on insurance companies’ statutory reserves. The regulator
therefore intends to obtain details of the impact of the proposals from all long term
business insurers in Actuaria. This information will also be used in finalising the
details of the proposal.
(i) List the information that the regulator should ask the insurers to provide in
respect of income protection business. [5]
(ii) Describe any complications that might be encountered by the regulator in

relation to this information request. [3]
The regulator realises that conflicts of interest can arise relating to the degree of
prudence included within statutory reserves, and wishes to put in place measures to
reduce the risk of inappropriate reserves being calculated.
(iii) Describe how these conflicts of interest might arise and the measures that
could be put in place to ensure that appropriate levels of reserves are set. [8]
For critical illness, one insurer has proposed that the new method of reserving should
be a retrospective approach under which the reserve is set using an asset share
calculated “on a prudent basis”.
(iv) Discuss this proposal. [5]

[Total 21]
END OF PAPER
ST1 A2009—6

EXAMINERS’ REPORT
April 2009
Introduction
R D Muckart
July 2009
General comments
and receive a pass in the subject. Candidates will lose marks if they do not address the
question asked. There was often a lack of sufficient detail in the answers. The mark
allocation for each question part gives an indication of the relative length of answer or
number of points to be made to gain full marks. In general each valid point in the answer
would normally attract ½ marks with the more basic elements e.g. details in a pricing basis
such as age and sex, attracting ¼ marks.
Some papers were not clearly marked at the top of each page as to which part of the question
was being answered.
Marks may be lost where answers are difficult to read.
Question 1
This question was poorly answered with many candidates not realising that the object was to
test whether the claims experience was significantly different using the rating factors given.
Question 2
(i) The question concentrated on how a market might react to a medical advance in
elderly care. Many candidates missed out on marks by not taking account of the
information provided in the question – it’s very important for candidates to apply
their answers to the exact situation given.
(ii) Although many candidates made a good effort at this question, more marks would
have been gained had candidates addressed the cost of the treatment or given an
assumption as to who paid for what. The cost of the new drug is important but is
likely to be a fraction of the cost of care in an institution.
Question 3
(i) This question was a good opportunity for a well prepared candidate to score very
highly.
(ii) Most candidates could generally comment intelligently on the proposal in the
question. Candidates should bear in mind that the proposal has advantages as well
as disadvantages, and discussing these would enable them to score extra marks.
Page 2
Question 4
(i) This part was generally well answered.
(ii) As the question talks about the extreme case of a policy not paying out, the
circumstances to be listed should be commensurately extreme.
(iii) This part was generally well answered.
(iv) Candidates should not automatically assume in a question like this that a
"suggestion" is a bad idea, particularly where they are asked to discuss the "merits"
of that suggestion. This is a process which is currently being adopted by some
healthcare insurers and has generally resulted in a great reduction in non-disclosure.
Question 5
(i) Candidates could generally find plenty to write about in this bookwork question – but
note that to score highly, it isn’t enough to repeat a standard list. The answer needed
to be applied to the specific situation in the question.
(ii) Candidates who knew the course could score full marks on this question.
(iii) Candidates did not always calculate the retention in claim A on the basis of the life
with the highest aggregate sum insured across all CI policies held. For claim B
marks were awarded for all reasonable approaches for calculating the period of
sickness.
Question 6
(i) This part was generally well answered
(ii) The better scoring answers considered a wide range of complications, ranging across
both financial and practical considerations.
(iii) This question caused some difficulty. Candidates who thought about the different
parties and how they are affected by the level of the reserves to generate a number of
answers scored well. Scripts that attempted to apply a standard list of reserving good
practice generally missed out on a lot of the marks available, as their points were less
relevant.
(iv) Better answers included consideration of what an asset share really represents, what
a reserve is intended to achieve, and how the two could be reconciled.
Page 3
1 Data should be split by family status rating basis

Data should be further subdivided by
• Sex
• Age group (as defined by the insurer)
Data required is
• Claims Incidence
• Cost of claim as defined by the insurer
Data can then by considered by
• Member
• Spouse
• Children
to check whether there is a material difference in the experience between rating
classes and to see to what extent data from the various marital status areas can be
combined
Data should be taken from the past few years in order to be relevant
Trends should be considered
Rating cells should be credible
Consider rating factors used by competition
2 (i) Immediate Needs Annuity market
The underwriters of Immediate Needs (IN) annuities will need to revise their
assumptions on the progress of the disease where the insured is seeking an
annuity.
The pricing assumptions will need to make due allowance for the annuity
likely to be paid for a shorter period so either premium reduces or annuity
increases
If the demand for Alzheimer cases reduces, the effect on incidence and
availability of care will need to be considered.
If the drug evaluation is correct, i.e. two years more in the community is
achieved, there will be a slowdown in annuity sales for two years as the
treated Alzheimer cases are not being placed in a home.
If the use of the drug is extended to other Alzheimer cases with some duration
of the Alzheimer condition, then there will be a further slowdown in annuity
sales.
If the market in Actuaria for IN annuities is primarily for Alzheimer cases, the
impact could be substantial.
However, Alzheimer's is not the only possible claim or reason for purchasing
IN annuities. There may also be less substantial impact if people don't take
the drug.
The delay in purchasing IN annuities will mean that some pre-Alzheimer cases
will die before effecting the IN annuity.
However, there could be a counter-balancing effect in that more IN annuities
are purchased due to more publicity and / or reduced prices
Page 4
Pre – funded Long-term care insurance market
May affect underwriting procedures

Will the potentially treatable Alzheimer cases have a genetic marker so that
the insurer can give a differential price for these cases?
Or will a discount due to the lower risk be applied to the class?
With a measurable proportion of cases benefiting from the delay in needing
LTC there should be a drop in price for the risk (two years more premium and
two years less payment) and so you might sell more
But there may be fewer sales due to a more optimistic view on the level of
senile dementia (Alzheimer’s)
In all probability, any spin-offs of a successful drug could lead to a new
generation of more powerful drugs lowering the price for pre-funded even
further.
If more pre-funded LTC sold then may sell less immediate needs business
(ii) The impact on the medical and care costs

The drug cost of Alzheimer’s treatment at onset of the disease is A per annum
Assume it is the same for both males and females
Let the annual cost of care for Alzheimer’s sufferer in care state s (may be
residential or nursing) be Cs
Assume care cost in state s is the same for both males and females
Then the saving in cost at each age and sex is
The number of cases receiving treatment multiplied by
(the cost of the care which would have been needed minus the drug
cost)
As the drug treatment goes for two years we allow for deaths from all causes
in that time
Inflation of care cost and drug costs need to be considered (at rate j)
This is likely to be higher than RPI
General rate of interest assumed is rate i
Choose discount rate approx = i − j
So the unit cost per life for the two years will be a x:2 years (at rate i − j)
The formula will be (for males) summing for all x and s
∑ mx (Cs − A) a x:2 years at rate i − j (on male mortality)

x,s
Similarly for females
∑ f x (Cs − A) a x:2 years at rate i − j (on female mortality)

x,s
Then add males and females costs together for total population cost.
Page 5
3 (i) Expenses will need to be split down and analysed into the required “cells”.
Typically the cells may be the whole business of the insurer/each business
fund/each main product line of the insurer
These may be further sub-divided between regular and single premium
business.
The choice of cells will vary across offices depending upon the types and
volumes of business written and the purposes of the analysis
The cells chosen should not be so small that the analysis becomes unreliable.
Also need to split by direct costs v overheads
and initial/renewal/claim/termination/investment
and proportionate to premium/sum assured/number of policies
There may be exceptions
The investigation should exclude commission
Record costs of medical reports and tests as external underwriting expenses
One possible approach to split these costs is as follows.
Salaries and salary-related expenses
A large part of the expenses are staff-related, owing to the labour-intensive

nature of administering the business
In the short term, much of this may remain fixed in real terms.
In the longer term staff costs will vary to meet changing levels of new and
existing business and changes in services provided
The degree of automation used to provide those services will also have an
effect
Staff can be split into various groups:
Staff whose work comes entirely within a single cell
The costs for this group can be directly allocated to the appropriate cell
Staff whose work comes within more than one cell
Time-sheets can be used to split the costs of this group between the
appropriate cells
Some staff will be wholly overheads
Some staff will straddle both overheads and direct expenses in which case the
split between the two is likely to be made pragmatically
The direct part can be split further in proportion to the overall split of the other
two groups
Property costs
If the company owns the buildings it occupies as an asset of its long-term

fund, notional rent needs to be charged to the relevant departments
This rent, plus property taxes, heating costs etc., can be split by floor space
and allocated in accordance to salaries.
Computer costs
The cost of purchasing a new computer could be amortised over its useful
lifetime and then added to the ongoing computer costs
Page 6
These can then be allocated according to computer usage (or other sensible
allocation method)
Investment costs
These would be directly allocated to investment expenses and hence allowed

for in assessing the investment return to be used
One-off capital costs (other than purchase of a new computer)
The expenses analysed exclude large one-off capital costs, which need to be
amortised over the expected useful lifetime of the item purchased
The amortised cost may then simply be treated as part of the overheads
If the item can be treated as an asset of the long-term fund, a notional charge
would usually be made
Exceptional items, which are not likely to recur, would be excluded

completely from the analysis
(ii) Pros
Less hassle and allows management to focus on other areas

Initial costs may be lower
More certainty over expenses
Particularly important as company is small
Expertise provided by the third party provider
No or low fixed overheads – economies of scale
Can leverage existing experience/best industry practice
Flexible, especially for fluctuating volumes
Easier to set pricing/reserving assumptions
Lower expenses could mean more competitive premiums
Lower risk of expense overruns
Cons
May pass profit margin to supplier

There will be one-off system/data transfer costs
Adverse effect on company image
and low morale due to redundancy of staff
Loss of control
Uncertainty over service and quality
which could put brand at risk
Risk of having poor quality or no data
Compliance issues, e.g. requirements by the regulator
Need to manage relationship with third-party provider
Still need to maintain link to accounting system even though services are
obtained externally
Less easy to implement changes
May not benefit from future cost savings
May not benefit from lower overhead if future business volume increases
Page 7
Lock-in contract terms may have penal termination clause

Possibility of fee increases at time of re-negotiation
Small company so may not have much bargaining power
If renewal terms are unfavourable, it might be difficult to find another
provider
It might be difficult or costly to set up in-house services again if the company
fails to renew the agreement
Possibility of third party default
Many of the disadvantages can be managed through a carefully worded

service level agreement and regular audits and checks
May do client servicing in-house but outsource the administration
4 (i) Protect the company from anti-selection

In particular, from lives whose health is so seriously impaired that it is
impossible to assess the risk accurately
leading to increasing frequency of claims
and increased average cost of claims
It enables the company to identify lives with a substandard health risk
for whom special terms must be quoted
or declined
It will identify the most suitable approach and premium level for the special
terms
Adequate risk classification will help to ensure that all risks are rated fairly
Help in ensuring that actual morbidity experience does not depart too far from
pricing assumptions
For large proposals, it helps to reduce the risk from over insurance
Helps get better reinsurance terms
(ii) Address/Territory (e.g. move overseas)

Occupation
Personal/family health
Hazardous leisure activities
Alcohol consumption
Smoking habits
Use of drugs
Frequency and duration of overseas travel
(iii) Main savings are the costs of medical examination reports

and the cost of the underwriter’s time in assessing the reports
The total costs normally form a small proportion of initial expenses
Not all medical examination reports are due to sum assured exceeding
underwriting limit;
some are as a result of information on the proposal forms
The prospect of higher level of underwriting limit before requiring a medical
would attract more medically substandard applicants
This could increase sales
Some of these may need a medical as a result of information on the proposal
forms which reduces the benefit of cost savings
Page 8
Some may obtain cover on standard terms

This would worsen mortality/morbidity experience
The company would then need to increase risk premiums despite the expense
savings
This would make the premium rates less attractive to standard lives
They would seek cover elsewhere with a further worsening of
mortality/morbidity experience and further increase in premiums
As a small company, competitors are unlikely to follow this strategy
Need to consider reinsurance implications
The proposal would reduce the hassle factor and is likely to increase sales
It would also reduce acceptance time
Increase in sales would increase capital strain
and decrease per policy expenses
May lead to higher volatility of profits requiring higher reserves
As a small company would need to consider what competitors were doing
Would need to make changes to systems and internal processes
There may be regulatory constraints
Need to monitor experience
Overall the company will need to assess the balance of the extra underwriting
expenses against possible savings elsewhere
(iv) (a) Sales Advisers
Relieves them of what can be a difficult and time consuming process

Frees up time for what advisers do best – giving advice and making
sales
Faster policy issue
Leads to earlier sales remuneration/commission payment
Advisers can track application’s progress
If not currently widely used in the market, means of differentiation for
sales advisers
If already widely used in the market, means of catching up with
competitors
No change in commission but less work
They are not normally trained to ask/interpret medical questions
Some may find it embarrassing to ask personal medical questions
(b) Company
Leads to faster policy issue

Reduced medical evidence requirement – mainly fewer MARs
Better quality risk information
Reduced non-disclosure
Fewer “incomplete” applications
Fewer “Not Taken Up” cases
Improved reputation due to high quality customer service
Audit trail for application process
Page 9
Additional costs of paying nurses salaries whilst still providing same

remuneration for sales advisors
and the initial costs of setting the system up
Mortality/morbidity experience likely to improve
(c) Customers
Skilled interview by trained staff

Interview in privacy
Avoids discomfort of discussing medical history with adviser
Better service
Better customer experience due to faster policy issue
As the interview is by phone, it will be easier for customers to choose a
convenient time
Should lead to fairer premiums being charged and fewer claims
rejected
5 (i) Limitation of exposure to risk
Accumulation of risk could materially (negatively) affect business results
Avoidance of single large losses
Depends on size of free assets

To ensure the claims payment can be made without detrimental effect to
business results
Smoothing of results
Particularly useful when the portfolio is relatively immature

Most likely to be needed for income protection due to higher level of claim
volatility
Potentially also for critical illness
Availability of expertise
Particularly useful when entering new risk areas

Where the insurer has little previous experience
The reinsurer can help with product design/pricing, underwriting and claims
management
Once the insurer’s expertise and confidence has grown, it may choose to
reduce reinsurance
Most likely to be needed for income protection
Increasing capacity to accept new business volumes
thereby potentially increasing diversification

Increasing capacity to write large cases
Page 10
Financial assistance
Alleviate new business strain

Bolster free assets
Tax arbitrage
Solvency arbitrage
(ii) First estimate the statistical distribution of the risk experience costs of the
portfolio based on various assumed retention limits
For various degrees of departure from the average risk costs, needs to judge
what probability should be aimed at
Can set retention level to keep the probability of insolvency below a specified
level
A stochastic model can be used for expected claims rates
Project forward expected claims together with the company’s assets and
liabilities
Using simulation a retention level can be determined such that the company
stays solvent for 995, say, out of 1,000 runs
Another possible is to consider the total of
(a) The cost of financing a risk experience fluctuation reserve, and
(b) The cost of reinsurance
As the retention limit increases, (a) will increase and (b) will decrease
A retention can be adopted which minimises the total (a) + (b)
To calculate (a) you would use a simulation approach as above.
(iii) (a) Retention
ACI + CI as based on the life with the highest aggregated sum assured
(75,000 + 50,000) * 25% = 31,250
ACI claim is 75,000
So reinsurance claim = 75,000 – 31,250 = 43,750
(b) Retention IP
7,000 * 30% = 2,100 p.a.

So reinsurance claim is 7,000 – 2,100 = 4,900 p.a.
Date of sickness = 17/11/2007
With a deferred period of 26 weeks, payment would have started in the
week commencing 19/05/2008
Date of death = 12/10/2008
From 19/05/2008 to 12/10/2008, there are approximately 21weeks
Reinsurance claim for sickness = 4,900 * 21/52 = 1,979
Page 11
Retention ACI
80,000 * 25% = 20,000

Reinsurance claim for death is 80,000 – 20,000 = 60,000
So total reinsurance claim = 61,979
(c) Retention
500,000 * 25% = 125,000 which exceed the 100,000 maximum

So retention is 100,000
ACI claim is 500,000
So reinsurance claim is 500,000 – 100,000 = 400,000
6 (i) Information to be provided
Details of any approximations that had to be made when implementing the

method
Feedback regarding the difficulties faced in implementing the method
Details of the basis used, including:
• claim inception rates
• claim termination rates
• mortality rates in claim
• mortality rates not in claim
• valuation interest rates
• inflation assumption
• expense assumption
• lapse rates
• treatment of options
Comments on how these assumptions were determined including margins of
prudence
Assets backing the reserves
Details of the products the reserve relates to
The amount of the reserves on the current method and on the new method
(ii) Complications
Insurers may want to influence the outcome in order to reduce the level of the
reserves
except possibly insurers who are very well capitalised who may wish for high
reserves if they think it puts them at a competitive advantage
They may therefore wish to make their reserves look excessively large in the
submission so that the rules are amended
Different insurers may have very different approaches to setting the basis
which will make comparisons very difficult especially as there is no
prescribed degree of prudence – it may be difficult to tell the companies which
have prudent reserves from the companies with more realistic reserves
Different insurers may have very different experience
e.g. because of different underwriting approaches or target markets
Page 12
May not have systems available to do this straightaway

If not compulsory, may not get many responses
The format the data arrives in may vary
There may be gaps or errors in the data or misunderstandings or
misinterpretations of what the Regulator was wanting
(iii) Possible conflict of interest and solutions
Regulators will generally prefer higher reserves to give a high degree of

confidence that the liabilities can be met
Policyholders will generally feel the same
This may conflict with shareholders, who will generally prefer lower reserves
so that profit can be released more quickly
Other advantages of lower reserves:

May create more investment freedom, and ability to seek higher yielding
investments
Frees up capital to write more new business, with a view to adding more
shareholder value
There may be tax implications – there could be tax advantages to holding a

higher reserve and deferring the emergence of profit
Possible methods to protect the integrity of the reserves

Requiring the basis used to be disclosed
Regulations could specify how the basis is to be set, even if the basis itself is
not prescribed
Guidance could be issued by the regulator or the local actuarial body
Internal audit could be required, and possibly external audit
Very detailed regulations could be laid down around the method of calculation
of the reserves
Segregation of duties
The introduction of a supervisory or regulated role (e.g. “Reserving Actuary”)
that has a responsibility to the regulator
Introduce minimum level of reserves
Requirement to hold mismatching reserves
(iv) Asset share basis for reserving
Principle of statutory reserves is to meet all the liabilities arising in the future
To an extent the asset share is irrelevant, as it relates to the past
Asset share could be valid if the premium is set correctly
especially if the basis is “prudent”
However, critical illness policies last many years
and the premium may have been correct at the time, but may have since
proved to be inadequate
This would make an asset share reserve insufficient to cover the liabilities, and
hence inappropriate for a statutory reserve
Would be possible to have an asset share based reserve plus a reserve for
inadequate premia – similar to a URR.
Page 13
Could have potential use where a policy is reviewable, especially if the

reviews are carried out actively/frequently
More useful would be a retrospective reserve calculated using a premium set
using current assumptions.
Do the companies even have sufficient historic data to be able to do retro
approach?
The requirement “to be prudent” is very vague and might need more clarity,
especially considering the concerns about conflict of interest
What does prudent mean in the context of an asset share?
Asset share maybe negative at early durations – is the regulator comfortable
with allowing negative reserves?
Approach might be beneficial for that insurer but not for the industry as a
whole
Page 14
EXAMINATION
9 October 2009 (pm)

booklet.
2. You have 15 minutes before the start of the examination in which to read the
questions. You are strongly encouraged to use this time for reading only, but notes
may be made. You then have three hours to complete the paper.
supervisor.
5. Attempt all seven questions, beginning your answer to each question on a separate
sheet.
question paper.
1 A health and care insurer sells a range of products, including critical illness. The
marketing manager has proposed adding to the critical illness contracts an option to
increase the sum assured without further evidence of good health.
One of the approaches that the company could take to reduce the risks involved in
such an option is to limit the exercise of this option to the occurrence of special
events.
(i) List eight such special events that could be included in the contract terms. [2]
(ii) Outline other steps that the company could take for the purpose of reducing
the risks involved in offering the increase option. [4]
[Total 6]
2 In Actuaria medical treatment is free. However all Actuaria’s residents currently pay
for all drugs prescribed by the Actuaria medical profession. There is a preset refund
from the medical scheme for each drug. The refund is based on an average
countrywide price and is a fixed amount, which varies by drug.
A very recent development in Actuaria has been that people are now able to buy some
of the prescribed drugs on the internet at a cheaper price and still claim the refund
under the medical scheme. It is possible to use the internet for drug purchase as
Actuaria’s local currency is freely convertible. The internet drug suppliers do not
require sight of the prescription.
(i) Discuss the advantages and disadvantages of this new internet development,
from the perspective of individuals requiring drugs. [5]
The duties of the social insurance regulator of Actuaria include setting the refund
amounts and forecasting the total cost of Actuaria’s State medical scheme. The
developing internet drug market has just been brought to the regulator’s attention, and
he is concerned about the implications for the State medical scheme and for public
health.
(ii) Discuss how the regulator could manage the situation. [4]
A leading supermarket group has now started to import a selection of the more
common prescription drugs for sale to the public.
(iii) Discuss the advantages and disadvantages of being able to buy the drugs direct
over the counter at a supermarket, from the perspective of individuals
requiring drugs. [2]
[Total 11]
ST1 S2009—2
3 (i) State six reasons for calculating the technical reserves of a health and care
insurer. [3]
For a particular block of business, the reserving team is considering whether to use
the same assumptions for calculating its reserves as the pricing team used to price the
business.
(ii) Describe the factors that would influence whether or not this is appropriate.
[4]
One of the products written by the insurer is group private medical insurance
business, written on a short term indemnity basis. The reserving team is also
responsible for setting any additional reserves (i.e. in excess of the normal amount of
reserves that would be held for each scheme member) used to cost the group renewal.
(iii) Explain what additional reserves should be held for the three scheme members
whose details are set out below.
(a) Mr A is a clerical worker who in the past scheme year has had an
operation for appendicitis and has now fully recovered.
(b) Mrs B contracted breast cancer some years ago. In the last scheme
year, specialised drugs for cancer treatment have been prescribed for
Mrs B. The drugs cost £10,000 in the last scheme year. The
government subsidised health service would not fund the treatment,
and the cost was fully paid under the group scheme. The current
expectation of life forecast by the oncologist for Mrs B is described as
reasonable, and the drug treatment remains ongoing.
(c) The insurer has agreed that a hip replacement will be performed in a
private hospital on Miss C. She is not yet immobile but the operation
has been fixed for just after the renewal date.
[6]
[Total 13]
4 (i) Discuss the relative merits of using a formula approach and a cash flow
approach for pricing health and care products. [6]
(ii) List typical cashflow components in a profit testing model for unit-linked
health and care products. [5]
[Total 11]

5 XYZ plc currently insures its group private medical insurance policy with company
Q, a health insurance company. Company Q has been asked to provide a quotation on
the renewal of this policy for the 2009 policy year.
The following data relating to the XYZ plc policy has been provided:
Year Data months Claims
2006 12 £20,000
2007 12 £25,000
2008 9 £28,000
Employee data and Inflation
Year Members Spouses Children Inflation
2006 70 30 20
2007 60 30 25 6%
2008 70 50 30 10%
2009 60 35 25 12%
Benefits insured
Up to the end of the 2008 policy year, members, spouses and children had full cover.
With effect from the 2009 renewal, spouses and children will be on budget cover.
Company Q’s Quotation Basis
1 Spouses experience 120% of member cost per head

2. Children experience 25% of member cost per head
3 Budget cost is 50% lower than full cover
4 2009 Expenses: £50 per member
5% administration on the risk cost
5% commission on the premium
All expenses are incurred at the start of the policy. The inflation rate given for year X
represents inflation from the middle of year X−1 to the middle of year X. Taxation
can be ignored.
(i) Calculate the premium ignoring any profit, contingency or cost of capital
loadings. You should show your workings and state any additional
assumptions that you make. [15]
Company R is a competitor in this market, and has quoted XYZ plc a premium of
£30,000.
(ii) Discuss the factors that Company Q should take into account when producing
its final quotation for XYZ plc. [3]
[Total 18]
ST1 S2009—4
6 The pricing team in a health and care insurance company is reviewing its approach to
allowing for the non-financial risks of the products that it is writing. Financial risks
are defined as movements in the stock market and in interest rates, and other macro-
economic risks involved in the business. Non-financial risks are all the other risks
undertaken.
It intends to implement a change to the approach for its next pricing exercise, which
will be for its accelerated critical illness product line.
(i) Describe eight non-financial risks to be taken into account for the accelerated
critical illness product. [4]
Three options are being considered for the allowance for non-financial risks:
Option A: the risk discount rate used will be increased to allow for the level of non-
financial risk in the product, with the same adjustment to the discount rate being used
for each product.
Option B: the risk discount rate used will be increased to allow for the level of non-
financial risk in the product, with a different adjustment being used for each product.
Option C: a margin will be included in each assumption to allow for the risk of
adverse deviation.
(ii) Discuss the relative merits of each proposal. [11]

[Total 15]

7 A proprietary health and care insurer has written a pre-funded long term care product
for several years. The product has a conventional design (i.e. it is not unit-linked). The
benefit payable on claim is an income throughout the policyholder’s lifetime, subject
to ongoing disability. There are two benefit options available: a fixed monetary
income and an indemnity option. The benefit required is chosen at outset, as it affects
the premium payable.
The regulator is concerned about the security of these plans as they have a potential
term of several decades. There are therefore strict regulations constraining the
mismatching of the assets backing the reserves on these contracts.
(i) Explain how restrictions on mismatching may be implemented by a regulator.

[2]
(ii) Describe how the company might invest its assets in order to match its pre-
funded long term care liabilities as closely as possible. [10]
Following extensive lobbying by insurers, the regulator is planning to remove the

restrictions on mismatching for pre-funded long term care business.
(iii) State the controls that the regulator may introduce in relation to investment,
other than restrictions on mismatching. [3]
(iv) Describe how you would determine the optimal investment strategy for the
assets backing this book of business following this change. [11]
[Total 26]
END OF PAPER
ST1 S2009—6
Subject ST1 — Health and Care.
Specialist Technical.
September 2009 Examinations
EXAMINERS’ REPORT
Introduction
R D Muckart
December 2009
Comments for individual questions are given with the solutions that follow.
©Faculty of Actuaries
©Institute of Actuaries
19/02/2010
Subject ST1 (Health and Care Specialist Technical) — September 2009 — Marking Schedule
General comments
and receive a pass in the subject. Candidates will lose marks if they do not address the
question asked. There was often a lack of sufficient detail in the answers. The mark
allocation for each question part gives an indication of the relative length of answer or
number of points to be made to gain full marks. In general each valid point in the answer
would normally attract 0.5 marks with the more basic elements e.g. details in a pricing basis
such as age and sex, attracting 0.25 marks.
Some papers were not clearly marked at the top of each page as to which part of the question
was being answered.
Marks may be lost where answers are difficult to read.
Question 1
This is a fairly typical question for this subject and so students who had invested time in
practising past papers were able to score highly.
Question 2
Many candidates made a good effort at this question by applying common sense to the
subject matter contained in the course.
Question 3
Candidates with a good grasp of the core reading were able to apply it here and demonstrate
their knowledge to the examiners.
In part (iii), candidates who gave more specific answers scored relatively highly.
Question 4
(ii) Candidates often failed to list sufficient items to gain all the marks available. In order to
score fully, candidates needed to address the unit and non-unit funds separately.
Question 5
(i) In general, candidates made a good attempt at this part, although they did not always set
out the assumptions they were making. The commission payment was often incorrectly
determined.
(ii) Candidates generally failed to give many considerations in answering this part.
Candidates should remember to attempt all parts of the question - even if they are not
satisfied with their answer to earlier parts.
Question 6
(ii) The better scoring answers considered a wide range of advantages and disadvantages.
Candidates should bear in mind that different approaches can be calibrated to the same level
of prudence, and so comments relating to the relative prudence of the different methods
would not score here.
Question 7
(ii) The candidates who scored most highly would have considered pre and post claim
periods separately.
(iii) Many candidates commented on rules relating to mismatching - as stated in the

question, this would not score any marks
(iv) In general, candidates did not put down sufficient points to score highly on this part.
1 (i) Possible special events include:
Marriage
Divorce
Entering into a civil partnership
Ending a civil partnership
Death of a spouse or other family member
Becoming a parent /birth of a child
Legal adoption of a child
Salary increase as a result of promotion or change of job
Business expansion for people running own business
Buying a new residential property
Mortgage/loan increase
1 (ii) Impose maximum allowed increase either expressed as fixed monetary amount
or as a percentage of the original sum assured
Underwrite the original contract on the basis that option taken up for
maximum amount
Limit times when option can be exercised. e.g. on specific date/dates,
maximum age
Maximise take-up rate to get better risk by making sure that the option is well
publicised
Make sure that premium rates are attractive to those in good health otherwise
they may go elsewhere if they require additional cover
Impose time limit after the special events
Only offer the option to lives that are in good health at outset (ie non-rated
cases
Reinsurance
2 (i) Advantages:
May be easier to order drugs via the internet than to have to collect them in
person from a pharmacy (or similar)
Cheaper prices
May bypass import taxes and controls
The State refund will still be received, so the individual will take all of the
“profit” from the cheaper price (unless the regulator decides to intervene so
that it shares in the savings, thereby reducing or removing any cost benefit)
Increased competition in the drug market may push down prices to the
population’s advantage including for those unable to access the internet
Could provide access to a wide range of drugs even without having visited a
doctor
Disadvantages:
May buy inappropriate drugs
Need to know the precise drug that needs to be purchased and the correct time
of the day to take and prescription amount
No control on the drug being genuine and of good quality
The poorer/older section of the population may not be able to access the
internet and therefore are not able to benefit from the lower prices etc
(although also are not vulnerable to the disadvantages)
Strong price competition could have an adverse effect on the current drug
distributors; this could result in constriction of the non-internet market and
thus a reduction in available choice
Longer delivery times
Drugs may get lost in the post and it is hard to engage with the supplier if
there are any problems or non-delivery
2 (ii) Prescription requirement

In order to manage the total scheme costs, the regulator could require a
prescription to be obtained before any refund is paid.
This could introduce extra administration and cost for the State, depending on
how the current system is controlled.
Internet providers could instead be required to obtain sight of a prescription
before drugs can be provided but this is unlikely to be successful in practice.
Amount of refund
The regulator could give a reduced refund if the drug is purchased on the
internet, reflecting the lower price and require sight of a receipt
General
If quality control is likely to be a significant issue then the regulator could take
a more extreme action, such as not giving any refunds for drugs purchased on
the internet or the regulator could attempt to block these websites or ask the
government to declare ordering or importation of drugs over the internet
illegal.
Alternatively, the regulator could approve or licence sites.
These options could be practically and/or politically difficult to achieve.
The regulator could ask the government to increase tariffs/taxes on imported
drugs, to reduce their relative attraction.
Alternatively the refund system could be redesigned so that the refund is given
directly to the customer by the pharmacist used to obtain the drugs, and the
pharmacist then claims this back from the State on production of the
prescription.
2 (iii) The advantages and disadvantages will be mainly the same as for the internet
However:
More of the population will be able to participate in potential savings.
Drug costs may be cheaper via this route than from a pharmacy because of
bulk buying, the purchasing power of the supermarkets or the use as loss
leaders as likely to be a small proportion of actual business.
However, the drugs may be more expensive than on the internet.
If the supermarket drug price is a deep discount on the existing price, then the
regulator may wish to drop the subsidy altogether.
Provides easy access and quicker delivery than via the internet.
Doesn't provide a full range but if successful, the range may be increased.
There is possible access to a pharmacist within the supermarket which
alleviates quality concerns.
Page 5
There is also greater accountability of the supermarket group if the drugs are
not of the required quality.
3 (i) Reasons for calculating reserves

To determine the liabilities to be shown in the insurer’s published accounts
If separate accounts have to be prepared for the purpose of supervision of
solvency, to determine the liabilities to be shown in those accounts
To determine the liabilities to be shown in internal management accounts of
the insurer
To estimate the cost of claims incurred in recent periods and hence provide a
base for estimating the future premiums required to attain a given level of
profitability
To value the insurer for purchase or sale
To set investment strategy
Because the reinsurer may require them
3 (ii) Are pricing assumptions appropriate?

The level of prudence of the pricing basis; in some countries, a prudent basis
is used, in others, a realistic basis is used, and the risks allowed for via the risk
discount rate
The purpose of the reserves: if the reserves are to be used for internal
management; a realistic basis may be required, for supervisory reserves, a
prudent basis is required
How up to date is the pricing basis? If the product was priced a long time ago,
the assumptions may have changed considerably
May not still be selling all products so pricing assumptions may not be
available for all products for which reserves have to be set
Which assumption is being considered: this may be a valid approach for
demographic assumptions but a risk discount rate is not appropriate for the
calculation of a reserve
Not all the pricing assumptions will be required for reserving, for example,
initial expenses are required as an assumption; these are not required for
reserving on a prospective basis
There may be specific regulatory requirements about how to set both types of
basis
Competitive pressures on the pricing basis would not be appropriate to reflect
in the reserving basis
The materiality of the assumption is relevant
3 (iii)(a) Appendicitis is a one-off event and with no complications reported the reserve
is nil. However if the claim for the previous year has not yet been fully paid,
then an outstanding claims reserve would be required.
(b) The insurer must not be seen to stop payment in order not to incur a
reputational risk. The £10,000 should be pro-rated up to represent a full year’s
worth of drugs (if they were not purchased from right at the start of the last
scheme year). The present value of the annual amount, including a drug
Page 6
inflation cost, any associated non-drug costs and any margin, should be held as
the reserve.
(c) Miss C’s operation is standard and reasonable. The reserve should be set
either at the total package price (if a package price has been quoted by the
hospital), or at a level similar to other cases paid recently.
4 (i) The formula approach:

is simple to apply
does not require sophisticated modelling packages
is easier to check and audit
is quicker to run.
However, it:
does not allow for the proper timing of events
does not allow for the accumulation of reserves
does not allow for the impact of net negative cash flows in any period
does not allow for separate inspection of premium related flows
does not allow for the variation in returns/assumptions that vary over time
does not properly allow for capital needs
Cash flow techniques

Cash flow techniques were developed to overcome the problems outlined
above
The formula approach may be more suitable for short term business (eg PMI)
but the cashflow approach is more suitable for long term business
Practical difficulties in implementing the cashflow approach can be overcome
in many territories through the use of commercial software packages
Sensitivity tests can be performed simply by varying the assumptions
Iterations can be incorporated to produce the premium that meets the
shareholders’ profit criterion
It allows for shareholder return on capital (RDR) - the formula approach does
not
Results can be readily combined into a new business model or full model
projection for other purposes
Multi-state models are impossible with the formula approach
The cashflow approach would be necessary if stochastic methods are required
eg valuation of complex options or guarantees
4 (ii) Separate projections for unit fund and sterling fund
Non-unit Fund
Premiums
Unit allocations
Initial commission
Renewal commission
Policy fee
Initial expenses
Page 7
Renewal expenses
Claim expenses
Mortality/morbidity deductions
Mortality/morbidity claims cost
Tax charges
Change in non-unit reserve
Investment income on non-unit reserve
Change in solvency capital
Investment income on solvency capital
Fund management charge
Unit Fund
Unit allocations
Mortality/morbidity deductions
Unit growth
Unit expenses directly charged to unit fund
Fund charges
Unit funds paid on claim or surrender
Reinsurance premiums and recoveries would also be allowed for where
appropriate
5 (i) Assume claims occur evenly through the year

Assume claims are all closed in the period shown (i.e. no IBNR)
Full claims (i.e. gross up 2008 to 12 months = £28,000*12/9 = £37,333)
Adjust risk units for 1.2 and 0.25 ratios correctly (i.e. multiply number of
spouses by 1.2 and number of children by 0.25)
Adjust risk units for budget version in 2009 correctly (i.e. multiply number of
risk units for spouses and children derived for 2009 by 0.5 = 35 x 1.2 x 0.5 =
21.0 for spouses and 25 x 0.25 x 0.5 = 3.125)
Add up total risk units for each year 2006-2009
Cost per unit before inflation for years 2006-2008
Cost per unit including inflation to mid 2009
Average cost per unit including inflation (= 235.3+301.22+304.1)/3=280.206)
Assumption how the averaging should be done (NB here have taken simple
average over years, ignoring volumes of claims in each year)
Assumption whether to allow for other trends (NB the inflated cost seems to
have an increasing trend over time but here we have ignored that)
Assumptions about interest and discounting
Total expected risk cost (= 280.206*84.125 = 23572.33)
Expenses: per member ( = 60 * 50 = 3000)
Expenses: % risk cost (=0.5*23572.33 = 1178.62)
Commission = (23752.33 + 3000 + 1178.62)/0.95 - (23752.33 + 3000 +
1178.62) = 1460.58 (NB needs to be 5% of gross premium not 5% of
premium less commission)
Total premium ( = 23752.33 + 3000 + 1178.62 + 1460.58) = 29211.53
Page 8
5 (ii) If Co Q matches the Co R quote, is there sufficient margin for profit,

contingency and cost of capital and sufficient contribution to expense
overheads?
The importance and strength of relationship with XYZ plc
Does XYZ plc have other policies with Co Q?
Quality of the business and therefore whether want to keep it
Can Co Q offer other attractive services to retain XYZ plc, i.e. compete on
other than price?
Quotes may not be directly comparable because benefits may not be the same
(eg different excesses/exclusions)
Might Co R reduce its quote further and start a price war
6 (i) Non-financial risks for critical illness

Morbidity risk – risk that more people incur a critical illness within the term of
the policy than expected (including effects of early
diagnosis/screening/pandemics)
Mortality risk – risk that more people die within the term of the policy than
expected
Lapse risk – risk that more people than expected lapse their policy in the early
years when the accumulated value of the cashflows (i.e. the asset share) is
negative or very small
Expense risk – risk that expenses are higher than expected (other than due to
general inflation)
Operational risk – risk that mistakes are made by staff which cause the
products to lose money or be badly managed
Third party default risk – eg the risk that a reinsurer fails to make good on the
reinsurance recoveries due
Regulation/legislation risk – risk that regulations or legislation changes, or
have been misinterpreted, eg so that we have to pay out on more illnesses than
we expect
Tax risk – risk that the tax position changes and so the policies make less
money than expected
Fraud risk – including the risk of policyholder non-disclosure and the risk of
fraudulent claims.
Option take up risk – mis-estimating the proportion taking up any option
offered, linked to anti-selection
New business volume risk - could go either way
New business mix risk - if cross subsidy in pricing
Reputational risk - eg from declining claims
6 (ii) Relative merits of each

A:
+ simple to apply and quick to implement
+ easy to understand and explain
- does not differentiate between high risk and low risk products; would
therefore cross subsidise and underprice high risks and overprice low risks
which would result in selling relatively more of the (underpriced) higher risk
Page 9
and less of the (overpriced) lower risk products if other companies price with
more sophistication
- the allowance for risk will be heavily skewed by the timing of the cashflows
eg shorter term policies will be much less affected than long term policies
- is only relevant for profit criteria using a risk discount rate
- how do you calculate the correct adjustment to use
B:
+ is more accurate than A in that it can allow for the different levels of risk in
each product
+ therefore more useful for making strategic business decisions
+ should be easy to implement
+ can allow for all risks, not just those with a relevant assumption to model
- is less accurate than C in that the same level of risk is allowed for in every
model point
- need to determine the correct allowance to make for each product
- difficult to explain – will need to be able to justify the different rates used for
the different products in a way that non-actuaries will be able to understand
and accept.
C:
+ easy to understand and explain
+ accurate – can allow for the risk in each assumption
+ accurate – will incorporate the allowance for risk into each model point
+ can be allowed for in either a cashflow model or a formula approach
+ is useful for a wider range of profit criteria, i.e. can also be used in
comparison of IRR and payback period
+ can vary the margins easily by product
- cannot allow for risks not included in the pricing model – e.g. some
operational risk, customer service risk
- time consuming if intending to complete a full statistical analysis to assess
the correct margin to include in every assumption
- might be difficult when setting margins to allow appropriately for
correlations in order to avoid 'double counting'
- may give the impression of more accuracy than is merited
In each case need to consider any regulatory requirements on pricing bases

that would favour or prohibit any of these options
7 (i) How to implement mismatching regulations

Have rules on the extent to which mismatching is allowed at all
May require assets to be held in a matching currency even if no further
mismatching rules are in place
Requirement to hold a mismatching reserve
Returns will be required to the regulator to evidence that the rules are being
complied
Restrict valuation assumptions to encourage matching
Page 10
7 (ii) Assets for matching

Need to match by nature, term, currency
Pre-claim:
For the benefits guaranteed in money terms, fixed interest bonds would be the
best match. For closest matching these should have no default risk, e.g.
government bonds
The cashflows arising from the bonds should be matched by term to the
expected liability cashflow profile but there may not be any bonds of a
sufficiently long term in which case an alternative would be to seek an
immunised approach
For the indemnity based business, the benefits will be both a long time in the
future and highly uncertain in amount – so perfect matching will not be
possible
One approach might be to invest in assets offering a “real” return, such as
equities; however this would be a high risk strategy
For both forms, if the benefit is payable in the domestic currency, the assets
should also be denominated in the domestic currency
Expenses:
Inflation linked assets to match expenses. These could be government index-
linked bonds, but as these particular expenses are likely to be closely linked to
salary inflation, and may be many years in the future; equities may be a better
match.
Premia:
Also need to take account of expected future premium income, e.g. when
calculating the discounted mean term.
Post claim:
The benefits will be of much shorter duration
Liquidity will be much more of an issue
Best match will be made up of some government bonds, and some cash type
investments
For indemnity benefits, may still want some inflation linked assets, however
equities are unlikely to be appropriate given the short duration of long term
care claims so index-linked bonds may be used instead and we also still have
some expenses to match with inflation linked assets
The company should try to diversify its assets provided it can still be matched
7 (iii) Other investment controls:

Restrictions on the types of assets that can be invested in
Restrictions on the amount of any particular type of asset that can be taken
into account for the purpose of demonstrating solvency
Restriction on self-investment
Limit on the amount that can be invested in any class
Restrictions on the maximum exposure to a single counterparty
Custodianship of assets
Page 11
A requirement to hold a certain proportion of total assets in a particular class –

for example government stock
Secondary methods include affecting the choice of assets through their
relationship with the basis used to value the liabilities
7 (iv) Develop an investment strategy

Will need to use a stochastic model projecting liabilities, and assets backing
them, including a proportion of the free assets
Need to determine an appropriate timeframe over which to project
Deterministic assumptions will be best estimate – realistic and sensitivity or
scenario testing could also be carried out
Build asset model, which should allow for
investment income and growth on a range of asset classes
timing and amount of investment income
reinvestment
growth in level of investment income
capital growth
investment expenses
The investment income and capital growth can be modelled stochastically.
This could also be used to produce a stochastic model for the inflation rates to
be used throughout
Use the current asset portfolio as a starting point for the model
Build liability model, which should allow for:
benefit payments – amount and timing of claim
benefit escalation
probability of death prior to claim
expense outgo
premium income
Use model points to represent the current in-force book and use the current
statutory basis to ensure solvency is correctly modelled at outset.
Future projected liabilities should be calculated using the valuation basis
appropriate to the economic conditions within that scenario ie the asset and
liability models should be dynamically linked.
Then identify the item of interest, this will be the excess of assets over
liabilities which needs to be sufficient to cover the amount of solvency capital
required by some comfortable margin. What makes the margin comfortable
will depend on items such as regulatory requirements, nature of business, and
amount of parental support.
The stochastic model will produce a statistical distribution of solvency for
each modelled investment strategy and hence a probability of potential future
insolvency. This will allow us to identify acceptable strategies, ie ones that
have a probability of future insolvency below the company’s chosen target (eg
99.5%).
We also need a secondary item of interest to identify the optimal strategy out
of the acceptable range. This means we also need to project a measure of
shareholder value, for example shareholder income combined with change in
embedded value.
The model will have to be re-run on a number of different investment
strategies until the optimal position is found.
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Examination: Subject ST1 Health and Care Specialist Technical

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Examination: Subject ST1 Health and Care Specialist Technical

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Faculty of Actuaries Institute of Actuaries

15 April 2005 (am)

Subject ST1 Health and Care

Time allowed: Three hours

INSTRUCTIONS TO THE CANDIDATE

4. Mark allocations are shown in brackets.

6. Candidates should show calculations where this is appropriate.

AT THE END OF THE EXAMINATION

2 The following events might lead to personal financial loss or hardship:

B The occurrence of sickness or disability after retirement age.

3 A leading life insurer is considering broadening its individual product range. It is

4 An insurance company is considering the introduction of an immediate needs annuity

You are given the following extract from a mortality/morbidity table:

Age Exact (1) (2) (3) (4) (5)

39 2.3 0.1 1.1 0.55 0.1

(1) Incidence rate for critical illness per 1,000.

All the decrements are assumed to operate uniformly over a year.

You are given the following claims information:

Claim amount Date of critical Date of death Date of claim Date of

1 £35,000 3 Mar 2005 6 July 2005 23 Aug 2005

ST1 A2005 3 PLEASE TURN OVER

(ii) Describe the sources of medical information typically used in underwriting

(iii) Describe how a moratorium clause may be used to manage risk as an

Subject ST1 Health and Care

1 Benefits typically available on a PMI plan include:

Benefits may be offered on an indemnity basis or there may be limits to payments or

2 (i) Event A may lead to the following:

Event B may lead to the following:

(ii) A suitable product to cover event A would be medical expenses insurance

This would be a traditional non-profit (short term) contract with an element of

This could have an inflation-proofing element and be either a traditional non-profit or

If the individual is already in failing health, a special enhanced annuity may be

Other major risks include:

Other major risks include:

Private Medical Insurance

Long Term Care

Other major risks include:

This question was generally well answered.

(ii) Assumptions for the pricing basis include:

It is necessary to construct the likely experience of the policy. Reinsurance data

Own data are not available; so compare with existing products.

Add prudential margin: depends on extent of reinvestment income (as a proportion of

Solvency margin and reserving basis

For accelerated critical illness, claim rate = ix + (1 kx) qx

Age 39: Dependent rate = 2.3 + (1 - .55) * 1.1 = 2.795

Age 40: Dependent rate = 2.4 + (1 - .56) * 1.2 = 2.928

Expected claim cost = (2.655+2.782)/2 * £63,000 = £171,265.50

Hence claims amount = £35,000 + £42,000 + £71,000 = £148,000

Actual/expected = 148,000/171265.5 = 86.4%

Age 39: Dependent rate = 2.3 * .9

Age 40: Dependent rate = 2.4 *.9

Age 40 next rate = 2.35 * .9 * .95 = 2.009

Expected claim cost = £63,000 * 2.009 = £126,583

Actual claims to include = £35,000

Need to consider cost of any options and guarantees.

The level of statistical risk could be assessed:

Differences in level of expertise

Need to consider trends in experience especially for morbidity

Rates included in reassurance terms would probably be followed. AIDS projections

Almost certainly likely to use the experience to generate an adjustment to a standard

The company should have an analysis of expenses over recent years.

A series of analysis helps to identify trends to use in assessing future rates

National data on inflation of prices and earnings