Institute and Faculty of Actuaries (IFoA) Exams Life Insurance Specialism (SP2 and SA2) Syllabus

What is financial reinsurance (fin re) primarily used for?

Financial reinsurance is structured mainly to provide financing/capital relief rather than to transfer significant insurance risk. It can reduce new business strain or improve the regulatory balance sheet, though Solvency II limits credit unless meaningful risk is transferred.

Define the sum at risk (death strain at risk) for an assurance policy in year of death.

The sum at risk is the excess of the death benefit over the reserve held: $$\text{SAR} = S - {}_{t}V.$$ It represents the additional amount the office must find from elsewhere if the policyholder dies, beyond the reserve already set aside.

State the retrospective and prospective definitions of a policy reserve and when they are equal.

Prospective reserve = EPV(future benefits + expenses) − EPV(future premiums). Retrospective reserve = accumulated past premiums less benefits/expenses with interest. They are equal when the same basis (mortality, interest, expenses) and the same premium are used throughout.

What is a net premium reserve (net premium valuation)?

A net premium reserve values benefits and a notional net premium (ignoring expenses) on prescribed prudent assumptions. The net premium is recalculated on the valuation basis, implicitly allowing for future expenses via prudence rather than explicit expense cashflows.

What is a gross premium (bonus) reserve and its advantage over a net premium reserve?

A gross premium reserve explicitly values the actual office premium, real expenses and (for with-profits) future bonuses. Its advantage is transparency: each cashflow is allowed for explicitly, making the reserve responsive to actual premium adequacy and expense levels.

What is meant by a 'prudent' or supervisory reserving basis, and how does it differ from a best-estimate basis?

A prudent basis incorporates margins for adverse deviation (e.g. lighter mortality for assurances, heavier for annuities, lower interest) so reserves are deliberately conservative. A best-estimate basis uses unbiased central assumptions with no deliberate margins, as used for realistic/embedded value work.

Why is a zillmerised reserve used, and what does zillmerisation do?

Zillmerisation modifies the net premium reserve to allow (partially) for the recovery of initial expenses, reducing the reserve in early durations. It effectively offsets new business strain by recognising a notional asset for future loadings, subject to a regulatory limit on the Zillmer adjustment.

Define embedded value (EV).

Embedded value is the value to shareholders of the existing (in-force) business plus the shareholders' net assets, excluding any value from future new business. It is the sum of the shareholders' net worth and the value of in-force business (VIF).

Write embedded value as a sum of its main components.

$$EV = \text{Free surplus} + \text{Required capital} + \text{VIF}$$ where the first two together form the shareholders' net worth, and VIF is the present value of future shareholder profits from in-force business, net of the cost of holding required capital.

What is the value of in-force business (VIF) and what is netted off it under traditional/European EV?

VIF is the present value of future after-tax shareholder profits expected to emerge from in-force business. Under EEV/MCEV it is reduced by the time value of financial options and guarantees, the cost of residual non-hedgeable risks, and the frictional cost of holding required capital.

Distinguish traditional embedded value (TEV) from European Embedded Value (EEV).

TEV uses a single deterministic risk discount rate and typically intrinsic-only allowance for options/guarantees. EEV (CFO Forum principles) requires explicit allowance for the time value of financial options and guarantees (usually stochastic), an explicit cost of capital, and clearer disclosure of assumptions.

What additional principle defines Market Consistent Embedded Value (MCEV) versus EEV?

MCEV values cashflows consistently with market prices: assets and liabilities are valued using market-consistent (risk-neutral) techniques, options and guarantees are valued stochastically calibrated to market data, and a reference/risk-free rate (with allowance for liquidity) replaces an arbitrary subjective RDR.

Define the cost of capital (cost of required capital) component in embedded value.

It is the reduction in value to shareholders from being required to lock capital in the business rather than distribute it: the difference between the face value of required capital and the present value of the future releases of that capital plus investment earnings on it (net of tax).

What is the analysis of surplus (sources of surplus), and why is it performed?

The analysis of surplus attributes the change in surplus over a period to its sources (mortality, interest/investment, expenses, withdrawals, new business, bonus, etc.). It validates the valuation, monitors experience versus assumptions, and informs management and assumption-setting.

Give the general principle for computing the surplus arising from a single source (e.g. mortality) in an analysis of surplus.

Compare expected with actual experience holding other items at their expected basis: surplus from a source = (expected − actual) cost on the valuation basis, or equivalently the change in reserves released versus the valuation assumption for that decrement. Each source is isolated by varying one assumption at a time in a stepwise (order-dependent) decomposition.

Why does the analysis of surplus depend on the order in which factors are analysed?

Because the effects of the sources interact (are not additive in general): the surplus attributed to a later factor is measured after earlier factors have already been updated, so changing the order changes the split. A consistent, disclosed order is therefore needed and cross-terms are absorbed into the chosen sequence.

What is the difference between analysis of surplus and analysis of (embedded value) profit / movement of EV?

Analysis of surplus explains the change in supervisory/statutory surplus by source. Analysis of EV movement reconciles opening to closing embedded value, splitting it into expected return (unwind of discount rate), value of new business, experience variances, assumption changes, and economic variances.

Define the value of new business (VNB) and why it is a key KPI.

VNB is the embedded-value contribution of business written during the period, measured at point of sale (present value of future shareholder profits net of cost of capital and time value of options/guarantees). It is a key KPI because it measures the value created by current sales activity, independent of legacy business.

What are the three pillars of Solvency II?

Pillar 1: quantitative requirements (market-consistent valuation of assets/liabilities, technical provisions, SCR and MCR, own funds). Pillar 2: governance, risk management, ORSA and supervisory review. Pillar 3: reporting and disclosure (to supervisors and public).

Under Solvency II, how are technical provisions (in the absence of a reliable market value) calculated?

Technical provisions = best estimate liability (BEL) + risk margin. The BEL is the probability-weighted present value of future cashflows discounted at the relevant risk-free term structure; the risk margin is added so the total equals the amount another insurer would require to take over the obligations.

How is the Solvency II risk margin calculated (cost-of-capital approach)?

$$RM = CoC \sum_{t \ge 0} \frac{SCR_{RU}(t)}{(1+r_{t+1})^{t+1}}$$ where $SCR_{RU}(t)$ is the projected SCR for non-hedgeable risks of a reference undertaking and $CoC$ is the prescribed cost-of-capital rate (6%). It discounts the cost of holding future SCR for non-hedgeable risks at the risk-free rate.

Distinguish the SCR from the MCR under Solvency II.

The SCR (Solvency Capital Requirement) is the capital needed to withstand a 1-in-200-year (99.5% VaR over one year) loss; breaching it triggers supervisory intervention. The MCR (Minimum Capital Requirement) is a lower floor (calibrated near 85% VaR) below which authorisation is withdrawn; it is bounded at 25%–45% of the SCR.

State the confidence level and time horizon defining the Solvency II SCR.

The SCR corresponds to the Value-at-Risk of basic own funds at a 99.5% confidence level over a one-year time horizon, i.e. enough capital to survive a 1-in-200-year adverse event over one year.

What is the difference between the Solvency II Standard Formula and an Internal Model for the SCR?

The Standard Formula is a prescribed modular calculation (risk modules combined with regulator-specified correlation matrices). An Internal Model is a firm's own (full or partial) model, requiring supervisory approval and meeting use-test, statistical quality, calibration, validation and documentation standards; it can better reflect the firm's specific risk profile.

What are the three 'tiers' of own funds under Solvency II based on?

Tiers rank capital by quality, judged on permanent availability and subordination (loss-absorbency). Tier 1 is highest quality (e.g. ordinary share capital, reconciliation reserve); Tier 2 and Tier 3 are progressively lower quality, with limits on how much of each may count toward the SCR and MCR.

What is the matching adjustment under Solvency II and its purpose?

The matching adjustment increases the discount rate used to value eligible (predictable, e.g. annuity) liabilities backed by matched, held-to-maturity assets, by adding the spread on those assets less an allowance for default/downgrade. It reduces technical provisions and removes artificial volatility from spread movements on assets held to maturity.

What is the volatility adjustment under Solvency II?

The volatility adjustment is a regulator-published addition to the risk-free discount curve (based on a reference portfolio's spread) intended to dampen the impact of short-term bond-spread volatility on technical provisions and own funds, reducing pro-cyclical forced selling.

What is the ORSA and who owns it?

The Own Risk and Solvency Assessment is a Pillar 2 process in which the firm assesses its own overall solvency needs given its specific risk profile, over its business planning horizon, including stress and scenario testing. It is owned by the board/senior management and must be embedded in decision-making, not merely a compliance exercise.

What is the principal challenge a with-profits actuary manages, and via which two main mechanisms is surplus distributed?

Managing policyholders' reasonable expectations and fairness while running the with-profits fund. Surplus is distributed via regular (reversionary) bonuses added during the term and a terminal (final) bonus paid at exit, allowing smoothing while keeping discretion to react to experience.

Distinguish reversionary (regular) bonus from terminal bonus, and contrast their reversibility.

Reversionary bonus is added to the guaranteed benefit during the policy term and, once declared, cannot be removed (it is guaranteed). Terminal bonus is paid only at maturity/death/surrender, is not guaranteed and can be varied or removed, giving the office flexibility to absorb investment volatility.

What is 'smoothing' in with-profits, and what risk does it create for the office?

Smoothing pays maturity values that move more steadily than underlying asset values by holding back surplus in good years and topping up in poor years. The risk is that during sustained falls the smoothed payouts exceed the underlying asset share, creating a cost of smoothing borne by the fund/shareholders.

Define the 'asset share' for a with-profits policy.

The asset share is the accumulation of premiums paid, less expenses, cost of cover and tax, plus the actual investment return earned (with allowance for the cost of guarantees, smoothing and any miscellaneous profits/charges). It is the benchmark fair payout against which maturity values are set.

What is the role of the Principles and Practices of Financial Management (PPFM) for UK with-profits business?

The PPFM is a published document setting out the principles (enduring) and practices (current approach) by which the firm manages its with-profits fund — bonus setting, smoothing, investment strategy, charges, surrenders and the estate. It promotes transparency and helps demonstrate fair treatment of with-profits policyholders.

What is the 'estate' (inherited estate) of a with-profits fund?

The estate is the excess of the fund's assets over the aggregate asset shares and liabilities — the working capital of the fund. It supports smoothing, guarantees, new business strain and investment freedom, and its ownership/distribution between policyholders and shareholders is a key governance issue.

Who is the UK prudential regulator of insurers and what is its statutory objective relevant to SA2?

The Prudential Regulation Authority (PRA), part of the Bank of England, regulates insurers' financial soundness. Its general objective is promoting the safety and soundness of insurers, with a specific insurance objective of securing an appropriate degree of protection for policyholders.

What is the role of the FCA relative to the PRA for UK life insurers?

The FCA (Financial Conduct Authority) is the conduct regulator, focused on consumer protection, market integrity and competition (e.g. fair treatment of customers, conduct of business rules). The PRA handles prudential/solvency. UK insurers are 'dual-regulated' by both.

What are the With-Profits Actuary and Chief Actuary roles in the UK Senior Insurance Managers/SMCR regime?

The Chief Actuary holds an actuarial PRA Senior Insurance Management Function responsible for the actuarial function (technical provisions, opinion on underwriting and reinsurance). The With-Profits Actuary advises the firm's governing body on the fair treatment of with-profits policyholders and the exercise of discretion (bonuses, smoothing, PPFM compliance).

Under Solvency II Pillar 3, name the two main reports UK insurers must produce and their audiences.

The SFCR (Solvency and Financial Condition Report) is public/policyholder-facing. The RSR (Regular Supervisory Report) is private to the supervisor (PRA). Both are supported by Quantitative Reporting Templates (QRTs) of standardised data.

How is shareholder profit on UK with-profits business typically determined, and what is the customary split?

Shareholders typically receive a share of the cost of bonus declared to with-profits policyholders, commonly via the 90:10 rule: of the surplus distributed, 90% goes to policyholders (as bonus) and up to 10% to shareholders. The shareholder transfer is thus geared to the bonus rate declared.

What is unit pricing for unit-linked funds, and the difference between the bid and offer price?

Unit pricing values the underlying assets of a unit fund and divides by units in issue to give a price per unit. The offer price is the (higher) price at which units are allocated/bought by policyholders; the bid price is the (lower) price at which units are cancelled/sold; the difference is the bid-offer spread, a charge to the policyholder.

Distinguish unit reserves from non-unit (sterling) reserves for unit-linked contracts.

Unit reserves equal the value of units allocated to policies (the unit fund liability). Non-unit (sterling) reserves cover the future net cost to the office of expenses, mortality cover and charges in excess of charges received — i.e. the value of future negative non-unit cashflows, including any reserve for guarantees.

What is a non-unit reserve negative cashflow problem, and how is it addressed in reserving?

Charges may exceed costs in some years (positive cashflow) but costs exceed charges in others (negative). Prudent reserving (e.g. the 'sterling reserve' method) requires holding reserves so that no future negative cashflow has to be financed from future positive cashflows that are not yet certain, often by reserving for the worst run of future negatives.

List the key actuarial assumptions needed to price and reserve for a conventional life product.

Mortality/morbidity (and trends), investment return/discount rate, expenses and expense inflation, persistency (lapses/surrenders), tax, take-up of options/guarantees, new business volumes and (for with-profits) future bonus rates. Each is set with appropriate margins for the purpose (pricing, reserving, EV).

What is meant by 'options and guarantees' in life products, and give two examples.

Features giving the policyholder a valuable right exercisable in their favour, whose cost to the office rises in adverse scenarios. Examples: guaranteed annuity options (right to convert a fund at a guaranteed annuity rate), maturity/investment guarantees (minimum maturity value), guaranteed surrender values, and premium-rate or insurability guarantees.

Why must options and guarantees be valued stochastically rather than only at intrinsic value?

Because their cost has a time value: even if currently out-of-the-money, future adverse movements (interest rates, markets, mortality) may bring them into the money. A stochastic (market-consistent) valuation captures the full distribution of outcomes, whereas an intrinsic-only approach understates the liability.

Give the relationship linking gross premium, net premium and the expense loading.

Office (gross) premium = net (risk) premium + loading for expenses, profit and contingencies. Equivalently, the loading is the part of the office premium in excess of that needed to meet benefits on the premium basis; it funds initial and renewal expenses, commission and the required profit margin.

What is the purpose of sensitivity testing and scenario testing in pricing and capital work?

To assess how results (profitability, reserves, capital, EV) change when assumptions or economic conditions vary, identifying the most material risks and the robustness of conclusions. Scenario testing combines several stresses into a coherent adverse scenario; both support risk management, ORSA and assumption setting.

What is a model point, and why are model points used in actuarial projections?

A model point is a representative specimen policy standing for a group of similar policies, defined by characteristics (age, sum assured, term, premium, etc.). Model points reduce computation by projecting a manageable number of representative cells instead of every individual policy, while aiming to reproduce the portfolio's aggregate cashflows.