Faculty of Actuaries Institute of Actuaries

EXAMINATION

5 April 2005 (am)

Subject SA1 Health and Care

Specialist Applications

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 both 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
SA1 A2005 Institute of Actuaries
1 You are an actuary of a UK critical illness and income protection insurance company.
Your company is considering launching a health and care insurance company in
another country and you have been asked to provide advice to your managing director
on this proposal.

(i) Outline the approach that you would take in assessing the market for the
launch of a health and care company. [15]

The managing director has asked you to specifically focus on UK-style individual
critical illness and UK-style individual income protection contracts.

(ii) Describe the methodology that you would adopt in determining the
assumptions required to price these contracts. [19]

(iii) Assuming that the economic and demographic conditions in the other country
were similar to those current in the UK, suggest values for these assumptions.
[6]

Your managing director has been approached by a UK company providing income

protection and critical illness products, who would be interested in discussing a
takeover of them by your company.

(iv) Discuss the factors which should be taken into consideration in assessing such
a company for takeover. [11]

(v) Indicate how your answer to (iv) might differ if the local provider also offered
private medical insurance. [3]
[Total 54]

2 For a number of years a UK life insurance company has written three types of long
term care contract:

A regular premium individual contract where premiums are guaranteed for 10

years.

A single premium individual contract where the insurer reserves the right to
change the sum assured after 10 years.

A group contract written as a renewable one year contract. Contract terms and
premiums may be revised at each annual renewal.

Overall volumes of business have been disappointing and some concerns have been
expressed about the profitability of this business. You are aware that the market
leader is currently in the process of significantly increasing premium rates both for
new and existing business.

SA1 A2005 2
 You have been asked to look at the company s involvement within the long term care
market and to produce a report for the senior management team. A drafting style is
not required.

(i) Describe the areas which should be covered in the report. [12]

(ii) Describe the data needed to carry out an analysis of sales expenses,
persistency, claim inceptions and claim terminations, and comment on any
difficulties that might be experienced in extracting data or interpreting the
results of the analysis. [18]

(iii) Describe how the analyses carried out for part (ii) could be used in the
financial management of the company. [3]

(iv) Discuss the possible implications for the company of withdrawing from the
long term care market. [4]

(v) Assuming that your investigations indicate that the business is unprofitable
suggest, with reasons, what actions you would recommend. [9]
[Total 46]

END OF PAPER

SA1 A2005 3
Faculty of Actuaries Institute of Actuaries

EXAMINATION

April 2005

Subject SA1 Health and Care

Specialist Applications

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

Faculty of Actuaries
Institute of Actuaries
 Subject SA1 (Health and Care Specialist Applications) April 2005-Examiners Report

1 (i) The following areas would be amongst those considered in assessing the market for
the launch of a health and care company in another country:

Does critical illness and income protection insurance already exist in the country?

Consumer demand

will customers buy in sufficient quantity to make viable?

will products fit a need?
are customers aware of this need?
are products affordable?
could carry out a survey of consumers
impact of personal taxation

Consumer confidence

in the company/brand
in the product

Level of competition

fit with existing products

will the products be revolutionary or similar to any already existing?
is there a gap in the market for this product?
have there been any previous invaders from outside and, if so, have they been
successful?

Profitability of players

if they re not making money, why should you?

Availability of data

are suitable data to price the contract available?

are data relevant to product and target market?

Availability of capital for a new product

expense overruns
new business strains
solvency requirements

Availability of capital for a new company

contingency plans

Potential distribution channels

will you be able to sell the product?

how easy is the product to sell?
what research needed
substitution of existing products

Page 2
Subject SA1 (Health and Care Specialist Applications) April 2005-Examiners Report

different potential channels sales force employed by insurer, employed by 3rd

party, independent advice, direct

Regulatory issues

can business be authorised/written in country?

solvency margin requirements
reserving requirements
financial reporting
EU v Non-EU
any restrictions on product design or investments?
any regulation of distributors/sales processes?

General legal issues

contract law, employment law

ability to repatriate profits

Availability of key staff and systems

administrative and claims systems

key staff
availability of service partners (eg disability counsellors)
possibilities for outsourcing

Reinsurance

willingness of reinsurers to support business; availability and cost

State provision

what employee benefits are available?

what is currently provided by the State?
medical provision system of hospitals and doctors (referrals, reports)
how does this product fit with this?

Demographics and earnings levels

demographic projections
earnings levels and projected growth
influence on choice of products and distribution methods

Culture

impact on the product claims experience

Others

approach, modelling and profit testing

levels of corporate taxation
currency considerations/volatility
comparability with alternatives of company purchase, badging

Page 3
 Subject SA1 (Health and Care Specialist Applications) April 2005-Examiners Report

(ii) 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

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:
Industry data e.g. from insurers associations
Data from reinsurers
Published tables based on insurance experience
Population figures and government health statistics

Assess the level of adjustment needed to the local data (which may be more plentiful)
to make it relevant to the prospective overseas market. Ratios may be appropriate
initially but margins will be needed.

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.

For CI, if data permits, analyse risk premiums and trends by specific diseases.

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 arrangements of various sorts e.g.
risk premium, original terms. In a new territory, company may wish to reinsure a
significant proportion.

May base premium terms on reinsurance rates, subject to the above analyses.

Need to investigate potential impact of AIDS/HIV

Further adjustment needed to align different target market in the overseas territory
with that underpinning the base data.

Adjustment may also be needed for differences in potential size of policy.

Need to include reserving basis among pricing assumptions, affecting cash flows.
Will probably use adjustments to a standard table, with the adjustments derived from
the above analysis. Need to allow for deterioration also.

Mortality

Carry out similar analysis to the above. Data needs to be interpreted with care

For IP, need to split pre-claim and in-claim mortality

Page 4
Subject SA1 (Health and Care Specialist Applications) April 2005-Examiners Report

For CI, need to split pre-claim and post-claim (survival period) mortality. Other
deaths from critical illnesses covered will be irrelevant, because a claim has already
been paid. Need to avoid double counting in cases of accelerated CI.

Investment

Assess the level of potential investment return on the assets backing this portfolio,
dependent on where the assets are held. Allow for currency differences. Include net of
direct investment expenses.

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

Allow separately for IP and CI

Include both head office and overseas territory costs

Claims costs will be split between initial claim validation (CI and IP) and ongoing
claim maintenance (IP).

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

Reinsurers will be able help with certain expense information e.g. cost of obtaining
medical evidence and its likely impact on premium rating.

Need to analyse and project the impact of inflation in the two countries. 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

Investigate levels of sales reward to be paid to the distributors in the new territory.
Load directly into premium basis. May need some adjustment if there are volume-
related overrides thus dependent on new business forecasts

Lapses

Analyse home experience for CI and IP products

Page 5
 Subject SA1 (Health and Care Specialist Applications) April 2005-Examiners Report

Limit scope of analysis to experience produced by the distribution channel which will
sell the healthcare products abroad. Else (or as well as) obtain industry data if
available for these healthcare products and this form of distribution

Adjust data if target market is different from those underlying the above researches

Further adjustment may be needed if past period of data collection was influenced by
unusual economic circumstances, or any other abnormal historical situation

Tax

Make suitable assumptions as to the insurer s current and future tax position

Make allowance for any tax liability in overseas territory, including premium/sales
tax

Profit

Include company profit criteria, commensurate with underlying risk of venture risk
discount rate, PVFP, pay back period

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 then
adjust assumptions if deemed appropriate.

Assumptions and strategy

The values of the assumptions and the premiums that they produce will reflect the
company s strategy in launching into the new market: An aggressive growth strategy
may require assumptions stripped of margins. A slow portfolio build strategy may
permit more caution in the assumptions

(iii) Assumptions these may depend on mix of business and product size

Mortality/Morbidity reinsurers rate with a loading of 0 to 10%

Morbidity deterioration
Investment returns 5%
Expenses:
Initial £125
Renewal £20
Critical illness claims £250
Income Protection claims £1,500
Commission 150% Lautro
Expense inflation 3% say
Withdrawals Year 1 15%, 2 10%, year 3 on 5% but very dependant on
distribution channel
Tax dependant on office s tax position
Profit 10% return on capital

Page 6
Subject SA1 (Health and Care Specialist Applications) April 2005-Examiners Report

HIV/AIDS test

(iv) In assessing the company for takeover, the following are amongst the areas which
should be considered:

Seller

why is the seller selling the business?

are the other companies interested in acquiring the company?

Data available and quality

need more data for a health product

level of detail available
quality of staff

Models, discounted cashflows

use embedded value calculations to assess the value

concerns that considerable sensitivity in results
timing will be an issue

Market precedents

to understand the dynamics of the market

Regulatory issues

check with regulators what information and procedures they might require

Adequacy of reserves

if not adequate, what is required?

certain liabilities may need to be ring-fenced.
check existence of any options and guarantees

Demutualisation may be an issue, which will take time

Are there any synergies available?

caution is required in assessing these

If either company is quoted

market timing is an issue

shareholder approval may also be required

Other

Ability to service claims and administer the business

Non-insurance liabilities (eg pension benefits)
Monopoly considerations
Tax implications of takeover

Page 7
 Subject SA1 (Health and Care Specialist Applications) April 2005-Examiners Report

Price sought
Brand name
Competitive position of your company and takeover company

(v) Private medical insurer

May not have expertise in this business

Absolute and relative size of PMI book
Any synergies with UK business on PMI will be limited
PMI is shorter term business
Need to look into data and models for this
Will probably need to get external help
Potentially could sell off this element separately

2 (i) Areas that may be covered in the report include:

Recap of history of long term care involvement. What was the rationale for entering
the LTC market?

Current and future State provision/incentives/means-testing

Demographic trends

Does current product design fit market needs?

Projected volumes of business.

Expected level of profitability

Full description of the products

History of product changes

Current and future reinsurance availability

What were the original pricing assumptions?

Expected claim basis split by both inception and claim termination (recovery,
death and policy expiry (if appropriate))

Lapses

Expenses split by acquisition (distribution and underwriting), maintenance and cost of

managing claims

Expected investment return and tax assumption

Assumed business mix (age, sex, size of policy, premium, any optional benefits)

Basis for setting reserves and solvency capital

Need to look at the actual experience since launch

Page 8
Subject SA1 (Health and Care Specialist Applications) April 2005-Examiners Report

Compare actual experience against the assumptions used in pricing

Look at reported profits and the current embedded value of the business

How sensitive are the projected profits to various future scenarios?

What is the current supervisory valuation basis of the company and how does this
compare with realistic reserves?

What are the current expectations for market growth or changes in experience are
there any social, medical or regulatory changes which are expected to impact on the
market?
What is the current competitive position and how are other players acting within the
market?

What options are available given the current product range to make changes to
improve profitability?
revision of premium rates
changes in product design for new business
changes in underwriting for new business
changes in claims admittance process

Other options:
Abandon business and sell off
Abandon business and manage run-off
Purchase better positioned insurer
Focus on niche

(ii) The basic requirement is that there is a reasonable volume of stable, consistent data
from which future experience and trends can be deduced.

The data ideally needs to be divided into sufficiently homogeneous risk groups
according to the relevant risk factors. However this ideal has to be balanced against
the danger of creating data cells that have too little data in them to be credible.

Sales expenses

Note that the question only asks about sales expenses

For expenses ideally want to split costs between direct expenses and overheads. In
practice there is not a clear dividing line between these two categories

Information may be obtained form timesheet/functional analysis, activity based

costing

Need to know the level of commission

Non-commission expenses need to be split between

initial expenses which arise at the start of the policy
renewal expenses

Expenses should be split according to whether the expense is proportional to:

Page 9
 Subject SA1 (Health and Care Specialist Applications) April 2005-Examiners Report

the number of contracts written

the benefit written
the premium written

Persistency, claims inceptions and claim terminations

Lapses may be understated because of any non forfeiture provisions

Lapses on single premium business unlikely if no surrender value

To analyse inception, termination and lapse experience will require sufficient

exposure data to enable expected decrements to be calculated. Similar information
will be required for actual claims and lapses

Type of contract including benefit conditions

Date of birth (age)
Sex
Smoker status
Policy commencement date (or duration from entry)
Policy status inforce, lapse, claim, recovery, death
Date of status change
Rated information (at least sufficient to split policies in to standard and sub
standard risks)
Source of business/sales method
Definition of disability satisfied
Level of original benefit
Level of current benefit
Basis used to calculate current benefit
Marital status at policy issue

Possible difficulties in extracting data or interpreting results of analysis

It is assumed that data from the period being examined is sufficiently homogenous as
to enable the results to be considered as a whole

Any errors in the recording of data are not so great as to invalidate any analysis

It is possible that for the group contract pricing may have been based on a unit rate
and individual exposure details may not be available

Claim information may be incomplete because of delays in claim reporting and delays
in claims acceptance and settlement

There may be delays in the reporting of claim terminations

On the single premium policies deaths occurring prior to any claim may not be
reported and so this could lead to an overestimate of the exposed to risk

The number of claims and lapses may be insufficient to give credible results
particularly if the analysis considers a large number of rating factors.

For claims in payment there is likely to be considerable uncertainty about the

expected future duration of the claim.

Page 10
Subject SA1 (Health and Care Specialist Applications) April 2005-Examiners Report

It may be necessary to consider future improvements in mortality or trends in

morbidity assumptions.

(iii) An analysis of experience is a key part of the control cycle of the company. The
analysis would enable:
Refinement of assumptions used in the product pricing bases
Profit testing of existing premium rates against revised assumptions to determine
current profitability
Analysis of any surplus/loss arising between valuations in order to identify areas
of experience with poor trends
Projection of profits arising in the future under different scenarios
Review of the assumptions used in the supervisory valuation basis
Setting of the assumptions for and calculation of the embedded value of the
business
Review of sales processes and commission levels
Review of underwriting process
Identification of target markets for concentrated efforts
Assessment of capital requirements

(iv) Possible implications of withdrawing from the market include:

Effect on market perception.

May create considerable negative customer sentiment
Brand damage, particularly if viewed very negatively by media
Can lead to increased lapses (which may be antiselective) from disgruntled
customers

Cannot cancel cover for existing contracts

Can close product to new business but must consider existing business already in the
pipeline

May cause concern with distributors who have been trained to sell contract or who
have clients to whom contract is targeted

Group contract is yearly renewable and so this may cause greater distress

Product is being dropped because of profitability so any replacement contract is likely

to offer poorer value for money

Could lose key staff

Considerable expense saving and possibly insurance loss/saving also

Frees up capital to be used elsewhere

Impact on share price (up or down)

(v) The recommended action will depend on the reason for the lack of profitability

If future business volumes are expected to be insufficient a decision to withdraw from

the market may be the most appropriate action

Page 11
 Subject SA1 (Health and Care Specialist Applications) April 2005-Examiners Report

Assuming this is not the case alternative approaches include:

Closure to new business of one or more of the existing product lines and relaunching
revised contracts

Change the policy wording/conditions for new business cases or introduce brand new
contract. For the group contract this approach could be applied to existing business as
terms are reviewable

Increase premium rates for the regular premium and group contract and reduce the
benefit level for the single premium contract

Change the remuneration structure as a means of cutting costs or more directly to

increase business

Pay increased commission for business which adds most to profitability

If persistency is an issue, enhancing benefits or reducing premiums may be

appropriate

Change mix of business between O/R, rated and declined

Improve the questions asked at underwriting or reduce medical limits

Introduce a computerised process for acceptance for all but the most complex
applications. This may improve consistency in underwriting decisions and may
reduce costs

Change claims information and procedures eg increase training, more accurate and
appropriate information obtained at time of claim, involve all parties (underwriters
and policy developers) in claims process, check quality of information obtained

Change investment policy and/or managers

Change IT structure

Change office personnel and competence balance

Consider whether a change to the reinsurance structure can improve profitability by

either risk sharing or improved capital management

Reduce periods of guarantee on non-group products

Concentrate on products over which the company has most control (eg yearly
renewable products)

Page 12
Faculty of Actuaries Institute of Actuaries

EXAMINATION

6 September 2005 (am)

Subject SA1 Health and Care

Specialist Applications

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 both 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
SA1 S2005 Institute of Actuaries
1 A leading bank has a long-term insurance subsidiary which offers investment and life
assurance products to its customers. The bank does not offer any other insurers
products. The subsidiary does not currently offer any income protection or critical
illness products. The bank is considering its options for expanding the product range
to its customers.

(i) Describe how income protection and critical illness products could be used to
meet the needs of the bank s customers. [8]

(ii) The subsidiary is considering seeking reinsurance for these products. Discuss,
with reasons, the reinsurance arrangements that are most likely to meet the
subsidiary s requirements and any other practical assistance that the reinsurer
could offer the subsidiary in managing these lines of business. [7]

(iii) An alternative approach has been proposed where the subsidiary provides the
policy to the bank s customers but a specialist health and care insurer issues
the policy and undertakes all policy processing and claims administration,
payments and administration. Discuss the advantages and disadvantages of
this approach to the subsidiary. [5]

(iv) The bank has asked for information regarding how these contracts would
generally be priced. Describe the investigations usually used for pricing own
product business, highlighting the differences in approach between critical
illness and income protection. [22]

(v) If the subsidiary also offers with profits contracts, describe the potential
impact on its profits distribution of also offering income protection or critical
illness products. [6]

(vi) A health services provider has recommended that the subsidiary implements a
claims management process for its income protection business where health
professionals are used after a claim is notified to the subsidiary to treat the
claimants and help them back to work. Discuss the advantages and
disadvantages of this approach to the subsidiary. [6]

(vii) A director of the bank has raised concerns over income protection business.
He is aware of other companies having had very poor claims experience on
this line of business. Discuss the possible reasons that could have given rise to
this poor experience. [6]
[Total 60]

SA1 S2005 2
2 A UK Health Insurer currently sells in the UK both individual and corporate private
medical insurance through a range of intermediaries and direct to customers. Over the
last three years there has been a significant reduction in the volume of new individual
PMI business sold through intermediaries.

(i) Discuss the possible reasons for this reduction in new business sales. [10]

(ii) Describe how you would monitor individual PMI claims experience. List the
additional claims factors to be considered if this claims analysis were to be
part of a pricing calculation. [5]

(iii) It has been suggested that, to halt the decline of sales in this sector, a new,
PMI style plan, offering coverage for acupuncture is developed. You have
been asked to price this product but only have limited data. Outline how you
would reduce the risk associated with this lack of data. [5]

(iv) An alternative suggestion is that the definitions of benefit covered will be

tightened to reduce the level of claims outgo. This saving will then be passed
onto the customer by way of a reduced new business premium. In addition, it
is suggested that this approach is extended to existing customers to minimise
increases in premium at renewal. Your existing PMI policy has a guaranteed
renewability clause. Outline for new and existing business the considerations
associated with this proposal. [11]

(v) Describe how the introduction of genetic testing may impact in the future on
your portfolio and the proposals suggested in parts (iii) and (iv) above. [9]
[Total 40]

END OF PAPER

SA1 S2005 3
Faculty of Actuaries Institute of Actuaries

EXAMINATION

September 2005

Subject SA1 Health and Care

Specialist Applications

EXAMINERS REPORT

Faculty of Actuaries
Institute of Actuaries
 Subject SA1 (Health and Care Specialist Applications) September 2005 Examiners Report

1 (i) Bank customers include mortgage customers, individuals deposit holders,

small businesses. IP and CI products could meet following needs:

To meet specific needs

Repay loans
CI lump sum
IP meet repayments
Replace income - IP
Key person cover
Compensation for loss of profits
To pay for a replacement

To provide cash
CI lump sum
More than cost of immediate concern
CI provides cash to repay loans whilst p/holder is still alive
For a change in lifestyle
IP income stream
Proportional benefit if part time work

To allay fears
Provide financial comfort
Help prevent financial hardship for dependents
Pay for domestic help

To pay for medical fees

Other
Home modification
Recuperation benefits
For employers, as an employee benefit, to attract staff
For employers, limit own payouts on ill-health
Partnership dissolution on CI

(ii) Reinsurance arrangements

Insurer looking to limit its exposure to adverse fluctuations in experience
Shareholders require stable results
Probably use quota share on original terms
Written under treaty on an obligatory basis
An experience refund to manage the claims experience better
Portfolio stop loss/catastrophe reinsurance

Other practical assistance

Assistance with product design and marketing strategy
Assistance with setting the premium rates - lack of previous experience - set using
risk rates loaded up to allow for insurer's cost of capital, expenses and profit.
Staff training
Systems and policy documentation

Page 2
 Subject SA1 (Health and Care Specialist Applications) September 2005 Examiners Report

Medical underwriting
Claims
Market information
Financing
Access to market research
Low retention initially, then build up
Possible tax advantages

(iii) Badging

Advantages
Benefit from professionals expertise in all areas
Particularly relevant for IP claims
Medical underwriting expertise
No current experience so can benefit from all of this
Historically poor income protection experience
Potentially cheaper for them to do than the insurer
Can concentrate on distribution
Can be a speedier installation than own product or subsidiary
Additional profit sharing
Cross-selling of life products, may be bank products to H&C insurer

Disadvantages
Lack of synergies with internal operating procedures
Linking to the 3rd party systems etc
Loss of control over policy process and claims administration with possible
resulting reputational risk
May be less profitable in long run
Loss of economies of scale
Skill needed in drafting service level agreements, other contract issues
No involvement means no expertise derived - difficult to reclaim longer term
Loss of link between sales staff and u/w
Actuarial control cycle more difficult to apply
Counterparty risk

(iv) Investigations for pricing own product business include:

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
Stand-alone, acc
Make allowance for any changes in underwriting standards

In addition, and particularly if the company has insufficient data

Industry data (such as CMI reports in the UK)
Data from reinsurer
Published tables

Page 3
 Subject SA1 (Health and Care Specialist Applications) September 2005 Examiners Report

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 may analyse by specific disease.

For income protection, consider claims inceptions

and claim terminations experience
Look at partial recoveries

Claims data would be subdivided as follows :

Age at inception
Sex
Smoker status

If sufficient data, may analyse by:

Current age (or elapsed duration of policy)
Duration of claim
Policy term
Deferred period
Occupational group
Ratio of benefit to income
Type of sickness and injury
Date of termination of claim
Reason for termination of claim
Sales channel
Geographic location

Because of doubts over morbidity rates the company is likely to reassure a larger
proportion of this business.

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 is a different situation from the type of policy the data were
collected from.
Assess credibility of data in each cell and group accordingly
Exposure and claims data must be collected and subdivided consistently.

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.

Page 4
Subject SA1 (Health and Care Specialist Applications) September 2005 Examiners Report

Investment returns
This should reflect the expected return on the underlying investments

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.

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.
Launch expenses

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.
Analyse lapses by duration, product, sum assured, age, sex

Page 5
 Subject SA1 (Health and Care Specialist Applications) September 2005 Examiners Report

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.
Wider margin for risk as first time and inherently more risky than life and investment

Market Rates
Analysis would also be made with competitors products and rates.

Other
Mix of business
Margins in rates generally

(v) Actuary needs to understand how the with-profit distribution operates in the company
under consideration

Do any health and care products share in the distribution; if so, how? In a UK context,
this is very unlikely.
To what extent do the with-profit policyholders share in the profits of the health and
care operation?
The actuary will be particularly careful where the size of the health and care book is
significant in its contribution to distributional surplus

Policyholders Reasonable Expectations - Profits from a health and care operation do

not emerge on a smooth basis; the actuary should be cautious in promulgating any
profit expectations from the health and care area.

Smoothing - The distribution of any surpluses from the health and care operation will
be volatile; the actuary will determine such profit as does emerge on a smoothed
cautious basis.

Reversionary or terminal - Any profits arising from the health and care operation are
likely to be small in relation to other component parts of the insurance business. The
impact on bonus distribution will therefore be less significant and may be only a small
addition to the bonus rate. It is usually perceived that terminal bonus is used to take
up the slack from more volatile past contributions to surplus when allocated to a class
of maturing policies. This might be the case with the none-too-regular profits from
health and care insurance but their relative size would normally suggest distribution
on a reversionary basis.

With-profit guide
Principles and practice of financial management (PPFM)
Treating customers fairly (TCF)

Page 6
 Subject SA1 (Health and Care Specialist Applications) September 2005 Examiners Report

(vi) Advantages
Some claimants should return to work sooner
Should improve claims terminations
Claims notified during deferred period may also return to work sooner
Improving claims inceptions
May also discourage borderline claimants from claiming
Could provide positive PR for company

Disadvantages
Professionals are expensive
Average benefit levels may be low and so the benefits of doing this may not be
worthwhile doing
May be seen as trying to say no to valid claims
Note these are customers of the bank
Health professionals, if not employed directly, may advise people to stay off work
who would otherwise have returned to work

In general, only worthwhile for large claims due to the expenses

(vii) Products price too high so only attracting those customers who would be rated by
other companies
Medical underwriting standards may be worse than competitors
Financial underwriting standards may be worse than competitors
Claims admissions rules more generous than average
Non-identification of fraud/non-disclosure
Claims management - less active than average
The replacement ratio (benefit relative to income) may be higher than average less
incentive to return to work.
Customer segment poor
Policy design encouraging anti-selection e.g. high replacement ratio
Weak disability definition
Pricing wrong - e.g. no occupational rating
Distribution channel - anti selection high risk for IFAs
Inflation higher than allowed for in the premium rates.
Economic factors may have led to higher claims
Threat of redundancies
Directors information could be wrong
Random fluctuation
Over conservative reserving
Concentration of risk
Medical advances may prolong claim (instead of death)
Change in attitude to claim
Anti-selective lapses

Page 7
 Subject SA1 (Health and Care Specialist Applications) September 2005 Examiners Report

2 (i) May be part of a reduction in volume of all individual PMI business sold
May be overall intermediary market reduction
or may be a reduction in market share

Reduction in volume of all individual PMI business sold

Overall number of PMI purchasers has reduced
(Overall market size in premium terms has increased, fuelled by premium inflation)
Market premiums too high (premiums typically higher than for corporate schemes)
Reduced customer need (eg NHS improvements, reduction in waiting lists)
General improvement in welfare benefits
Economic climate, job insecurity
Possible changes in premium tax or tax on benefits

Overall intermediary market reduction

Alternative distribution channels may be substituting for intermediary business
Increase in regulation may deter intermediaries from selling
Intermediaries focused on corporate business (higher premiums and commissions)

Reduction in market share

New entrants into market
Premiums too high relative to competitors
Benefits not competitive (eg competitor product design may have moved forwards)
Commission levels uncompetitive (eg competitor levels may have increased)
Difficult to do business with
Late payment of commission
Arduous process for intermediary (eg for quotation)

Poor company reputation relative to rest of market

Perception of poor customer service
Perception of reduction in credit rating
Perception of strict claims philosophy (high profile non-payment of claims)
Poor relationship between intermediaries and other parts of the company
Other product types deemed to be better value

(ii) Normally assess in yearly cohorts

But may undertake quarterly for up to date position
Check costs by provider (for heavy chargers)
Check preferred providers, service level agreements
Changes in practices at u/w, claims stages
Changes in distribution methods
Changes in terms and conditions

Key indices are:

Rate of claims incidence
No of claims / exposed to risk
Split by procedure/benefit types
Compare actual v expected

Page 8
 Subject SA1 (Health and Care Specialist Applications) September 2005 Examiners Report

Split by occupation or other rating factors

Check cost of 'family' claims against assumptions
Average cost per claim
Total incurred claims / no of separate claims
Claims expenses
Loss ratio
Total incurred cost of claims / relevant earned premium
Calculated for cohort of business under review
Consider cohort by duration in light of selection effect
But depends on type/extent of medical underwriting at outset
Incurred claims includes:
Claims paid to date
Reported but not paid
Incurred but not reported

Additional claims factors which might be considered if claims analysis were to be

used as part of a pricing calculation might include:
Trends in costs of procedures, drugs and dressings
Overall private hospital capacity, current and projected
Competitors' rates movements where these are caused by their own claims experience

(iii) Use data from other sources

Professional/governmental bodies
Other countries
Reinsurers

Own claims data is likely to be more relevant but may not be available as this is a new
product
Implement benefit caps to limit claims per case and hence maximum liability
Benchmark premiums against any similar plans already in the market
Build margins into pricing and reserving to reflect the uncertainty
Avoid guarantees, both for premium and benefit
Write product on a short-term basis without guaranteed renewability
Reinsure appropriately to limit retained risk
Ensure adequate capital is in place to meet uncertain claims outgo
Collect relevant data from policies written to accumulate own experience as quickly
as possible
Delay product launch until better data is available
Tight benefit conditions
Claims preauthorisation
Monitor claims experience
Excesses
Preferred provider acupuncturists
Do not adopt the plan
Introduce NCDs
Offer cash benefit, not indemnity

Page 9
 Subject SA1 (Health and Care Specialist Applications) September 2005 Examiners Report

(iv) Legality
Difficulties in worsening the terms of contracts
Guaranteed renewability. Customers have the right to renew.
Exact legal implications will depend on the wording of the contracts
Expect greater difficulty for long-term contracts
Regulator's approach/views

Market perception
Need care that approach is not out of line with market.
May be a strong competitive disadvantage
Strong reputational risk
Especially if in-force claims are denied which would previous have been paid
Changes are likely to need to be significant to have a really material impact

Projected volumes
Need to consider the positive volume impact of reduced premium
Against the potential negative impact of market perception, PRE
Both on new business and retention
All will be based on assumptions with little data to support
What are competitors already doing and how will they react?
Selective lapses

PRE/Treating customers fairly

Difficult to gauge for short-term policy
Depends on policy wordings
And strength of sales message at point of sale
Implications if approach has changed significantly from point of sale message

Administration
Would need to be able to run two claims processes in parallel
Before renewal approach and Post renewal approach
Likely to result in practical difficulties
Will add to costs of processing
May be contamination of old and new approaches
Problem is less acute than for long-term policies where many cohorts of business may
apply
IFA training

Reinsurance
Changes to the treatment of existing business will need to be discussed with the
reinsurer

(v) Currently a Moratorium on genetic testing until 2006

Not allowed to used genetic testing in determining
Availability of insurance
or Terms of insurance

Page 10
Subject SA1 (Health and Care Specialist Applications) September 2005 Examiners Report

Disability Discrimination Act 1995

May decline or impose special terms
But must be based on information or data relevant to the assessment of the risk

Anti selection
Individuals may have information not available to insurers
Particularly with moratorium in place
More likely to insure
Change claims frequency of portfolio
Or may insure for more on average
Increase average cost of claim

Lack of affordability
Premiums might be loaded for extra risk
But for some disorders premiums might be unaffordable
Individuals may become uninsurable
More common to exclude certain conditions within PMI context

Availability and cheapness of tests

If tests become sufficiently cheap may enable much better targeting of premium to
risk
Could use in the underwriting process
Depends on the costs saved in terms of claims cost against the cost of the tests

Impact on pricing
Anti selection likely to result in increased premiums

Other
For PMI, generally acute cases, so possibly little impact. However, may allow earlier
diagnosis, which may mean treatment is cheaper
Relatively little impact on group cover.

END OF EXAMINERS REPORT

Page 11
Faculty of Actuaries Institute of Actuaries

EXAMINATION

3 April 2006 (am)

Subject SA1 Health and Care

Specialist Applications

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 both 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
SA1 A2006 Institute of Actuaries
1 A UK company (Positive Pickles PP) has recently completed a takeover of another
company manufacturing similar but not identical products (Fantastic Spices FS).
The combined company will trade as Positive Fantastic Pickles (PFP). There are
currently two separate health benefit arrangements for employees. Both schemes are
non-contributory and insured. The details are as follows:

Positive Pickles scheme Fantastic Spices scheme

Members 1,500 2,500

PMI scheme Members and dependants No scheme

Full coverage for acute conditions
No excess

Hospital cash scheme No scheme Typical scheme in UK market

50% excess with low benefit limits

Critical illness benefits No scheme 2 times scheme salary

Income protection 50% of scheme salary No scheme

26 week deferred period
Expiry age 65th birthday
No increases to benefits in payment

Scheme salary Total taxable earnings in previous Basic salary at 1 January

tax year

Long term care benefits No scheme Care home fees paid for member,
spouse, parents and children

The combined company has decided to merge its health benefit arrangements for
employees. It is proposed that all members of the Fantastic Spices scheme will be
transferred to the Positive Pickles scheme and receive the Positive Pickles scheme
benefits.

(i) Discuss the advantages and disadvantages to the employer of merging the
employee health benefit schemes. [6]

(ii) Discuss the advantages and disadvantages to a member in the Fantastic Spices
scheme of merging the employee health benefit schemes. [3]

It has been agreed that the insurers of the current PMI, Hospital cash, IP, CI and LTC
schemes may quote for the merged PMI and IP schemes for Positive Fantastic Pickles
at renewal.

(iii) Discuss the areas which insurers should consider in providing:

(a) a generic pricing basis for group IP and group PMI products

(b) a scheme specific quotation for the merged PMI and IP schemes for
Positive Fantastic Pickles at renewal [15]

SA1 A2006 2
 (iv) The Finance Director of Positive Fantastic Pickles has chosen one insurer as
the party with which to proceed. However, he feels that the quoted cost is too
high. Discuss how the benefit terms and conditions might be amended in
order to reduce the premiums payable for:

(a) the income protection benefits

(b) the PMI benefits
[6]

It has been suggested that current members of the Fantastic Spices scheme will have
the choice of remaining in the scheme or transferring to the Positive Pickles scheme.

(v) Outline how general medical issues might affect the medical underwriting
requirements that Fantastic Spices scheme members being transferred to the
Positive Pickles scheme might be asked to provide. [4]

It has been suggested that the PMI and IP schemes could be self-insured by the
company.

(vi) Explain what is meant by self-insured in this context and how it can be
achieved. [4]

(vii) Discuss what insurance and other business risks the company may be taking
on as a result of self insuring and how the company might seek to reduce these
risks. [13]
[Total 51]

2 You are the actuary for a large life office, offering both group and individual
healthcare products. You have been approached by an intermediary regarding a
potential product. This product would be sold to parents to provide cover for school
fees on incapacity of either one of the parents or the child attending a private school.
Schools fees vary by school but on average are around £9,000 p.a.

(i) Discuss the key issues in determining whether you would wish to develop this
product. [12]

(ii) Describe the investigations that you would undertake in developing this
product and to determine a suitable price for this product. [24]

(iii) Outline the areas of experience of this potential new product which could be
monitored after sales had commenced. [5]

Rather than providing cover on incapacity, it has been suggested that the product
should focus providing cover on critical illness type events.

(iv) Discuss the advantages and disadvantages of such an approach to each of the
parties involved. [8]
[Total 49]

END OF PAPER

SA1 A2006 3
Faculty of Actuaries Institute of Actuaries

EXAMINATION

April 2006

Subject SA1 Health and Care

Specialist Applications

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

June 2006

Faculty of Actuaries
Institute of Actuaries
 Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

Comments

Actuaries specialising in Health & Care require many attributes similar to actuaries
practising in other practice areas. Candidates were examined in two of the more specialised
requirements in April 2006, namely:

(a) in question one, the ability to work through a mass of detail and understand the basic
insurance coverage given by the five main elements of health insurance PMI,
Hospital Cash Plans, CI, IP and LTC, and

(b) in question two, the ability to examine a new potential product idea at the strategic and
technical level

In both questions, candidates who approached the problem, 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. Generally, there was 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.

The Specialist Applications subject can examine candidates on their knowledge of aspects of
UK Health Insurance practice. Each question had a section relating to the UK market,
question 1(vi) and 2 (i). Candidates generally exhibited little or no knowledge of the UK
market.

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.

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 Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

1 (i) Advantages

Reduced overall cost (this depends on the relative cost of the benefits
generally the cover seems to be improving but LTC can be a wild card)
Reduced administration costs.
All employees of combined company have same benefits; this can help
corporate identity.
Package may be viewed as more attractive, so easier to attract new staff
Benefits are limited to members and dependants and no longer cover parents.
If PP has good claims experience, may attract good overall scheme rate.
More corporate bargaining power.
Increase credibility in larger scheme; future costs easier to predict.
Disability treated quicker under PMI so employees are likely to return to work
more quickly.

Disadvantages

Overall cost of scheme may be increased.

Professional costs of the merger and communication exercise.
Problem of dealing with employees who feel that benefits have been reduced.
No longer any cover for parents.
May have to deal with LTC claims in payment. What happens if claimant
recovers and is then sick again?
Claims history for PP may make insurance expensive.
Late reported CI claims.
Problem of two identical claim events, one before and one after the change
date, being treated very differently (e.g. diagnosis of cancer).
Inconsistency of new salary definition of FS staff with FS pension plan and
possible overlap of benefits with provision of ill-health benefits.
Likely increase in PMI claims when replacing cash plan.
Redundancies in merged scheme increase potential for PMI claims.

(ii) Advantages

PMI arrangement is indemnity (has no excess) so the individual will not have
to contribute own funds.
PMI more comprehensive.
PMI covers dependants.
IP provides cover for wider range of disabilities e.g. back problems, mental
problems.
IP benefit is payable throughout the duration of disability so better matches the
loss of income.

Disadvantages

CI benefit may be greater for the same disability event in FS scheme.

CI provides a lump sum which may be used for capital costs (e.g. alterations to
a house).
With CI an individual can choose how to use money.

Page 3
 Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

Hospital cash plan may give individual cash while PMI provides no cover (e.g.
dental and optical cover).
May be required to provide medical evidence for the new benefits.
Other insurance may have been bought to fit in with scheme benefits.

(iii) (a) Generic premium basis for both IP and PMI will include:

Risk premium calculation including

Burning cost / Experience rate element

Book cost / age rate element
Adjustment from risk premium to office premium

Burning cost / experience rate calculation will need to take account of:

Inflation in expenses
Inflation in PMI average claim size
Legislation
Recruitment/dismissal
Growing inclinations to claim
Changes in benefits

You will need to analyse trends.

You will need something on employer s discretionary insistence.
This will be applied to the prospective exposure.
What activities/occupations will continue into the future?

Book cost / age rate calculation will need to take account of:

Specific profile of scheme membership

Applied to a set of tables

Burning rate and book rate combined using credibility approach

Dependent on scheme size

From future risk premium to unit office premium

Then for the quote, you will want information about expenses,
including:

Commission
Margins
Cost of capital
Profit
Cost of reinsurance
IPT (PMI)

Also need to consider competitors rates.

Page 4
Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

(b) In providing the specific quotation consideration would be taken

of:

Book rated scheme membership profile requirements

Scheme members may differ in key risk characteristics
Health and Safety arrangements
Free cover for IP
Term of contract
Impact of unemployment/redundancies
Sex
Age
Does employer have no-smoking policy?
Occupation mix
Ratio and composition of dependants
Location
Salary (for IP benefit levels)
Brand new arrangement historical data may not be particularly
relevant.
Long-term sickness absence records (IP has 26 week deferred period).

Specific Experience related requirements include:

Exposure past and coming year broken into homogeneous subgroups.

Benefit details past and coming year.
Past claims by product by homogeneous subgroup.
This will help you calculate the historic burning cost.
Large or unusual claims (if likely to recur).

Final adjustments

The new scheme

Are there different levels of initial health screening operating currently
between the various schemes?
Will the future selection procedure for employees be different?
Differences in claims control procedures.
Do we need ancillary services to run a new line: rehabilitation
counsellors, on-line claims assessors etc?

Other considerations

Not all insurers might be authorised to write each of the policy types
on offer.
We are in competition to write this business. Do we pare margins?

Page 5
 Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

(iv) 1. Restrict benefit

IP Extend deferred period

Strengthen definition of disability
Remove any escalation of benefit
Reduce expiry age
Reduce percentage of salary
Increase exclusions e.g. working abroad

PMI Restrict choice of hospitals

Reduce upper limits
Introduce excesses
Fixed benefits, not indemnity
Pre-authorise claims
NHS-waiting times before private access
Eliminate aspects of cover: e.g. recuperation, out-patients,
alternative treatments
Increase exclusions e.g. exclude treatment abroad

2. Stricter underwriting at entry / on transfer

Pre-existing exclusions
Full underwriting
Lower free cover limit (for IP)
All scheme members must re-apply
Scheme becomes compulsory not voluntary

3. Restructure scheme

Alter benefit structure for different groups of employees e.g.

management continue as is, but workers get reduced benefits as
above.
Proportionate benefits
Linked claims
One scheme, but restructure eligibility.
Reduce policy term/guarantees
Change definition of salary
Introduce profit sharing
Deduct other income
Reduce benefit after a period

4. Abolish dependants benefits

5. Introduce member contribution if none before

Page 6
Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

(v) The transfer is voluntary, so some underwriting will be required by the new
insurer to prevent anti-selection.

Employee agreement will be required to join the Scheme.

PMI

As the group is large enough then Medical History Disregarded may apply.
A declaration of being Actively at work may be required.
Or pre-existing exclusions may apply subject to a moratorium basis.

Group IP

As the group is large enough then free cover will apply.

A declaration of being Actively at work will be required.
Benefits for Directors and Senior Staff may be above free cover.
If so, will be underwritten as per Individual IP.

(vi) Self-insured means that the company takes the risk

and does not use an insurer for the total risk.

PMI needs to use a Medical Trust

as self-insurance creates a tax charge on benefits paid to the recipient.

An alternative is to use a captive

or cost-plus arrangements.

IP can be self-insured by the company although the company will be unable to

create a claims reserve acceptable for tax purposes.
so the claimant is in a weaker position on company wind-up than for an
insured scheme.
Also loses ability to offset insurance premium against gross profits (treating
them as a trading expense) even if there are no claims.
An alternative is to use a captive.
Need policy wording.
Deals with local hospitals.

(vii) The insurance risks are:

Parameter Error
Actual morbidity is greater than expected.

Process Error
Random variation around expected incidence.

Specification Error
Error in the choice of model structure, in this case morbidity level.

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 Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

Other risks include:

Expense risk
Costs too much to administer.

Administrative risk
Specialised system needed.

Data risks
data quality is poor

Parameter and specification errors can be dealt with by stop loss insurance.
Process error can be dealt with by surplus reinsurance.
Expense, administrative and data risks can be dealt with by the use of a
specialist Third Party Administrator, perhaps with a fixed cost contract.

Investment risks
if it holds reserves
manage with close matching

Credit risks
if it uses third parties
mitigate by using credit rating, vetting, break clauses in contracts,
credit insurance

Enterprise risks
in any case

Currency risks
on liabilities abroad
manage by close matching of assets

Insurance/reinsurance of some of the larger benefits.

(e.g. surplus reinsurance (capping the retained benefit) or some form of
extended wait (e.g. purchase insurance with a long deferred period)
May look for excess loss cover for PMI
Possibly purchase some form of catastrophe cover
Use of other out-sourcing arrangements.
Medical expense inflation greater than expected
e.g. buying power effectively reduced.
Inappropriate claims more difficult to decline
outsource claims control; need documentation.
Improve working environment.
Build in margins.
Apply entry criteria to reduce anti-selection.

Page 8
 Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

2 (i) Key issues are profitabilility, volumes, market profile, office strategy.

Size of potential market

No. of distributors
No. of schools
Whether compulsory
Likely parental take up

Are there existing providers in this area?

If so, is it profitable?
Is this additional business or competition with others for the same pot?

Systems development required

Consistent/compatible with current distribution

Need to train sales teams/distributors

Need to consider commission requirements

Is it badged?
Is there a reputational risk?
Is reinsurance available

Legal issues

Writing IP on life of child

Who holds policy?
Who pays premiums?

Forms of underwriting/screening anticipated likely to be limited. Can this

be managed (pre-existing condition exclusion)?

Pressure to pay out from schools.

How does this product fit with overall business plan, company culture and
strategy.

How would you price this business any similar experience?

Childrens benefits particularly difficult

Company expertise and experience is this relevant?

(ii) The target here is to reach suitable risk premiums and then load for expenses
and margins.

Thus need data that is relevant, reliable, credible and useable.

Page 9
 Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

Investigate if such a product exists in the local or similar market place.

If yes, investigate the following data items:

Policy conditions
Underwriting practices
Claims acceptance procedures
Volumes of premium by year and by scheme
Volumes of claims by year of inception, by age of claimant
No. of schools
Commission paid
No. of lives insured, split between parents and children
Media commentary on product
Expenses incurred
Persistency of particular schemes
Profit emerging
Reinsurers/consultants may help with detail
Else make approximations on published data: Report and Accounts, FSA
Returns etc.

If no, initiate customer research.

Investigate own portfolio for nearest equivalent.

Analyse keep components for premium calculation as above.

Establish base product risk features.

Policy conditions
Benefit levels
Approaches to underwriting
Claims acceptance processes

Adjust information as above to make it relevant.

Differing conditions, procedures of external providers etc.

Changes in approach from own historical data
Trends in claim inception or claim termination levels
Changes in legislation or other external market/economic factors

Calculate exposed to risk suitably subdivided.

Subdivision will depend on volume of data.

Subdivision will depend on market approach to rate differentiation.
For example, different rates for girls and boys schools, different rates for
schools by region.

Page 10
Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

Estimate the equivalent claims incepting.

Calculate claim inception rates, noting trends by year.

Smooth these calculated rates by reference to a published table.

Use data gathered to estimate claim termination rates.

May well need data from reinsurers/consultants or published data.

Particularly for childrens experience

Estimate suitable claim payment annuities for each inception rate.

Need to use a suitable interest rate that insurer is capable of earning on its
assets, say over a five-year period.

Establish risk premiums, noting trends. Project to mid-point for which

premiums will be payable and at which claims may occur.

Investigate levels of expenses.

Expenses of sale, underwriting, new business processing

Annual administration costs, regulation costs
Claims acceptance, payment and monitoring
Expenses incurred in developing product
Other overheads such as management time

Forecast volumes may be needed for premium loading purposes

Investigate levels of commission payable.

Investigate capital required and its cost to the insurer.

Investigate any further investment earning potential

e.g. between premium payment and point at which claims begin

Investigate potential for intermediary to sit on premiums

Incorporate margins in final premiums.

To reflect approximations/unknowns in earlier calculations

To reflect insurer s attitude to risk
To reflect any short term guarantees given

Establish insurer s profit requirement or return on capital.

Page 11
 Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

Model business forward to assess whether criteria are met.

iterative process
may use stochastic processes
may use deterministic model, allowing for certain extreme scenarios

Recalculate with final adjustments.

To reflect competitive position in market (if product exists)

Size of premium against school fee payable
Any reductions must be consistent with margins built in

Other practical considerations areas for investigation.

Will we know the number of parents, the ages of parents, the sex if single?
Need to investigate current and potential childhood diseases.
Need to know anticipated future levels of fees by school insured.
Degree of compulsion . Who pays? Is it voluntary? Can parents opt out?
Will we get any occupational information?

(iii) New business

Key factors are:

Life covered (parent, child, 2 parents)

Sex
Age of child/parent
Level of fees
School of child
Intermediary (it may only be one!)
Level of underwriting

Morbidity

Inceptions
Recoveries

Lapses

May be able to analyse lapses and claims experience in similar way to new
business (although claims may not be that credible)

Expenses

Investment returns

Profit

Mortality is not an issue with this product.

Page 12
Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

Could analyse homogeneous subgroups.

Depending on volume of data/credibility (not distribution channel as

presumably sold through one intermediary).

(iv) Advantages to insurer

CI event depends on incidence only thus lower expenses in claim

payment.
Better data available for pricing
Less susceptible to pressure to pay if claims condition more objective.
Less underwriting

Disadvantages to insurer

Problems with benefits

Should the product provide balance of fees on leaving school?

Does school take inflation risk?
What waiting period should be used?

Advantage to parent

Lump sum more attractive

Can move school if necessary (if benefit paid to parent)
Allows flexibility in use of money
Insurer cannot cut off benefit
More insurers offer CI than IP so likely to be more competitive market
No deferred period

Disadvantage to parent

Does not provide the protection required e.g. if illness not covered by CI
policy.
Does not cover further episodes, once benefit proceeds are spent.

Advantage to school

Fees are paid by insurer for balance of school career (presumably) cash
in hand.

Disadvantage to school

Money may not get to the school if one lump sum covering many years.

Advantage to distributor

Lump sum can make CI an easier sale

Page 13
 Subject SA1 (Health and Care Specialist Applications) April 2006 Examiners Report

Disadvantage to distributor

On the other hand, does not best fit the need which is income over period
of schooling, so maybe more difficult to sell.

Other interested parties (e.g. reinsurers, regulator) may be happier with CI.

END OF EXAMINERS REPORT

Page 14
Faculty of Actuaries Institute of Actuaries

EXAMINATION

11 September 2006 (am)

Subject SA1 Health and Care

Specialist Applications

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 both 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
SA1 S2006 Institute of Actuaries
1 You are a consulting actuary undertaking a piece of work for a small life insurer,
Healthcover4 Life, which has hitherto specialised in the provision of individual
income protection and critical illness policies. Initially the company focused on
selling its policies as part of the mortgage process within smaller building societies.
More recently it has also distributed policies through intermediaries. All policies sold
by the insurer have reserved the right for Healthcover4 Life to change the premium
that the policyholder pays.

The Finance Director is concerned at a possible deterioration in claims experience and

has asked you to undertake an investigation.

Following a recent Board meeting, the Managing Director has sent you the following
email.

To: Actuarial Consultant

From: MD, Healthcover4 Life
Subject: Claims Deterioration

Further to your brief received from my Finance Director last week I would like to add
my own concerns. The financial management information pack that was circulated
shortly before last week s meeting showed the following trend:

Average claim per policyholder:

2001 2002 2003 2004 2005

£200 £245 £255 £290 £350

It would appear that, despite strengthening the reserving basis in 2003 and 2004, our
claims experience continues to deteriorate. I am aware from discussions with my
counterparts in other organisations that the market premium for this type of business
is £300 £350. This seems to indicate that from next year our portfolio will be loss-
making.

As part of your remit, can you outline the options available to me to redress the
situation? Given that we have the right to change our prices, a premium increase
would appear to be a natural course of action. Naturally, I am keen to ensure that we
are able to rectify the in-force position without prejudicing our competitive position
for new business.

More broadly, in my position I have a keen interest in the implications that this has
relating to the efficacy of the control systems in the company. I would welcome your
views on this also.

Kind Regards

MD

(i) Outline briefly whether the MD has cause for concern with regards to claims
costs. [2]

(ii) Outline any additional data you would require and any additional analysis you
would need to undertake to assess the claims experience of the portfolio. [10]

SA1 S2006 2
 (iii) Describe potential causes of the claims trend, drawing on the information
provided in the question. [5]

(iv) Outline the principles underpinning the FSA, FOS and ABI joint guidance on
reviewable long-term protection policies issued in May 2005, coupled with the
practical implications of the guidance for insurance companies. [7]

(v) Suggest possible implications of this guidance on the current situation. [3]

In response to the comment relating to control systems:

(vi) Outline the key elements of the actuarial control cycle as they would apply to
the provider, describing how they interact. [5]

Your investigation shows that there has been a genuine deterioration in claims
experience as a result of the new distribution approach.

(vii) Outline the strategic options available to the MD, together with their
implications. [18]
[Total 50]

2 You are a consultant actuary, who is providing advice to an employer concerning his
company s healthcare insurance needs.

The key details for the employer are:

800 employees working in factories mainly based in the UK but with 25

employees overseas
200 employees focussed on administration
10 management
3 directors

The company provides the following benefits:

Pensions For management and directors, a final salary pension arrangement with a
retirement age of 60. The other employees are provided for from a money purchase
arrangement with a retirement age of 65.

Death benefits For all employees, 4 times salary is paid out on death in service.

Sickness pay On sickness, for management and directors, the company will pay
out full salary for 6 months. For other employees, the company will pay out full
salary for 3 months and then 3 months on half pay.

No other health related benefits are provided.

(i) Describe the basic needs that healthcare insurance products meet for
individuals and employees. [6]

(ii) Discuss, with reasons, the types of healthcare insurance products most likely
to meet the employer s requirements. [4]

SA1 S2006 3 PLEASE TURN OVER

 The employer is particularly interested in group income protection business and has
asked for further information regarding how these products would generally be priced.

(iii) Suggest, with reasons, a suitable schedule of benefits for a group income
protection quotation for the employer. [3]

(iv) List the data required by a life office for pricing group income protection
business. [5]

The employer is also interested in offering individual income protection business

through worksite sales to their work-force.

(v) Describe the investigations that the insurance company would undertake to
determine the price of their individual income protection business. [15]

(vi) Describe how group income protection business would be generally priced and
how the investigations would differ from those for individual income
protection business. [8]

(vii) The employer is concerned regarding the cost of group income protection
business and has suggested that they retain this risk internally. Discuss the
key advantages and disadvantages of this approach. [5]

(viii) The employer is also the owner of a Premiership football club and has asked
you to consider their healthcare insurance needs. Describe the key factors you
would consider and which products would be suitable. [4]
[Total 50]

END OF PAPER

SA1 S2006 4
Faculty of Actuaries Institute of Actuaries

EXAMINATION

September 2006

Subject SA1 — Health and Care

Specialist Applications

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 A Stocker
Chairman of the Board of Examiners

November 2006

Comments

In both questions, candidates who approached the problem, 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. Generally, candidates lost marks by
giving insufficient detail in the answers. Usually each valid point in the answer would
normally attract ½ marks whilst 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
health insurance market reinsurance is not a panacea for all evils.

© Faculty of Actuaries
© Institute of Actuaries
 Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

1 (i) Cause for concern?

Insufficient information to tell — the MD’s claims trend is not necessarily
a deterioration in experience
Need more detailed investigation as to what the figures are
Strengthening reserving basis may indicate an underlying deterioration
since the policies were priced
The strength of the reserving basis will increase, not reduce, the average
claim per policy, if the numerator of the calculation includes both claims
paid and statutory reserves.
The growth in average claim size is significant. One might have expected
recent distributional changes to have worked through to claims more
gradually, especially with a six-month deferred period
Is the portfolio ageing on average (or any other demographic change that
could increase claims eg higher occupational class mix)?
What has happened to the company’s premiums; they may be higher than
the industry average.
Need to check accuracy of figures
Comnparison of claims experience against expected claims costs
Effects of selection

(ii) Additional analysis

Should be regular claims investigations
Typically quarterly
New claims / existing claim portfolio separately
Incidence and claims cost separately
Actual experience v expected
Important to subdivide data to assess trends and any causes
But need to consider credibility of data.
Especially as small insurer
Analysing trends in components of healthcare costs is vital
Investigate IBNR/RBNS
Output from previous premium reviews
Supplement with external data — published data, rates from consultants
or reinsurers — calibrate to own experience, where possible

Subdivision of data
Morbidity
Subdivision:
Product type
All products
Policy type
Sales channel
Age
Sex
Occupational class
Region / area
Duration from entry
Underwriting method
Level of benefit

Page 2
Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

Income Protection
Investigate inception rates
And recovery rates
Deferred period
Incapacity
Critical Illness
Cause of claim

Mortality
Mortality needs to be investigated
Pre and post claim
On some policies (e.g. Acc CI) death triggers claim payment
On others a release of reserves

Consider rest of market

Economic and demographic trends for this portfolio
Advances in medical science

(iii) Changes in mix of business from any of factors in (i)

Particularly
Sales Channel. We are now selling through intermediaries.
Different policy type. Previously sold alongside mortgages
Higher claims through greater anti-selection?
Greater market knowledge as increased sales through intermediary
Reduced positive selective effect of mortgage purchase
Higher sums assured
Intermediaries — higher net worth individuals
Sales alongside mortgages may have lower sums assured as only
cover mortgage amount
Higher average age — mortgage purchasers younger/intermediary
purchaser older

Strengthening of reserving basis

Increase claims figures if used to calculate outstanding claims
Particularly for IP where claims paid for long periods (so earlier
period claims still relevant)

Shorter deferred periods

Higher replacement ratios
IP benefit escalation rates
Change in incapacity definition
Reduction in survival period for stand-alone CI
Later cessation ages
Weakened underwriting
Weaker claims management

Random fluctuation
Relevant as we are described as a small insurer
Falling interest rates so IP annuity factors rise
Competitors use more rating factors

Page 3
 Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

(iv) Principles
The FSA Statement of Good Practice, the position of the FOS on existing
business, ABI advice and companies’ own processes should mean that
consumers get:
• clearer explanations of what reviewability means and why (or not) they
should choose it against guaranteed rates
• greater confidence that review increases or decreases were calculated
fairly
• continued availability of reviewable rate products in the future
• ability to buy valuable protection at a lower price than would apply to
similar cover if sold at guaranteed rates
• access to new forms of protection that insurers might not otherwise be
prepared to offer.

Practical implications
• Where premiums are reviewable, this should be prominently shown in
product literature
• and the basis for reviews should be clearly set out.

• Insurers should base reviewable premiums on assumptions that they

believe are valid for the full term of the policy.
• The assumptions on which premiums are based should be reviewed
regularly.
• The assumptions used for in-force business should be consistent with
those used for new business with justifiable grounds for any
differences.
• At reviews, premium increases can only be made if the insurer changes
one or more of the relevant assumptions stated in the policy for “valid
reasons”
• At reviews, insurers should not aim to recoup earlier losses from
claims.
• When a premium changes as a result of claims experience (and
expected future claims) it should be made clear that this does not relate
to the claims experience of the individual policy holder but to the
general claims experience for similar policies
• Policy reviews should always take place as specified in the policy.
• The results of the review should be notified to the customer.
• If premium rates increase as a result of a review, individual customers
may be given the option to continue paying the same premium but
reduce the sum assured instead.
• Where insurers offer a policy with a choice of guaranteed or reviewable
premium types, an explanation of the differences should be given.
• Insurers should keep records of the assumptions used to calculate
premiums and analyses undertaken to support reviews.

Page 4
Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

(v) Implications for this company

• Although not mandatory, it is advisable to follow statements of best
practice
• Company should ensure that for policies already sold the literature was
clear
• Analyses should identify valid reasons for increase in premiums
• In particular, investigations should demonstrate that the assumptions
require amending. Should not be used as a mechanism to recover
earlier losses from claims.
• MD appears to wants to review existing rates without increasing new
business rates
• Need to ensure consistency between NB and in-force
• But may be different if there are justifiable grounds
• Discussion relating to practical implications of amending processes and
record keeping

(vi) Product design — change policy or premium conditions

Pricing — setting a price according to a valid set of assumptions
Marketing / Sales — changing policy literature, remuneration structures
Underwriting — change mix between 0/r, rated or declined, automation,
more or less internal control
Claims Management — increased training, tighter control of both
acceptance and payments
Experience Monitoring — comparing actual v expected
Competitors/regulation

Links
Product Design to Pricing
Pricing to Marketing/Sales
Marketing/Sales to Underwriting
Underwriting to Claims Management
Claims Management to Experience Monitoring
Experience Monitoring to Valuation
Experience Monitoring to Pricing
Valuation to product design
Competitors/regulation to Pricing
Marks were also given to candidates who followed the approach outlined
in CA1 which, as well as the above, discusses specifying the problem,
developing the solution, monitoring the experience and professionalism.

(vii) General points

Need to understand profitability by sales channel (not just claims trends)
Need to understand costs of distribution and servicing by channel
Particularly levels of commission paid
Does volume of business justify lower profit per policy?
Consider competitors approaches
Discuss reinsurance/changes with reinsurer
Insurer should consider if they have any competitive advantages

Page 5
 Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

Strategic options
Concentrate on area of means of distribution with most profit potential
• Will save on expenses
• Will concentrate management effort
• In theory will maximise profit
• Will eliminate diversification
• Will cause market/policyholder ill-will
• Will reduce volumes and spread of overheads
• May not meet with shareholders’ requirements
• May have to write off investment in developing business

Increase premiums for in-force

• Implications covered in part (iv)

Increase premiums for all new business

• May correct any under-charging in current rating structure
• May need additional features to soften blow
• May lose new business
• May need to keep increases within market levels
• Effect on premium revenue depends on elasticity of demand
• Needs negotiation with distributors who may have difficulty with new
rates if out of line with the market

Introduce differential pricing between building societies and intermediaries

for new business
• Fewer subsidies — each policy pays for itself, expenses and claims
• Office’s profit is independent of source of business and is indifferent of
volumes in each risk cell
• Reductions may not produce new business, while the increases will
certainly deter portfolio growth

Introduce differential pricing between building societies and intermediaries

for in-force business as well
• May cause significant changes in individual premiums charged to in
force business
• Reductions may be offered where unnecessary to retain the business
• Elsewhere significant increases will cause lapses
• Big TCF/PRE issue
• Similarly may cause dissatisfaction with distributors who have to
explain reasons to policyholders
• May need reinsurer’s buy-in to new basis (if reinsurance is O/T)

Close unprofitable portfolio

• Expense saving
• Concentration of management effort
• Potential release of capital
• Managing run-off book may be expensive, with worst business
persisting

Page 6
 Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

• Selling run-off book may be difficult and may require enhancement of

reserves
• Distributors may not be happy and may not now support remaining
product
• Loss of EV and goodwill
• Shareholders requirements?

Consider alternative means of distribution

Amend commission payments so that intermediated business remains

profitable
• Risk of reduced business if not market proximate commission

Identify strongly performing intermediaries and deal exclusively with them

• Limits potential market
• Likely to be impacted by random fluctuations
• Upset distribution partners

Change terms and conditions through intermediary channel

Reduce level of benefits provided by the product
• May make product less competitive
• May not meet customer needs
• Dissatisfaction from intermediary IFAs
• May reduce sales

Stricter medical underwriting through intermediated channel

• Improve questions
• Stronger internal controls
• Increase automation
• Complexity of dual processes — likely to be applied to all channels

Stricter financial underwriting

Stricter claims management

Stop selling poor performing product line through intermediaries

Review competitor strategies

2 (i) Income
Replacement income when off work
Provision of assistance when spouse disabled
Locum cover for single person protection
Specific income needs e.g. pension contributions, national insurance,
mortgage repayments, policy premium, LTC

Meet cost of expensive healthcare where State does not provide

To provide immediate care/surgery where the wait is too long
To provide choice of best consultants/ hospitals

Page 7
 Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

To provide a savings vehicle with payout linked to disability

To offset capital needs on extreme disability
Vehicle for early retirement
Change in lifestyle as a result of disability or illness

To minimise time off work

To help meet cost of recuperation

(ii) Rationale
Employer requirement is to minimise absence from work of employee
by reason of illness or injury
or illness or injury of spouse
Provision of health benefits
Encourages employee loyalty
Aids recruitment

Group PMI
Meets employer needs
provides treatment for acute conditions in UK
need full cover — acute and chronic overseas
employee who is ill can be treated quickly
same applies to employee’s dependants

Group IP
Meets employer requirements in provision of sick pay for employee
Overseas staff will require full coverage
Can provide longer IP benefits for permanently ill employees

Group CI does not match requirements

Group LTC does not match requirements

Keyman IP
Can be used to cover key staff
Whose absence directly affects employer’s profitability

Short term sickness and accident

Meets some but not all sick pay requirements

Group Dental
Provides cover — useful in areas where there is a shortage of NHS dentists

(iii) A suitable schedule might include:

2 categories — management and directors, other employees (note may
need to separate out those overseas employees — benefits may be
different)
Deferred period — management & directors 6 months,
other employees split 50% for 3 to 6 months and then full from 6 months
Benefit basis: (75% salary — State incapacity benefits) OR 50% salary.
Termination age — 60 for management and 65 for employees

Page 8
Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

May need to consider age discrimination laws here

Escalation of benefits — RPI to provide some link to salary
Proportionate/rehabilitation
Counselling services
No u/w — actively at work requirement or limited u/w cover
Free cover

(iv) Data
IFA — Broker
Commission basis

Employer details
Name of employer
Location where employees work and numbers
Nature of business
Eligibility
Occupations — mix — professional, supervisory, skilled, semi-skilled,
unskilled manual
Sales reps — driving > 18K miles p.a.

Cover required
Basic benefits — deferred period
Escalation of benefits
Basic benefit basis e.g. 50% of salary, 75% of salary less state benefits
Salary definition
Guaranteed period
Free cover level and treatment of cases above this
Supplementary benefits
Pension contributions — employer and employee
National insurance
Commencement date
Renewal date
Aids cover
Continuation option
Are benefits in payment to be limited
Is PMI available? If yes, may give discount

Are there employee helplines available?

Has the scheme been previously insured?

If so, who by and details of cover

Claims experience
Scheme exposure — past 5 years, number of lives, salary roll (split by
category if poss)
Current claims details — date of birth, sex, inception date, cause of
incapacity, benefit amounts.
Ceased claims (same info + date/reason for cessation)
Rated lives and details
(v) Morbidity

Page 9
 Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

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.
Compare own data with that from other sources over the same time period,
in both the home market and in the overseas territory:
Industry data e.g. from insurers’ associations
Data from reinsurers
Published tables based on insurance experience
Population figures and government health statistics
Assess the level of adjustment needed to the local data (which may be
more plentiful) to make it relevant to the prospective overseas market.
Ratios may be appropriate initially but margins will be needed.
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.
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
Further adjustment needed to align different target market with that
underpinning the base data.
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 the above.
Data needs to be interpreted with care
For IP, need to split pre-claim and in-claim mortality

Investment
Assess level of potential investment return on the assets backing this
portfolio, dependent on where the assets are held.
Allow for currency differences.
Include net of direct investment expenses

Expenses
Start with company’s most recent inhouse expense analysis.
Allow for trends if this is an annual exercise

Page 10
Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

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.

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.
Ensure appropriate to the distribution channel.
Adjust data if target market is different from those underlying the above
researches.
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.
Make allowance for any tax liability in overseas territory, including
premium sales tax

Profit
Include company profit criteria, commensurate with underlying risk of
venture — risk discount rate, PVFP, pay back period.

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.
Assumptions and strategy

Page 11
 Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

The values of the assumptions and the premiums that they produce will
reflect the company’s strategy in launching into the new market:
An aggressive growth strategy may require assumptions stripped of
margins.
A slow portfolio build strategy may permit more caution in the
assumptions.

(vi) General Comments

Group Income Protection will generally be priced using unit rates which
are scheme specific.
The unit rate will however be calculated based upon the expected
experience of the scheme based upon the insurers previous experience of
similar schemes.
and allowing for the profile of the scheme e.g. age, sex, occupation profile.
Some Group Income Protection business may also be single premium
costed where rates are calculated for each individual covered.
Book rates
Credibility formula
This would generally be used for cover above the free cover limit
and for partnership schemes.
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.
For specific schemes, would analyse their own claims experience.
Potentially use loss ratio analysis.

Investment
Note short term contract — limits potential for investment of premiums

Commission
Note many brokers may be on a fee basis, so may quote net of commission
rates.

Lapses
Generally 2 yearly renewable contract.
Analyse expected renewal rate.

Competitors rates
Note there would generally be a competitive tender process but may not be
aware of competitors’ rates for GP.

(vii) Self insured

+ any favourable experience will benefit the company
+ not paying out commission to broker
+ not having to pay insurer’s profit margins

Page 12
Subject SA1 (Health and Care Specialist Applications) — September 2006 — Examiners’ Report

+ control over all aspects of the benefits (not limited to what is available in
the insurance market)
− risk remains with the employer hence poor experience will impact
directly on the company
– smooth results
– lacking expertise in managing group income protection claims
– claims adjudication expertise required internally
– lack benefit design expertise
– lacks other services provided by insurers e.g. employee assistance
services
– less protection on claims following liquidation, takeover or sale

(viii) Key issue — the footballers are the assets of the football club.
Key concern that unable to play and have to continue to pay their wages.
Footballers generally very highly paid.
Medical costs not large relative to players wages.
Some form of income protection cover to cover their wages on incapacity.
Cover for limited period to meet the players contracts.
Due to large risk, may consider exclusions.
Also need to consider non footballers.
Management — key person cover.
Staff (e.g. groundsmen etc.) — protection in the event of illness — Group
Income protection/PMI cover
Availability of cover — how insurable is the risk?
LTC possible need but not likely to be available
Sports clinics, international physiotherapists, surgeons etc; may not be
insurable

END OF EXAMINERS’ REPORT

Page 13
Faculty of Actuaries Institute of Actuaries

EXAMINATION

18 April 2007 (am)

Subject SA1 — Health and Care

Specialist Applications

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 three 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
SA1 A2007 © Institute of Actuaries
1 You are a consultant actuary, based in the country of Actuaria, undertaking a piece of
work for the finance director of a large insurer which provides income protection and
critical illness policies on both a group and individual basis. The group policies also
include voluntary business, where the employee can choose whether or not they wish
to purchase the benefits.

(i) Describe how the insurer’s products meet the needs of employers and their
employees. [8]

(ii) Describe how group income protection would generally be priced. [8]

In Actuaria, employees are currently required to retire at age 65. The government of
Actuaria will shortly be introducing legislation which requires that:

(a) employees, if they wish, are able to work until they are aged 70

(b) employers are not allowed to discriminate in respect of age in the

benefits that are provided to their employees

The finance director has requested advice on this new legislation.

The insurer is looking at revising the provision of group income protection benefits in
the light of the new legislation.

(iii) Discuss the key issues and investigations which need to be considered in
determining your response to the finance director regarding group income
protection business. [10]

(iv) Discuss the key areas where your answer in (iii) would have differed if you
had considered individual income protection business. [4]

Several employers have existing group income protection claims with the insurer
which will terminate when the claimant reaches age 60 (five years before the current
retirement age). These employers would like to extend these claims until age 65 and
have asked the insurer to extend the claims until then.

(v) Describe the investigations that you would undertake to determine a price for
extending claims to age 65. [10]

The finance director would also like to consider both individual and group critical
illness. Note these products are similar to those offered in the UK market.

(vi) Discuss how your response to (iii) above would differ for critical illness
business. [4]

The government is also considering introducing legislation which will make it illegal
for insurance companies to discriminate between men and women in their
propositions.

(vii) Discuss how this might impact on the providers’ products and prices. [6]
[Total 50]

SA1 A2007—2
2 You are a consulting actuary in the United Kingdom with an extensive knowledge of
Actuaria and its health insurance market.

An existing client, the Actuaria Health Insurance Company (AHI) writes business
exclusively in its home country of Actuaria. In many respects, Actuaria is similar to
the United Kingdom including an extensive state medical insurance scheme. Actuaria
has a thriving health insurance industry with a number of local insurers writing
private medical insurance, critical illness, income protection and pre-funded long-
term care insurance.

There are no international insurers operating in Actuaria. However, there are no

domestic reinsurers and a number of international reinsurers provide reinsurance
facilities to the local Actuaria health insurers.

In a recent general election, a new government came to power under its Prime
Minister, Professor Dalek. Professor Dalek is an expert on foreign exchange markets
and was elected primarily on a party platform of solving the long standing shortage of
foreign exchange for Actuaria. The Prime Minister has noticed that there is a
substantial use of international reinsurance facilities by the domestic health insurers.
He has proposed new regulations to apply from 1 January 2008 restricting the amount
of reinsurance that can be ceded to a reinsurer to 5% of premiums.

AHI has contacted you and asked how it might cope with the new regulations
regarding reinsurance.

(i) Outline the information you would require from AHI in order to draft your
reply to their request. [10]

(ii) For each of the four health insurances written by AHI namely private medical
insurance, critical illness, income protection and pre-funded long-term care
insurance, discuss, with reasons, what reinsurance AHI should seek to
purchase in future. [10]

The Prime Minister’s Office has indicated after extensive lobbying that the limit
might be increased from 5% of premiums.

(iii) List the points your client should include in a letter to the Prime Minister
extolling the virtues of being able to reinsure a significant element of a health
insurance portfolio. [10]
[Total 30]

SA1 A2007—3 PLEASE TURN OVER

3 You work in the actuarial team within a life insurance company. As part of a regular
audit process you have been asked to review claims management of the income
protection portfolio.

(i) Describe how the claims management approach interacts with the other
departments within an insurance company. [5]

(ii) As part of the investigation you have been asked to review the following
specific cases.

Case A Claimant is a relatively new teacher who is suffering from a stress related
condition. Unable to work as a teacher and is claiming under an “own
occupation” definition. Disability counsellor advises that claim is genuine
and claimant keen to return to some form of work.

Case B Claimant has been in local press being awarded a prize for being leading
scorer in local football league. Has been claiming under an ADL definition.

Case C Claimant has been suffering from a knee injury for 5 months. Is claiming
under a linked claims policy condition on a policy with a 12 month deferred
period as policyholder was previously absent from work for 15 months with
a broken hip. Policyholder is a manual labourer under an “any occupation”
definition.

Case D Claimant is unable to undertake any work due to a degenerative heart

condition, which was known to the claimant at the time the policy was put in
force. The claimant is a member of a group income protection scheme that
applies an “any occupation” definition and has a free cover limit in excess of
the claimant’s salary.

Comment on the key aspects of each claim together with the options available to
manage the claim in payment. [15]
[Total 20]

END OF PAPER

SA1 A2007—4
Faculty of Actuaries Institute of Actuaries

EXAMINATION

April 2007

Subject SA1 — Health and Care

Specialist Applications

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 A Stocker
Chairman of the Board of Examiners

June 2007

© Faculty of Actuaries
© Institute of Actuaries
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

Comments

Candidates who approached the problems, 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. Generally, candidates lost marks by giving insufficient
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. Usually each
valid point in the answer would normally attract ½ marks whilst the more basic elements e.g.
details in a pricing basis such as age and sex, would attract ¼ marks.

Some papers were not clearly marked as to which part of the question was being answered.

Marks may be lost where answers are difficult to read.

Comments on individual questions are set out below:

Question 1

Part (i) of question 1 was well answered. However many candidates answers referred
directly to the UK when the country under consideration is Actuaria.

Parts (iii) and (iv) arose from the current UK market requirement relating to the extension of
benefits beyond age 65. The answers were often disappointing, little thought being given to
whether insurance might be required.

Many candidates failed to realise that part (v) referred to an existing block of income
protection claims where full details of these claims would be known. Many answers just
repeated the standard set of assumptions for pricing income protection business.

Part (vii) referred to the requirements of unisex pricing, terms and conditions. Candidates
gave their own opinion on the effect on prices but often failed to consider the overall impact
of the legislation.

Question 2

The examiners have noticed that in previous examinations the stock answer by the candidate
if a difficult risk was offered to a direct insurer was to pass it to the reinsurer. This question
posed the problem of what decisions might have to be taken if the availability of reinsurance
for a direct insurer were to be restricted.

Part (i) was reasonably well answered but marks were lost in places for lack of detail.

Part (ii) was poorly answered as candidates failed to appreciate the fact that:

(a) the amount of reinsurance was going to be restricted to 5%, and

(b) the reinsurers might not offer in Actuaria in future the full range of reinsurances
normally available

Part (iii) answers were often lacking in detail.

Page 2
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

Question 3

An actuary specialising in health insurance needs to have a working understanding of the

technical and practical issues in underwriting, administration and claims. This question
looked at two issues in income protection claims.

Part (i) looked at the relationship of claims management with other departments of an
insurer. The question was usually reasonably well answered but again marks were lost in
places for lack of detail.

Part (ii) set out some simple scenarios that arise in income protection claims. It was
designed to test the candidate’s ability to apply the product knowledge to these scenarios.
Whilst a few good answers were received, several were not. It was clear that some
candidates did not fully understand the product.

Page 3
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

1(i) Employer needs:

Protect workforce,
Keyman / locum cover
Minimise awaytime
Attracting staff
Tax relief/allowable benefits
Value: cost < Σindividuals
May help the e/er meet statutory payments
Requires cost-effective way of meeting needs
Cap cost if otherwise met from other funds

Employee needs
Replacement income when the insured is off-work
depend on how long the employer will pay and for how long
the State will pay and at what levels.
Benefits provided are not indemnities

IP
Finance to speed recovery and provide home help as required.
May provide rehabilitation services to speed recovery
Specific monthly outgoings — include pension contributions,
mortgage repayments, policy premiums waivers

CI
To meet cost of expensive healthcare where the State does not
provide
• to provide cash for immediate care/surgery where the wait
is too long
• to enable more choice of the best consultants/hospital
Will only pay out if illness serious enough to qualify
To offset capital needs on extreme disability
e.g. repayment of a mortgage, the settling of a partnership or
the move into specially adapted housing.

Vehicle for early retirement after serious illness

In the event of becoming unable to work ever again, his/her
financial welfare will be met.
Need to allay fears on financial destitution following inhibiting
disability

Page 4
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

1(ii) Group Income Protection will generally be priced using unit

rates which are scheme specific.
The unit rate will however be calculated based upon the
expected experience of the scheme based upon the insurers
previous experience of similar schemes.
or past experience of scheme
and allowing for the profile of the scheme e.g. age, sex,
occupation profile.

Some Group Income Protection business may also be single

premium costed where rates are calculated for each individual
covered.
Book rates — standard age/sex(?)/smoker(?) related risk costs
per £1,000 monthly benefit with adjustment multiples to allow
for other key rating factors - these are depicted by E in the
formula below
Book rates need to be adjusted for variations such as definition
of disability, location, employment, voluntary/obligatory,
where appropriate
Credibility formula of the sort Z × A + (1 - Z) × E, where Z is
a Bayesian factor to allow for statistical credibility to be
afforded to own experience (A).
This would generally be used for cover above the free cover
limit
and for partnership schemes.
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.
For specific schemes, would analyse their own claims
experience.
Potentially use loss ratio analysis.
Look to reinsurer’s and market data

Investment
Note short term contract — limits potential for investment of
premiums
But there is scope to discount claims which may have 30-year
duration

Commission
Note many brokers may be on a fee basis, so may quote net of
commission rates.
Generally follow market norm in commission allowed

Page 5
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

Lapses
Generally 2 yearly renewable contract.
Analyse expected renewal rate.
Need to be careful if amortising initial expenses beyond two
years

Competitors rates
Note there would generally be a competitive tender process but
may not be aware of competitors’ rates for GIP.

Loadings for
expenses
return on capital employed
uncertainty (to premiums generally and in individual
assumptions)
solvency
profit margins
Need to load for non-standard benefits (continuation options,
benefit escalation, guarantees etc)
Tax

1(iii) Offering GIP benefits past 65

Is there a market for this and how big is it likely to be?
There should be as employer will need to offer similar benefits
to employees above 65
Hence will seek insurance cover or will have to self insure

Investigations
• research legal opinion on implications of the legislation
• research employers and brokers views on the likely demand
for this and also what is the product that they require.

How does this fit with pension provision?

If pension benefits are paid from 65, then there will be over-
insurance.
What about ill health early retirement pensions — how are
these affected?

Product considerations
What are the actual product requirements?
Terminal age — should all employers provide all employees
with benefits to post 65 or to 65 and for those above 65, then
specific terms.

Page 6
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

Definitions of incapacity — do the existing definitions seem

sensible past age 65 or change to any occupation (post 65) for
some occupations?

Motivation to return to work — How do we ensure that

individuals are motivated to return to work if older?

With any of the above, need to take care that not discriminatory
However this is an employers issue not that of the insurance
company

Pricing considerations — different approach if voluntary or

obligatory
Data sources — government, reinsurers, overseas, products
offering benefits post 65
All of these would need to be adjusted to the likely experience
of this product for the target market in Actuaria

Medical underwriting — review non-medical and other limits

Free cover limits for post 65s

Claims issues

Implementation issues
Additional expenses
Systems requirements

Profitability requirements
Need for margins in rates

May need reinsurance help and financial protection, especially

in early years
Competitors response to legislation — careful watch of market
rates
Careful post-launch experience monitoring
Changes in sales literature and product documentation

1(iv) Individual IP

Demand in the individual market

Cost more of an issue
Need to investigate likely demand with individuals.

Page 7
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

Not legal requirement and so likely to be less demand

Product considerations
Anti-selection more of an issue — as individual chooses
whether to purchase or not
Need to be more conservative
Motivation to work without the employers help — more
difficult
Declining certain occupations
Revision of underwriting approaches
Greater need for reinsurance — longer liabilities per £ of
premium

1(v) Extending from age 60 to 65.

To determine the price we need to place a value on the current

liability and then a value on the new liability.
The difference will be the price for extending the claims to age
65.
To do this we need to consider the claim costs, expenses,
investment returns and profit/cost of capital. We may need to
consider reinsurance.
Should we calculate the current liability under each claim using
a case estimate approach
or should we look at the claims using a statistical approach?

Claim cost:
This is an existing block of business and so we will already
have a view as to the expected recoveries and deaths (required
for example, for calculating EV)

We need to determine whether there is any new data since the

basis was set:
Review latest claims experience for the business compared to
expected.
Review any new published industry experience.

Existing basis would have been set to apply to the total claims
in aggregate. Need to decide whether this is appropriate for the
particular block of claims. Will therefore want to compare the
profile of the subset of claims with the full claim portfolio. In
particular would investigate:
• Cause of claim — are the causes of claims for the subset
likely to be of longer/ shorter than average duration?

Page 8
Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

• Benefit level — how does the average benefit level and

benefit escalation rate compare with the average claim?
• How does the age, sex, occupation class, smoker status,
definition of disability and duration in force compare with
the average claim?

Expenses:
Need to determine the additional expenses. Expenses will be
increased because of the expected longer duration of claims.
We also need to consider the expenses of making the change —
updating administration records, IT costs, cost of producing the
quote, investment expenses.

Investment return:
We will have a notional block of assets backing this business.
Extending the cease age will increase the expected duration and
we need to determine how the longer duration will change the
expected investment rate.

Tax:
Are there any tax implications of the deal?

Capital/solvency margin
We will have a basis for determining the required capital
backing the claims. We can therefore calculate the additional
capital required. We need to ensure that this capital will be
available. The availability of capital is likely to depend on the
expected level of profitability of the deal.

Profit measure:
If profitability is measured in terms of return on capital then the
return needs to be high enough to attract the capital.
If there are other profit measures (e.g. percentage of premium)
then this needs to be factored in to the quote.

Reinsurance:
The existing claims block may be reassured. We need to
understand the basis of the reinsurance. Should discuss with the
reinsurer whether it would be prepared to take its share of the
extended claims and if so what premium it would charge for
this increase in reinsurance cover.

Page 9
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

Definition of claims:
We need to be clear on which claims are to be covered by the
quotation:
What do we do about claims that are currently in the deferred
period?
What do we do about IBNR claims?
What do we do about incurred but not reported terminations?

Other factors:
Will commission be payable to any third party?
What happens about linked claims?

1(vi) Typically in the UK critical illness policies do not have a

maximum age and so statistics available to age 70 and beyond
on UK (if not Actuaria) individual contracts
If do not currently provide, then would be able to consider
competitors products
Population data
Reinsurers data
Is there a need / market for this?
If yes, then need to consider likely propensity to buy
Claims criteria for CI more objective than for IP

1(vii) Uni-sex Policies

Need clarity over what this means

Product terms and conditions

Need to ensure policy conditions are uni-sex
Could potentially argue that critical illness covers illnesses
more relevant to particular sexes.
IP — occupation related no difference in product terms.

Rates
Individual major issues — rating factor for all products
Determining uni-sex rates — will require assumptions
regarding mix of business
Note target markets – ability to use uni-sex rates to competitor
advantage

Page 10
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

Group — the unit rates are uni-sex

• SP rated cases similar issues to individual
• Voluntary — may be impacted

Different distribution channels

• price differentially based upon likely mix of business
• not having different prices is likely to result in different
mixes of business i.e. for IP if cheaper for females then
more females buy hence need to allow for future likely mix.
If gender cannot be used as a rating factor then the provider is
at risk of the gender mix being different from that assumed in
the underlying pricing. This is a risk and additional capital
needs to be held against this risk. The capital will have a cost
and so premiums will need to increase. Some individuals may
then be excluded from cover as they are unable to meet the
increased cost.
The government’s legislation is likely to only apply to local
insurers. Off shore insurers may still be able to use gender (as
they are regulated in their home market) and this then creates
the risk of antiselection with the better gender seeking cover
overseas.
May see a rise in affinity groups

2(i) Details of all products covered, single premiums by product

line
Full details of the proposed regulations
Do the regulations apply to existing business or just new
business?
Full details for each of the four health insurances of the
reinsurance arrangements of AHI including:
Copies of reinsurance treaties
Reinsurance limits (max coverage, retentions, other annual
limits)
Recent accounts
Premium bases for reinsurance arrangement
Details of premium income over last 5 years
and claims paid over last 5 years
including details of very large claims or concentration of
claims to calculate position if risk had been retained
Forecast premium for new business in 2008 (pre regulation)
You will require a full risk register for AHI
Concentration of risk
Exposure to potential catastrophic events
Exposure to large policies

Page 11
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

Details of any financing provided for cash flow purposes

Details of financing for solvency basis
AHI’s need for reinsurance in other ways e.g. levels of free
capital against regulatory minima, expertise in the four
products, tax arbitrage

2(ii) Overall
It becomes an ordering of priorities within contracts
AHI needs to look at risk and financing requirements
Stop Loss contracts being of less interest to the reinsurer
as it gives reinsurer volatility and pricing problems
Reinsurance passes profits to the reinsurer
So need to consider the limits on reinsurance available
Assuming that AHI have a full reinsurance programme for each
health insurance
Look at exposure for contracts in relation to concentration of
risk

PMI
Various Stop Loss covers
If available
Quota share with a treaty
A good way to spread the risk
Facultative
may be available but will not spread the risk
Risk Excess of loss or aggregate excess of loss for large
individual risks
e.g. life support machines in the US or catastrophe affecting
premises which is covered on group basis

CI
CI is a long term contract so needs long term reinsurance
contracts
Quota Share and Surplus
If available
this will spread the risk
and may remove volatility from the portfolio
Surplus may not be available on its own
Various Stop Loss covers
unlikely to be available, as a one year contract

Page 12
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

IP
IP is a long term contract so needs long term reinsurance
contracts
Quota Share and Surplus
If available
this will spread the risk
and may remove volatility from the portfolio
Surplus may not be available on its own
Various Stop Loss covers
unlikely to be available, as a one year contract
Extended wait arrangement

LTC
LTC is a long term contract so needs long term reinsurance
contracts
Quota Share and Surplus
if available
this will spread the risk
and may remove volatility from the portfolio
Surplus may not be available on its own
Various Stop Loss covers
unlikely to be available, as a one year contract
Extended wait arrangement

2(iii) Health reinsurance enables AHI and others to provide a full

range of health insurances
With appropriate limits
Restricting the amount of reinsurance means that the maximum
covers will be cut
not in the best interests of some policyholders

Financing: Health insurance, especially critical illness, income

protection and long term care, can bring substantial up front
financing strains.
The commissions paid by reinsurers support the initial
development of young and smaller insurers where successful
new business would otherwise stretch their available free
capital.
Currently a full reinsurance programme with a financially
viable reinsurer
underpins the financial stability of the Actuaria Health Insurers
Health insurance has a high rate of claim

Page 13
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

so the current reinsurance programme limits the loss on foreign

exchange to the level of the profits repatriated by the reinsurer
Insurers only reinsure because it is a viable business
proposition

Tax Arbitrage: The insurance tax regime in the reinsurer’s

country may be different enabling the reinsurer to accept risks
from Actuaria insurers with lower margins than might
otherwise exist in the pricing basis.

Solvency Arbitrage: The regulatory capital which the foreign

reinsurer is required to maintain to demonstrate solvency may
be less per unit of risk than in Actuaria, thus permitting the
reinsurer to price a policy more cheaply than AHI.

As a result of tax and solvency arbitrage, significant

reinsurance will result in cheaper premiums for the citizens of
Actuaria, as our local insurers pass these benefits to their
policyholders.
This will encourage your people to make their own financial
provision for ill-health and relieve pressure on Government
funds

Data: While Actuaria has a thriving health insurance market,

few individual insurers have sufficient statistics to provide
credible input for disability product pricing and reserving.
Reinsurers have access to international databases which can
thus enable health contracts to have appropriate premiums and
robust reserves which will help to ensure market stability.

Ideas: On a similar vein, reinsurers bring international ideas to

Actuaria and back them with statistics and underwriting and
claims processes.
This happened in Actuaria with Critical Illness some years ago.

Training: Reinsurers have for long been trainers of our claims

and underwriting staff
They run courses and seminars in many aspects of the
insurance cycle.
This would/might cease if their involvement in the marketplace
were severely restricted.

Unusual complex risks: Reinsurers permit the more difficult

risks to be underwritten, which otherwise Actuaria insurers
would be forced to decline.
The new restrictions on reinsurance volumes may make the
latter happen and thus make some citizens uninsurable.

Page 14
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

Reinsurance helps to reduce volatility in terms of individual

large claims (through excess of loss reinsurance) and in terms
of aggregate loss (through stop loss arrangements)
International reinsurers may exit the market - in this case need
to encourage local reinsurers to fill the gap.

3(i) Pricing
Interaction
CMs will provide analysis of rates of claims’ incidence to feed
back into pricing exercise
CMs will provide analysis of claims in payment to enable
pricing actuaries to cost IP new business.
Pricing actuaries will have dialogue with CMs to understand
the future strictness of CMs’ approach so that this can be
applied to pricing mechanism

Underwriting
Interaction
CMs will consider carefully the underwriting analysis
performed at the time when the policy was accepted.
Particular attention will be paid to the pre-existence of the
condition for which the claim is now being made — was this
declared? To what extent was it linked to what was declared?
Liaise with underwriters, application-form designers, product
developers to tighten wording to reduce anti-selection.
CMs will investigate the loadings being applied by
underwriters and compare these with the additional claims
arising, to assess adequacy of these loadings.

Product design
Interaction
CMs would need to be fully aware of the product claim
conditions — both the legal context and any intended discretion
above this.
CMs would not want to incur unnecessary litigation costs
Equally would not want to be too lax in accepting claims and
thus giving wrong message to other policyholders (current and
potential)

Experience analysis
Interaction
CMs would be part of process of in-depth analysis of
experience to feed into the reports on profitability for
management,
to feed into reporting on state of company for regulatory
solvency purposes

Page 15
 Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

to feed back into product design and pricing so that appropriate

contract terms can be offered to policyholders for forthcoming
new business
to feed into the preparation of profit assessments for tax
purposes
to feed into the process of reviewing terms for existing policies
if this is permissible

3(ii) (a) Potential long-term claim with high potential claims outgo
Stress not uncommon in teaching profession
Claim is genuine — continue to pay
Possible non-disclosure
Could support continued counselling to address stress-related
condition
Could offer one-off cash payment to fund career change
Could offer lump sum to fund career change coupled with
reduced income to compensate for reduced earnings.

(b) Appears fraudulent

Establish with certainty that policyholder is the same person as
the one mentioned in press.
Cease payments with immediate effect
Take steps to recover income payments made

(c) Validate that hip and knee claims are linked

Doesn’t seem unreasonable
But may be unrelated “accident” injury
Establish that injured knee prevents any form of work
If not then cease claim
Otherwise continue with claim
Ensure that appropriate programme of recuperative care being
undertaken

(d) Under free cover limit so no obligation to disclose medical

condition
Very likely to be an actively at work clause in group contract
If so then need to establish if claimant was at work at the time
of the policy being effected
If not then cease claim
If no actively at work clause then may need to pay
Need to establish if claimant being paid by previous insurer (if
one exists)
Otherwise appears valid claim

Page 16
Subject SA1 (Health and Care Specialist Applications) — April 2007 — Examiners’ Report

May offer a lump sum payment to allow change of lifestyle.

Options would depend on life expectancy

END OF EXAMINERS’ REPORT

Page 17
Faculty of Actuaries Institute of Actuaries

EXAMINATION

1 October 2007 (am)

Subject SA1 — Health and Care

Specialist Applications

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 three 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
SA1 S2007 © Institute of Actuaries
1 You are the distribution actuary working within a health insurer.

(i) (a) Describe the different types of direct distribution available to a health
insurer

(b) Outline the costs associated with each of the above.

[8]

Your company has the following remuneration structure agreed with a key distributor.

Business line Commission

Private Medical An annual payment from the insurer to the

Insurance distributor based on the number of policies
sold by that distributor in the year.

The payment is doubled if sales in a given

calendar year exceed 1000 policies sold.

Income Protection 50% of year one premium paid in a lump

sum on receipt of the policy application.

Critical Illness 5% of monthly premium paid throughout the

life of the contract, on receipt of each
premium

(ii) Comment on the suitability of this structure, indicating for each product the
implications for the distributor, the customer and the insurer.
[20]
[Total 28]

SA1 S2007—2
2 You are a consulting actuary and have been asked by your UK client PQR plc to
report on their post-retirement plan which they have been providing for several years.
The plan provides private medical expenses for some of their retirees. In particular,
you are invited to report on the cost of the post-retirement liabilities in accordance
with the Guidance Note GN21 for Post-Retirement Medical Plans.

(i) List the reasons why a company would wish to provide a private medical
expenses plan for its retirees. [2]

(ii) List the disadvantages to a company of providing such a plan. [4]

(iii) List the information that you require from PQR plc to compile your report. [5]

(iv) Describe the methodology and assumptions that you should follow in
determining the accrued liabilities and periodic costs of this post-retirement
medical plan on the premise that it is not insured considering

(a) the actuarial techniques employed

(b) the sub-division of data into relevant groups
(c) the assumptions regarding future medical costs
(d) expenses
(e) taxation
(f) mortality and other assumptions
(g) credibility
[9]
[Total 20]

SA1 S2007—3 PLEASE TURN OVER

3 You are an actuary working for a large proprietary UK life and health insurer that
sells an accelerated critical illness plan covering a wide range of conditions including
cancer, heart attack and stroke. In the last three years the company has paid around
2,500 claims under the accelerated critical illness plan.

You have been asked to consider a new product design which pays a benefit on the
diagnosis of cancer only or on death from any cause.

The benefit payable on cancer is dependent on the severity of the cancer.

• If the cancer is diagnosed at a very early stage the benefit is 25% of the sum
assured and the sum assured is reduced to 75%.

• If the cancer is diagnosed at an intermediate stage the benefit is 50% of the

original sum assured less any early cancer payment (i.e. 50% reduced to 25%) and
the remaining sum assured is reduced to 50%.

• If the cancer is diagnosed at an advanced stage 100% of the sum assured is paid
less any previous payments

Only one payment may be made at each stage so that the maximum payout is 100% of
sum assured.

The remaining sum assured is payable on death.

Premiums are guaranteed throughout the term of the policy (maximum term 25 years).
The maximum sum assured at issue is limited to £500,000.

This type of plan does not currently exist in the market.

The UK government publishes an annual cancer register which details the number of
cases of cancer that have been diagnosed in the calendar year. The data is subdivided
by age, sex, cause of cancer and is split between first ever occurrences and all
occurrences. There is also an annual publication detailing deaths split by cause.

(i) Describe the customer needs that are met by the proposed product design,
contrasting this with the needs satisfied by a typical UK accelerated critical
illness contract. [6]

(ii) Suggest with reasons a target market and an appropriate distribution channel
for this plan. [4]

(iii) (a) List the changes, if any, that would need to be made to the scope of the
cover for the plan to satisfy the ABI requirements to be called Critical
Illness.

(b) List any additional requirements that the ABI Critical Illness Statement
of Best Practice imposes on the design of a Critical Illness plan.
[3]

SA1 S2007—4
 You have been asked to advise upon the construction of a profit test model for the
new product.

(iv) Give a formula for calculating the risk charge which could be applied to a
policyholder who has not previously made any claim under the contract
describing how you would adjust any population data so it is applicable for
your target market and defining all of the terms used in the formula. [9]

(v) Describe how you would allow for tax within the profit test model. [3]

You have been asked to draft a tender request for reinsurance terms.

(vi) Suggest, with reasons, an appropriate reinsurance structure for this product. [6]

(vii) Describe the main requirements under the Integrated Prudential Sourcebook
(“PRU”) relating to the calculation of mathematical reserves for a long term
insurance product, explaining why the calculation of mathematical reserves for
the proposed new contract is more complicated than for a traditional critical
illness plan. [9]

(viii) Outline the Pillar 2 (ICA) framework applied to an insurance firm giving
examples of the risks that a firm must access under Pillar 2. [8]

(ix) Discuss the insurance risks that are particularly relevant to the new cancer
product. [4]
[Total 52]

END OF PAPER

SA1 S2007—5
Faculty of Actuaries Institute of Actuaries

EXAMINATION

September 2007

Subject SA1 — Health and Care

Specialist Applications

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 A Stocker
Chairman of the Board of Examiners

December 2007

© Faculty of Actuaries
© Institute of Actuaries
 Subject SA1 (Health and Care Specialist Applications) — September 2007 — Examiners’ Report

Comments

Candidates who approached the problems, 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. Generally, candidates lost marks by giving insufficient
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. Usually each
valid point in the answer would normally attract 0.5 marks whilst the more basic elements
e.g. details in a pricing basis such as age and sex, would attract 0.25 marks.

Some papers were not clearly marked as to which part of the question was being answered.

Marks may be lost where answers are difficult to read.

Comments on individual questions are set out below:

Question 1

There were instances where candidates did not address the question e.g. Q1 (ii). In that
question, candidates gave their view on what the commission basis should be rather than
recording the pluses and minuses of each of the three commission bases. Few, if any, linked
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.

Question 2

At present, there is only one guidance note, GN21. It was inevitable that at some stage the
examiners would visit this subject. Few of the candidates answered this question with
confidence. Some were able to answer the question to a degree from first principles.

Question 3

For Q3, some candidates did not realise that there were new ABI guidelines so the concepts
of core and additional conditions no longer applies in Critical Illness new business.

There was a variation in the standard of answers, some reasonable, many not so. Some
candidates found that the sections on reserving and pillar 2 very difficult. Q3 (iv) on the risk
charge was poorly answered, students should realise in what form the cancer statistics are
published.

Page 2
 Subject SA1 (Health and Care Specialist Applications) — September 2007 — Examiners’ Report

1 Direct salesforce — Face to face

Usually employed but may be self employed
Commission payments
Salary
Combination

Direct sales — Telephone selling, Internet

Inbound
Outbound
For telephone selling, remuneration as above
Phone bill for telephone selling

Direct Marketing
Mailshot
Costs of campaigns / expense of contact
Press advertising / return coupon
Advertising costs
Combination of above eg press and generating inbound telephone calls

Other costs:
Head office / overheads
Direct sales force – expenses (eg office space, cars)
Training costs
Compliance costs
For internet selling, cost of developing and maintaining software

Overall
No consistency between products
Likely to be implicit bias towards a product type as a result of different distributor
reward so strong likelihood of distributor bias
Potential regulator interest
Differing approaches create admin complexity
None of the remuneration approaches reward profitability/quality of business
How does this compare with competition
Attitude of distributors

Private medical insurance

Distributor
Simple, easy to understand
Depends on level of payment as to whether this is a suitable return for investment of
time in sale
No incentive to sell more comprehensive policies as flat remuneration
May be better of selling 2 single life policies than one joint life policy
Incentive to focus on PMI if there is a possibility of exceeding 1000 sales in a year.
Timing of commission payments
Do sales include renewals?

Insurer
May be high lapses as no retention incentive

Page 3
 Subject SA1 (Health and Care Specialist Applications) — September 2007 — Examiners’ Report

Need to monitor lapse and resale as no apparent mechanism to address “churn”

Simple to administer as only one payment per year
May result in lower average premiums than anticipated as no reward for higher
premium business

Customer
May be sold inappropriate policy given:
strong distributor incentive to sell PMI if approaching 1000 policies
no distributor reward for policy retention
no distributor incentive to sell comprehensive cover

Income Protection

Distributor
Simple, easy to understand
Payment made early in process. Attractive.
Higher value sales rewarded by higher commission

Insurer
Big risk — policy does not appear to need to go in force before commission is paid
May receive applications for business with no intention of taking out policy
Will end up paying commission on business we decline
May be high lapses as no retention incentive
Need to monitor lapse and resale as no apparent mechanism to address “churn”
Relatively simple to administer
Full commission paid on policies that lapse quickly to because there is no clawback
New business strain

Customer
May be sold inappropriate policy given:
high product bias towards this policy
no distributor reward for policy retention so no incentive to ensure that needs are met.
commission largely independent of policy term so may be sold short-term policy (and
then resold following year)

Critical Illness

Distributor
Only get drip feed commission, amounts likely to be low and so low incentive to sell
Continue to receive reward if appropriately service existing book of business
Higher value sales rewarded by higher commission
Distributors may be enticed elsewhere
Commission payments do not reflect when most of the work done

Insurer
May not receive high new business volumes as level of commission may appear low
against market (if competitors pay lump sums)
Lapse performance likely to be good as retention incentive
Admin overhead of paying low commission amounts on a monthly basis
Commission outgo more closely reflected in receipt of premium income

Page 4
 Subject SA1 (Health and Care Specialist Applications) — September 2007 — Examiners’ Report

Customer

May not be sold CI even if meets needs as low up front commission payment
May be able to price more cheaply as expected higher retention levels but offset by
admin and process complexity

2 (i) Reasons for plan

Used for directors and other long-serving former employees

Provision of “Cradle to grave” cover
May be in the company ethos of benefit provision
Attract and retain staff

(ii) Disadvantages

Guaranteeing PMI cover for life

Expensive if insured
Can be very expensive if self-insured in the event of a large claim
Rapidly increasing cost for PMI with increasing age
Complex to administer
Expensive in time and money to administer
PMI claims increase at an annual rate well in excess of RPI inflation
Substantial liabilities created by the introduction of this scheme
Difficult in HR terms to restrict the cover to retiree if spouses covered whilst
in employment
May have risk of accelerated claims before retirement if spouses not covered
post retirement
Legal/actuarial costs
Longevity risk

(iii) The eligibility conditions for membership under the plan

The membership of the plan
The potential future beneficiaries of the plan
The entitlement, if any, of spouses and other dependants of members to
benefits under the plan
Details of the principal and other benefits of the plan including any limits, if
any, on treatment provided
Where the costs of a plan are partially met by members, the nature of the
employer’s subsidy has to be made clear.
Any anticipated changes in the subsidy, as a proportion of plan costs, should
be explained.
Details of recent withdrawal experience.
Details of recent mortality experience.
Medical costs experience
FRS17, IAS19 requirements
Plan expenses

Page 5
 Subject SA1 (Health and Care Specialist Applications) — September 2007 — Examiners’ Report

(iv) Methodology and assumptions

Actuarial Techniques

Follow actuarial techniques similar to those used to determine the liabilities

and periodic costs of a defined benefit pension plan ie projecting claims costs
and expenses and discounting back allowing for interest and demographic
decrements; possibly add in margins

Sub-division of data

Consider whether to incorporate in calculations:

the dependence of medical costs on age and gender
different medical costs for different geographical locations
or different sub-groups of plan members
The extent of the subdivision will depend on the credibility of the data

Assumptions on future medical costs

Incorporate in calculations the expected temporal changes in medical costs

over future years due to changing incidence frequencies, changing costs of
treatments and changing patterns of treatments.

Ensure that the assumed rates of temporal changes in medical costs are
consistent with any underlying assumptions for earnings and price inflation.
However, in most cases the expected temporal changes in medical costs will
be more complex than the expected rates of price or earnings inflation.

Where appropriate, incorporate in the calculations changing incidence

frequencies or changing “real” costs of interventions.

Expenses

Make allowances for the costs and expense inflation of self-administration by

an employer – e.g. might use national earnings index

Tax

Investigate what allowance (if any) should be made for taxation on investment
income of funds invested.

Investigate what allowance (if any) the calculations should make for future tax
relief on claims or premiums.

Mortality and other assumptions

Assumptions regarding mortality and withdrawal experience are generally of

particular significance in the valuation of post-retirement medical plans.

Page 6
 Subject SA1 (Health and Care Specialist Applications) — September 2007 — Examiners’ Report

Consider future expected improvements in mortality, possibly linked to

changing incidence rates and types of medical treatment, allowing for the size
and amount of selection of each group of the plan.

Credibility

The report should compare assumptions with the past experience of the plan
under consideration and the actuary’s experience of similar plans.
Consider factors which may mean that past experience may not be a fair
reflection of future experience.
Consider how much credibility should be placed on the recent experience of
the plan, with particular regard to the size of exposure and the volatility of
medical costs.
Consider how much credibility to give to recent withdrawal experience.

3 (i) The suggested product is a form of accelerated critical illness and so meets the
standard needs of ACCI but with the limited cover

• Income (if standard lump sum payment commuted)

• Medical costs
• Repay part of mortgage (or total on final payment)
• Business partners/business stability
• Recuperation after illness
• Medical Aids
• Lifestyle changes

Standard CI plan pays a lump sum which is independent of the severity of the
CI event.
The scope of cover of a standard CI plan is wider
Plan better matches severity requirement reducing windfall benefits
It may meet needs on incidence of cancer but it ignores financial distress
arising from the onset of all other illnesses.
It is less comprehensive (but cancer is a major cause)
For the same sum assured it should be cheaper than a standard plan.
Provides death benefit for dependents
Provides peace of mind for the policy holder

(ii) The target market may be very similar to the existing ACCI plan.

Cancer is a key risk for young lives for both males and females.
Females may be particularly interested because of high media coverage of
cancers affecting women and through screening programmes
The plan could be seen as appropriate for the mortgage market if the initial
sum assured is set equal to the loan.
Plan should be cheaper than traditional ACCI so may appeal to lower socio-
economic groups

Complicated product so will require face to face sales.

Page 7
 Subject SA1 (Health and Care Specialist Applications) — September 2007 — Examiners’ Report

Likely to be too complicated for direct.

New product to the market so it will be difficult for IFA’s to compare against
other providers.
Most appropriate distribution is likely to be tied agent or direct sales force
until the product has become established (then offer through IFAs)

(iii) ABI requirements

To be called CI plan must cover heart attack, cancer and stroke.

No other condition is compulsory
For certain conditions insurer must use model wording
If a standard exclusion clause is included it must follow the model wording.
Insurers are free to pick exclusions.

Suggested plan does not meet ABI requirements as there is no cover for stroke
and heart attack.

(iv) Pricing approach

Standard formula for pricing ACCI is ix + (1 - kx) * qx where

i is the incidence rate for the CI at age x

k is the proportion of deaths due to the particular CI event
q is normal mortality

This implicitly assumes that all lives who suffer from cancer die from cancer
and so the two terms are mutually exclusive.
We can apply the same approach for this product
This product will be cheaper because of the stepped payments. The total
payment under the plan may be 0, 25%, 50% or 100%. There may be multiple
payments. The maximum payment is limited to 100% and all earlier payments
are offset.

Payments will either be for cancer or for death from any other cause than
cancer.

Cost of death from any cause other than cancer is (1 - kx) * qx where kx is the
proportion of deaths from cancer.

Assume for cancer all policyholders go through stages early diagnosis —

intermediate — serious (note transfer from each stage could be instantaneous)

Payments will be 25% + 25% + 50%

Let ix (1) be probability cancer diagnosed at early, intermediate or advanced

stage
ix (2) probability cancer diagnosed at intermediate or advanced stage
ix (3) probability cancer diagnosed at advanced stage

Page 8
Subject SA1 (Health and Care Specialist Applications) — September 2007 — Examiners’ Report

Then cost is 0.25* ix (1) + 0.25 * ix (2) + 0.5* ix (3) + (1 - kx) * qx

If a life is diagnosed with cancer at the intermediate stage they will be

included in ix (1) and ix (2).

This formula effectively over costs lives who are diagnosed with cancer and
subsequently die of a non-cancer cause. The above formula assumes that the
payment on death will be 100% when, in reality, it will be reduced by the
earlier payments. This is also a feature of the standard ACCI formula. It is
difficult to make a formulaic adjustment as we are unlikely to have the
previous medical history of a life at death.

Can calculate a rate for the general population using population data.
Would need to adjust this for the insurance population and then allow for
particular features of the product and target market.
To do this can look at cancer incidence under the current ACCI plan and
compare this with the cancer rate under the general population.
Note ideally would adjust rates so they are applicable to the same exposed to
risk (ETR) i.e. for the general population the ETR is all lives alive while for a
ACCI plan it is all lives who have not previously been diagnosed as having a
CI.
Would need to adjust for underwriting selection.
Would need to adjust for additional rating factors such as smoking
Would finally need to decide how the resulting risk charges should be adjusted
to allow for future trends such as the earlier diagnosis of particular cancers as
a result of the introduction of a screening programme.

(v) Taxation in model

This is a form of ACCI so treated as a standard life plan.

Proprietary office so tax on the maximum of I-E or profits assessment (NC1)
Notional Case = undistributed surplus + transfers to shareholders – losses
brought forward.
If taxed on I-E then use net expenses and net investment return in the profit
test model (i.e. multiply expenses and investment return by (1-t) where t is the
tax rate.

(vi) What reinsurance arrangement

Will want reinsurer expertise therefore want a proportional type arrangement

Significant quota share (e.g. 50%)
Maximum cover is £500k so want some surplus cover (e.g. maximum
retention £100,000)
Because of uncertainty in pricing may seek profit sharing
As rates guaranteed will want guaranteed reinsurance rates
Risk premium or original terms
Will seek both and decide on which gives best value to cedant
Would look at financing (rebate/commission) if capital cost if reinsurance is
attractive
Treaty rather than facultative

Page 9
 Subject SA1 (Health and Care Specialist Applications) — September 2007 — Examiners’ Report

(vii) Reserving

Mathematical reserves must use a prospective valuation method using prudent

assumptions with sufficient margin for adverse deviations.
Must avoid any future valuation strains.
Must allow for with profit payments if appropriate
Valuation rate of interest cannot exceed 97.5% of the risk-adjusted yields on
the backing assets (risk-adjusted means reducing the yield on the backing
assets to allow for the risk of default)
In respect of sums to be invested in the future at unknown rates of interest
additional restrictions apply.
Must make specific allowance for guarantees
Must make specific allowance for options
When allowing for reinsurance the mathematical reserve used is the maximum
of 85% and the ratio of net-of-reinsurance reserves to the gross-of-reinsurance
mathematical reserves.
Complicated

Policyholders need to be split into those that have never claimed and those that
have already made a claim.
The former group can be valued in the same way as traditional ACCI
policyholders.
For the later group we know that the policyholder already has some form of
cancer and so needs to be treated as substandard risk.
This plan does not exist in the market and we are offering guaranteed rates;
making a specific allowance for the guarantee may be problematic.
Note that the guarantee charge used for traditional ACCI may not be
appropriate.

(viii) Pillar 2

Expressed in terms of guidance rather than rules.

Firms submit own confidential ICA calculations to FSA
FSA accepts or issues ICG

Example risks:

• Market and interest rate risk

• Credit risk
• Persistency risk
• Insurance risk (mortality, morbidity)
• Risks attaching to firm’s pension scheme
• Liquidity risk
• Reinsurance risk
• Group risk
• Operational risk
• Expenses risk

Page 10
Subject SA1 (Health and Care Specialist Applications) — September 2007 — Examiners’ Report

ICA calculations should be consistent with 99.5% certainty of solvency within

a one-year time frame or, if appropriate to a firm’s business, an equivalent
lower confidence interval over a longer time frame.

Firms need to conduct stress and scenario tests in respect of each risk

Calculations should be based on market consistent techniques which are likely

to require stochastic modelling.

Within the ICA calculations it is acceptable to take credit for diversification

benefits that exist between the various risks that recognise the degree to which
individual risks are correlated.

(ix) Specific insurance risks

Initial claim estimate is wrong because of volatility or based on inappropriate

data

Medical advances change risk in future e.g. screening results in more

diagnoses, screening accelerates diagnosis.

Legal/ Regulator changes requirements for payment of valid claim (e.g. what
insurer thought was intermediate is interpreted by courts as serious).

Shock event like Chernobyl

Lapses (selective withdrawals) – assumptions may be wrong

END OF EXAMINERS’ REPORT

Page 11
Faculty of Actuaries Institute of Actuaries

EXAMINATION

14 April 2008 (pm)

Subject SA1 — Health and Care

Specialist Applications

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 three 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 from the approved list.

© Faculty of Actuaries
SA1 A2008 © Institute of Actuaries
1 An employer plans to introduce a flexible benefits package for all staff. Each
employee will be allocated annually a fund which may be used to purchase benefits.
The fund will be calculated as the notional value of the current benefits given to
employees. The fund can be used to purchase additional holiday, gym membership,
travel insurance cover, life assurance cover and a range of health insurance benefits
(excluding income protection). Employees can increase the value of their fund by
reducing any existing benefits or holiday. Any fund value not spent will be added to
basic salary.

(i) Suggest suitable health insurance benefits which might be included in the
overall package. You should include a brief description of the cover and
suggest alternative benefit covers. [8]

(ii) Describe the potential for anti-selection under the various benefits of the
scheme, discussing how you would manage the anti-selection risk. [5]

(iii) Explain why income protection cover is usually provided as part of the basic
employment benefits rather than as part of a flexible benefits package. [4]

(iv) Suggest possible options and design features if income protection cover had
been included in the flexible benefit arrangement. [5]

One of the employees has suggested a discount on each and every health insurance
contract suggested in section (i) if gym membership is purchased.

(v) Comment on the suggestion. [4]

[Total 26]

2 The health insurance division of a UK bancassurer writes all of its healthcare business
in the UK. The health insurance division has been put up for sale. Your company, a
major UK health insurance provider, has been invited by the bancassurer to bid for the
business of the health insurance division. You have been assigned by the board as part
of the project team on this merger and acquisition project.

(i) List the information you would request in order to place a value on the target
business. [15]

From the information you obtain from the target company, you notice that the
mortality/morbidity assumptions used in the target company’s published embedded
value calculations are markedly different from the best estimate assumptions used by
your own company.

(ii) Suggest possible reasons behind the differences. [7]

(iii) Describe the methodology and assumptions you would use to place a value on
the in-force business. [10]

(iv) Discuss the other factors that you would consider before submitting the bid.
[12]
[Total 44]

SA1 A2008—2
3 You are the member of an actuarial task force (under the UK Actuarial Profession)
which has recently been set up to examine the current approaches in the area of
reserving with a view to recommending suitable practice. At the initial stage, the task
force wishes to get details of reserving practices in income protection and critical
illness from all the insurers in the UK market. It has been agreed that a questionnaire
will be sent out for this purpose.

(i) Recommend what should be covered in this questionnaire. (Your answer does
not need to cover the design or style of the questionnaire.) [20]

The representatives of an overseas actuarial professional body have approached your

task force asking for help with designing a survey in the area of pricing practices.

(ii) Suggest the additional topics that you might include in the questionnaire. [5]

While the exercise on benchmarking and recommending good practice proves to be a

success on reserving, members of your task force have expressed concerns over the
limitations of such a survey on pricing practices.

(iii) Suggest the areas in which potential problems could arise in respect of
benchmarking pricing practices and making recommendations on suitable
practices to the market. [5]
[Total 30]

END OF PAPER

SA1 A2008—3
Faculty of Actuaries Institute of Actuaries

Subject SA1 — Health and Care

Specialist Applications

EXAMINERS’ REPORT

April 2008

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 A Stocker
Chairman of the Board of Examiners

June 2008

© Faculty of Actuaries
© Institute of Actuaries
 Subject SA1 (Health and Care Specialist Applications) — April 2008 — Examiners’ Report

General comments

Candidates who approached the problems, 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. Generally, candidates lost marks by giving insufficient
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. Usually each
valid point in the answer would normally attract 0.5 marks whilst the more basic elements
e.g. details in a pricing basis such as age and sex, would attract 0.25 marks.

Some papers were not clearly marked as to which part of the question was being answered.

Marks may be lost where answers are difficult to read.

Comments on individual questions

Question 1

In general this was reasonably answered, although in part (i) several candidates failed to
suggest alternative benefit covers so losing the opportunity to gain marks. In part (v)
candidates often did not comment on whether gym membership might merit a discount or not
for each of the health contracts suggested in (i) or failed to discuss the advantages and
disadvantages of the suggestion.

Question 2

In general candidates did reasonably well on this question. No credit was given in part (ii) to
comments on differences due to whether a buyer or seller as this is not relevant to published
embedded values or the use of best estimate assumptions. Similarly no credit was given for
detailed experience investigations in part (iii) as this is not appropriate for the scenario in
the question.

Question 3

This question was generally not as well answered as questions 1 and 2. The best approach to
answering the question was to consider what aspects of reserving practices can be
researched. In part (i) no credit was given for comments on items such as geographical
location, product details, questions on regulatory guidance/audit of results, reinsurance or
underwriting arrangements, assets.

Page 2
 Subject SA1 (Health and Care Specialist Applications) — April 2008 — Examiners’ Report

1 (i) Suitable health insurance benefits include:

CI or Serious illness,
PMI
Dental Cover
Optician cover
Personal Accident
Hospital Cash
Major medical expenses
Non-indemnity Long Term Care
Indemnity Long Term Care would not be included since this is likely to be
very expensive

Credit was given for suitable descriptions of each of the above covers.

The covers need to be easy to understand and simple as there is unlikely to be

face to face selling.

Possible options for alternative benefit cover include:

Levels of benefit
Employee only or wider family cover
Scope of family needs to be carefully defined, especially for Non-indemnity
Long Term Care
Continuation Options
CI – policy term, stand alone or accelerated or TPD
NHS coverage or full private for PMI

(ii) Poor lives maximise health cover.

Poor lives may also maximise life assurance cover
Good lives maximise holidays.
So poor lives will anti-select
And so will good lives with a poor family health status

Tools to manage the risk of anti-selection include:

Actively at work criteria
Health Declaration at outset
Restriction on benefit eg term or amount
Pre-existing medical condition exclusion
May use moratorium on PMI
Limited application to tempt good lives
Price (better rates than individual cover)
Limit dates at which package may be changed e.g. once a year on scheme
anniversary
Have waiting periods
Require a health check for high sum assureds

(iii) Group IP is typically provided as part of the overall pension package.

It may therefore be difficult to give individuals free choice.
especially if there is a range of occupational classes within the company.
Difficulty in pricing individual IP with a range of occupational classes.
Perceived high cost of Individual IP

Page 3
 Subject SA1 (Health and Care Specialist Applications) — April 2008 — Examiners’ Report

Group IP may have significant benefits to employer

e.g. business expense relief on premiums
external claims admission and control
benefits can be tailored to employee status
and earnings
May also reflect paternalism of employer
May help with recruitment of key staff
Can be used with rehabilitation clauses to help encourage return to work

(iv) IP benefit design options and features include

Benefit level
Period of payment

Probably would want an own occupation definition.

Increase benefit if serious disability (e.g. failure of ADLs)
IP benefit formula related to pre disability earnings
Expiry Age to coincide with Normal Retirement Date in the Company
Some increase in benefit during claim payment
Could insure pension fund contributions
Varying by fund if directors etc. separate
Different benefit structure if specialist occupations
Deferred period
Proportionate benefits/rehabilitation clauses
Linked claims conditions
Counselling
Continuation options

(v) Suitable covers suggested under (i) are CI or Serious illness, PMI, Dental
Cover, Optician, PA, Hospital Cash and Non-indemnity LTC cover.

Dental cover – generally no impact but if strenuous exercise, could increase

dental injuries so no reduction in premium
Similarly for Optician cover, generally no impact but possible increase in eye
injuries
For Personal Accident, possible increase in injuries
CI or serious illness – suitable contract to add a modest discount
PMI would merit a larger discount but not that substantial (for example, may
have increased sports injuries which would increase PMI claims thus
offsetting to some extent the benefits from improved fitness)
Hospital Cash would merit some discount
Non-indemnity LTC cover – no discount

Someone who uses the gym may be regarded as a better risk than someone
who doesn’t.
It might be argued that if a discount is offered to gym attendees, a loading
should be added to non-gym members.
A discount may help encourage gym membership which might lead to
healthier lifestyles.

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 Subject SA1 (Health and Care Specialist Applications) — April 2008 — Examiners’ Report

The problem is that in each case the insurer would need to monitor each year
that the insured is still a gym member and is an active user. This requires the
insured to complete an annual declaration. So the administrative problem may
outweigh the likely reduction in claims experience.

As an option, the employer might use a local gym and seek a report from the
gym about attendance rather than asking individuals for records of attendance.
Administration would be easier if a gym were offered in the building.

2 (i) Group Structure

• Company Information (active and dormant companies)
• Group Structure
• Outline of Insurance Business Transfers
• Information on any previous mergers/acquisitions
• Report of the Appointed Actuary on the proposed merger
• Report of the Independent Actuary on the Scheme for any previous
transfer
• Memorandum and Articles of Association

Financial statements
• Annual Returns & Accounts
• ICA Reports (ICG)
• Published EV calculations
• Internal Management accounts/information pack
• Minutes of board meetings
• Board paper
• Terms of reference of any internal management/risk committee
• Minutes of committee meetings
• Risk management reports
• Investment strategy
• Investment reports
• External/internal audit reports

Actuarial information
• External actuarial reports
• Financial condition reports
• Valuation reports
• Surplus analysis
• Appointed Actuary/Actuarial Function Holder’s reports
• Statutory reserving methodology and assumptions
• EV methodology and assumptions
• Analysis of movement in EV
• Options/guarantees

Correspondence with regulators

• Correspondence with FSA
• Correspondence with ABI

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 Subject SA1 (Health and Care Specialist Applications) — April 2008 — Examiners’ Report

• Correspondence with FOS

Policy details
• Policy documents
• Distribution channels
• Underwriting standards
• Claims process
• Commission structure
• Sales literature
• Illustration system
• Samples of quotes/communications to policyholders
• Business profile

Third party arrangements

• Reinsurance arrangements
• Third party administration
• Medical providers. E.g. Hospitals

Experience analysis
• Mortality/morbidity
• Expenses
• Persistency

Operational
• IT system/system development
• Administration system
• Pension scheme
• Fraud control
• Data integrity
• Tax returns
• Employee details
• Insurance arrangements
• Risk management
• Corporate governance
• Underwriting
• Percentage of lives declined
• Percentage of lives rated
• Claims management
• Complaint process
• Past customer complaints
• Past legal actions
• Outstanding litigation
• Goodwill
• Historic and planned future new business volumes
• Market share
• Market capacity
• Details of owner occupied properties/geographical location
• Profiles of key management

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Subject SA1 (Health and Care Specialist Applications) — April 2008 — Examiners’ Report

(ii)
• Margins in EV assumptions
• Different mix of socio economic groups
• Different distribution channels
• Different sales methods
• Tied agents for bancassurer
• Large office may have IFA, DSF and direct marketing
• Different geographical distribution
• Period of investigations/averaging of experience
• Volume of data
• Quality of data
• Underwriting standards
• Claims underwriting
• Reinsurance rates
• Different weightings given to past experience and industry experience
• Differences in product design or cover
• Different view of future trends
• Different levels of selective withdrawal

(iii)
• Starting point is to calculate EV
• EV = shareholders’ net assets + Value of In Force (VIF)
• Net assets at market
• Need to set appropriate model points base don available information
• Project forward future cashflows and discount back

Assumptions
• Assumptions should be best estimate, possibly with some prudence since a
purchaser
• Assumptions should allow for your expectations of future trends
• Risk Discount Rate
• Possibly allowing for the inherent risks and uncertainty within the
cashflows
• Determined by board of purchasing company
• Mortality/morbidity assumptions
• Take into account factors in part (ii)
• Allow for reinsurance arrangements
• Expense assumptions
• Allow for own expense taking into account of potential synergy
• Expense inflation
• Persistency
• Take into account profile of business
• Consider possible on persistency experience following the takeover
• Statutory reserving
• Use own methodology and assumptions
• Investment return
• Consistent with RDR and expense inflation taking into account own
investment strategy

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 Subject SA1 (Health and Care Specialist Applications) — April 2008 — Examiners’ Report

• Tax
• Consider effects on pro-forma tax computations and allowed for
appropriately
• Commission
• Renewal commission
• Initial commission if on non-indemnity basis
• If on indemnity basis, may want to allow for clawbacks

(iv)
• Reason for sale
• Cultural fit with company
• Compatability of policy profile
• How competitive is the bid?
• Sole bidder or competing with other companies
• Structure of the bidding process e.g. opportunities to revise bid
• Own reason for takeover e.g. cross-selling
• Solely for the in-force or possible distribution arrangement with the bank
• Market reaction if purchase goes ahead
• Shareholder reaction if purchase goes ahead
• Quality of data
• Quality of experience investigations
• How desperate is the target company?
• Any possible legacy issues?
• Location of the target company
• Quality of the target company’s workforce
• Plans for the workforce, offices
• Integration/migration plan
• Costs of the takeover (e.g. advisors, legal, stamp duty etc.) and whether or
not factored into the offer price
• Payment method e.g. cash only
• Ease to raise capital
• Credit rating
• Capital structure
• Quality of asset profile
• Existence of high risk investment e.g. derivatives
• Quality of distribution channel
• Quality of systems
• ICA and ICG
• Possible synergies e.g. expenses, reserving capital, tax
• Pension scheme
• Commission arrangement
• General economic outlook
• Need to get warranties in place if any outstanding litigation
• Determination of goodwill/value of new business amount
• Regulatory constraints (e.g. Monopolies Commission)
• Time taken to complete purchase/management distraction
• Sensitivity testing

Page 8
 Subject SA1 (Health and Care Specialist Applications) — April 2008 — Examiners’ Report

• Alternative uses of capital

3 (i)
• What best describes your type of Office? Give examples
• What is the size and relative importance of your CI/IP business?
• How do you value IP claims in payment?
• What valuation methodology do you adopt for your statutory valuation?
• Gross Premium/Net Premium?
• If you use a net premium valuation, do you make a zilmerised adjustment
for initial expenses?
• Are negative reserves allowed?
• Are any approximations used e.g. grouped data?
• Frequency of reserving calculations

Mortality/Morbidity
• How often are investigations performed?
• In determining best estimate assumptions, over how many years do you
average your experience?
• What base table do you use?
- Death
- Critical Illness
- Incidence rates
- Recovery rates
• Own table/Reinsurer’s rates/Standard tables
• Do you use a select table in your assumptions for statutory reporting?
• What margin (%) between your best estimate assumptions above and your
valuation assumption do you use in your statutory valuation?
• Which differentiating features of your experience are used to apply
adjustments to factors in the standard tables you use to reflect your own
experience?
- Age
- Gender
- Smoker status
- Duration in force
- Location
- Sales channel
- Product
• Do you make any allowance for future mortality improvements in your
statutory reserving for ACI products?
• What allowance for future morbidity deterioration do you use in your
statutory valuation calculations?
• Do you use stochastic models? If not, do you intend to develop them?

Additional Reserves
• Do you set up additional reserves for:
- IBNR
- UPR
- Notified claims awaiting authorisation

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 Subject SA1 (Health and Care Specialist Applications) — April 2008 — Examiners’ Report

- Disputed claims (declined or terminated)

- Data quality
- TCF considerations
- Reinsurance/Third Party Default
- Contingencies

Lapses
• Do you allow for lapses in your statutory valuation?
• How frequently do you carry out experience investigations into lapse
experience?
• How do you derive your best estimate lapse assumptions?
• Own table/Reinsurer’s advice/Industry data/Other
• If you allowed for lapses what margin (%) between your best estimate
lapse assumptions above and your valuation assumption for business
written on both reviewable and guaranteed rates do you use in your
statutory valuation?
• Which differentiating features are used to apply adjustments to reflect your
own experience?
- Age
- Gender
- Smoker status
- Duration in force
- Location
- Sales channel
- Product
• How did you determine whether the margin used in your statutory
valuation should be an addition or a reduction in your best estimate
assumption?

Expenses
• What expense assumptions did you make?
- Per policy
- % of premium
- One-off claims related
- Ongoing claims expenses
- Investment related
- Margin over best estimate
Frequency of analysis
How are fixed and /or overheads allowed for?
Any allowance for expenses on closure to new business?

Financial assumptions
• Does the critical illness business have a hypothecated set of assets? If so,
what does it comprise?
- Gilts/Corporate bonds/cash/other
• What valuation interest rates did you assume?
• What expense inflation rates did you assume?
• Claims inflation
• Margin v actual yields

Page 10
Subject SA1 (Health and Care Specialist Applications) — April 2008 — Examiners’ Report

Guarantees/Options
• Types of options?
- Buyback/continuation/conversion/indexation/renewability/waiver of
premium
• What approach do you use to calculate reserves for options?
• Guaranteed/reviewable benefits?
• Guaranteed/reviewable Premiums?
• If reviewable, options/constraints to review
• Assumptions on option take-up rates

(ii)
• Profit criteria/margin
• Shareholders’ expected return on capital/risk discount rate
• Volume of new business
• Sample premium rates
• Margins between best estimate and pricing assumptions
• Cost of capital
• Distribution channels
• Whether different assumptions have been adopted for different distribution
channels
• Initial commission/clawback structure
• Acquisition expenses
• Underwriting standards
• Persistency assumption
• Tax assumption on initial acquisition expenses
• Rating factors (or number of “model points” used)
• Level of cross-subsidy or profit variation accepted between policies
• Relationship between pricing model and competition

(iii)
• Main problem is that companies will not want to share commercially
sensitive information with competitors
• Companies not likely to tell the truth
• In particular, the mortality/morbidity assumptions
• If these are based on the reinsurer’s tables, the reinsurer will not want the
cedant to disclose these
• Would not want to disclose profit margin/criteria
• Difficult to benchmark underwriting standards
• Should the professional body interfere with the pricing practices in the
market?
• How will this affect free competition?
• Standardising pricing practices could drive some companies out of the
market
• Unlike reserving practices, this is unlikely to add significant value in terms
of policyholders protection and could reduce value to policyholders
• Difficult to define good practice in terms of product pricing
• Much more diversity between the underlying influences (e.g. strategies,
capital structure, risk appetite) so hard to compare

Page 11
 Subject SA1 (Health and Care Specialist Applications) — April 2008 — Examiners’ Report

• Pricing practices change more rapidly than reserving practices

END OF EXAMINERS’ REPORT

Page 12
Faculty of Actuaries Institute of Actuaries

EXAMINATION

22 September 2008 (pm)

Subject SA1 — Health and Care

Specialist Applications

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 both 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 from the approved list.

© Faculty of Actuaries
SA1 S2008 © Institute of Actuaries
1 A consulting actuary is providing advice to an employer, ZAB plc, concerning its
corporate private medical insurance needs. The employer has about 1,200 employees
all based in the UK.

ZAB plc provides a group private medical scheme to its employees that is currently
fully insured with a UK insurer, LOM Insurance. No other health related benefits are
provided.

(i) Outline a typical schedule of benefits provided under a group private medical
insurance scheme for employees in the UK. [5]

ZAB plc has recently taken on a director from the USA who is concerned that
insurance cover is being purchased for benefits which might otherwise be provided by
the UK National Health Service.

(ii) Outline the points to be made in a letter to this director as to why this
arrangement is provided for all employees. [7]

Based on the US experience in group private medical insurance the director from the
USA is concerned that the premium rates for this insurance in the UK will rise in the
future at a rate faster than retail price inflation.

(iii) Suggest reasons why this might happen. [5]

The director from the USA has also requested a briefing paper on the medical
underwriting practices applied to individual and group schemes in the UK.

(iv) Outline the points to be made in the briefing paper for the director. [7]

ZAB plc has concerns regarding the current cost of group private medical insurance
and has suggested that this risk is retained internally.

(v) Discuss the key advantages and disadvantages of this approach. [6]

LOM Insurance insures both group and individual private medical insurance. LOM
Insurance is currently insuring the group private medical insurance scheme for ZAB
plc.

(vi) List the data and other information required by LOM for pricing group private
medical insurance. [7]

(vii) Describe the investigations that LOM would undertake to determine the price
of their individual private medical insurance business. [18]
[Total 55]

SA1 S2008—2
2 In the UK, the standards for capital management are based on the concept of two
Pillars. Pillar 1 covers public solvency information that appears within the FSA
Returns. Pillar 2, the Individual Capital Assessment (“ICA”), covers a confidential
assessment of solvency for the FSA.

You are the valuation actuary of a UK health insurance provider writing critical
illness, income protection and private medical insurance products. You are
responsible for preparing the FSA Returns and the ICA report.

(i) Under Pillar 1, describe how you will calculate the capital requirement in
addition to the mathematical reserves. [8]

(ii) Under Pillar 2, describe the nature of risks and the approach that a firm could
take to evaluate the capital requirement of each one of the following risk
categories:

(a) Market and interest rate risk

(b) Operational risk
(c) Credit risk (including Reinsurance risk)
(d) Mortality and morbidity risk [20]

(iii) Discuss the advantages and disadvantages of the Pillar 2 regulatory

framework. [10]

(iv) Outline the Solvency II framework that is likely to be adopted by the EU

Commission. [7]
[Total 45]

END OF PAPER

SA1 S2008—3
Faculty of Actuaries Institute of Actuaries

Subject SA1 — Health and Care

Specialist Technical

EXAMINERS’ REPORT

September 2008

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.

R D Muckart
Chairman of the Board of Examiners

December 2008

General comments

Candidates who approached the problems, 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. Generally, candidates lost marks by giving insufficient
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. Usually each
valid point in the answer would normally attract 0.5 marks whilst the more basic elements
e.g. details in a pricing basis such as age and sex, would attract 0.25 marks.

Marks may be lost where answers are difficult to read.

Faculty of Actuaries
Institute of Actuaries
 Subject SA1 (Health and Care Specialist Applications) — September 2008 — Examiners’ Report

1(i) The benefits typically available on a Group Private Medical Insurance Plan are:
Hospital Costs
In patient costs
At least two from: Accommodation, nursing care, operating theatre, diagnostic
procedures, surgical dressings, drugs
In-patient physiotherapy
Day patient costs/day surgery costs
Accommodation for parent accompanying a child
Specialist fees
Surgeons’ and anaesthetists’ fees for in-patient or day-care
Physicians fees/In-hospital doctor consultation
Outpatient fees/costs
Specialist consultations
Diagnostic tests (radiology, pathology, X-ray, laboratory tests)
Physiotherapy
Radiotherapy/chemotherapy/scans (any two)
Psychiatric treatment
Additional benefits:
Private ambulance
Recuperative care
Cash alternatives if the NHS is used
Access to private out-of-hours GP and/or telephone helpline
Alternative treatments e.g. homeopathy, acupuncture
Dependant's benefits

Conditions may include:

Excess and limits
Exclusions
Acute illness only

1(ii) Although National Health Service is free at the point of use to UK citizens there
are waiting lists
There are waits for doctor and hospital appointments, tests and treatments
Waiting times for operations for debilitating but non-life threatening conditions can
be significant
PMI reduces the overall medical treatment times
and thus reduce staff absenteeism
which reduces overall costs and/or increases productivity
Further, some advanced cancer and other treatments may not be available.
or they may not be available in all locations
Key attractions of PMI include:
Choice of hospital
Clean hospitals – possible reduced risk of MRSA
Choice of time
Choice of medical care
Quality of accommodation (generally better under private medical insurance so
people prefer this alternative)
The quality of care may be perceived to be better than in the NHS
PMI can provide cover when travelling overseas
Key attractions of employer cover

Page 2
 Subject SA1 (Health and Care Specialist Applications) — September 2008 — Examiners’ Report

Price
Available to all
Attract and retain staff
Ultimately group PMI cover is offered because the employee values it higher than
the cost to the employer

1(iii) Total cost increase includes other factors as well as retail price inflation
The main drivers apart from RPI are:
Treatment quality improves, often due to new technology
There may be increases in the volume of medical services claimed
Additional medical procedures may be added to the existing regime for a patient
New, more expensive, treatment may be substituted for the previous treatment
Other points include:
Premium increases may make up for prior losses or prior burning cost errors
Above RPI rises on existing services e.g. where these are linked to wages paid to
staff
Legal issues and costs including malpractice
The cost of the medical provider purchasing the necessary insurance cover is
increasing in many countries and may rise by more than RPI, particularly if
insurance claims costs are also increasing with increasing court awards
Cost shifting between various providers and payers
Improved diagnostic tests may increase claim incidence
Increased profit margins (e.g. due to a contraction in the number of providers)
Lack of control on provider spending
Drugs/supplies sourced from overseas where inflation exceeds UK RPI

1(iv) Individual
Individual underwriting similar to life assurance comprising:
Proposal Form
Medical Attendant’s Report/GP Report
Independent Medical Examination
Other items available such as ECG, chest X Ray, blood tests, urine tests
Special Questionnaires for certain conditions
Telephone underwriting may be used
Individual underwriting is expensive
Individual underwriting is also time consuming and delays acceptance
Underwriting Decision: may use
Ordinary Rates
Postpone
Exclude pre-existing medical conditions
or use moratorium (where pre-existing conditions covered after a period that
medics have not been consulted)
Numerical Rating
Decline
When underwriting at point of claim, can also check for non-disclosure

Group
May only use moratorium
MHD for large groups (Medical Health Disregarded)
Have 'actively at work' or self declared health condition

Page 3
 Subject SA1 (Health and Care Specialist Applications) — September 2008 — Examiners’ Report

1(v) Self insured

Advantages
+ any favourable experience will benefit the company
+ not paying out commission to broker
+ not having to pay insurer’s profit margins
+ control over all aspects of the benefits (not limited to what is available in the
insurance market)

Disadvantages
– risk remains with the employer hence poor experience will impact directly on the
company
– smooth results
– lacking expertise in managing group PMI claims
– claims adjudication expertise required internally
– claims operations can be sub-contracted to a specialist
– lack benefit design expertise
– lacks other services provided by insurers e.g. employee assistance services
– need to create medical trust
– otherwise claims become benefits in kind
– maybe more expensive to self-insure because of admin costs as will not have
economies of scale of a large insurance company
– maybe more expensive to self-insure because less likely to do deals with
providers
– company takes over the employee relationship in this area, which could be
problematic when claims are declined.

1(vi) Data
IFA — Broker
Commission basis
Employer details
Name of employer
Location where employees work
and numbers
and age/sex profile
Nature of business
Criteria for employees to join the scheme
Occupations — mix — professional, supervisory, skilled, semi-skilled, unskilled
manual
Cover required
Basic benefits
Guaranteed period
Free cover level and treatment of cases above this
Commencement date and/or renewal date
Aids cover
Continuation option
Is scheme compulsory?
and if not, historical take-up rates
Are family members covered? If so ask for further details
Has the scheme been previously insured?
If so, which insurer and details of cover

Page 4
 Subject SA1 (Health and Care Specialist Applications) — September 2008 — Examiners’ Report

Claims experience
Scheme exposure — past 3 years, number of lives, salary roll (split by category if
possible)
Current claims details — date of birth, sex, inception date, cause of claim, benefit
amounts
Claims paid in last three years (same information)
Rated lives and details

1(vii) Pricing model points (age, sex, occupation) should be chosen to reflect the
expected rating structure and profile of new business.
The company may use a cashflow projection technique, but is more likely to price
using unit rates.
The calculation should take into account supervisory reserves or the cost of capital.
A set of assumptions will be required to perform the pricing: the starting point is
likely to be best estimate.

Morbidity
Need to investigate both claim incidence and claim amounts
Perform an analysis of own company experience over a suitable recent period
2–3 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.
Compare own data with that from other sources over the same time period, home
and overseas
Industry data e.g. from insurers’ associations
Data from consultants
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 medical inflation
Investigate the suitability and cost of reinsurance arrangement of various sorts e.g.
risk premium, original terms.
Need to investigate potential impact of AIDS/HIV
Further adjustment needed to align different target market with that underpinning
the base data.
Need to allow for claim incidence deterioration.

Mortality
May carry out similar analysis to the above, but mortality unlikely to be an issue
for a one-year group PMI contract
Data needs to be interpreted with care

Investment
Not really an issue for a one-year group PMI contract

Page 5
 Subject SA1 (Health and Care Specialist Applications) — September 2008 — Examiners’ Report

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
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.
Need estimate of new business volumes to determine loadings

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.

Lapse or renewal
Analyse experience for PMI products.
Ensure appropriate to the distribution channel.
Adjust data if target market is different from those underlying the above
researches.
Further adjust 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.
Make allowance for insurance premium tax

Profit
Include company profit criteria, commensurate with underlying risk of venture —
risk discount rate, PVFP, pay back period.

The premium rates should then be varied until the profit criterion is met.
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.

Page 6
 Subject SA1 (Health and Care Specialist Applications) — September 2008 — Examiners’ Report

Competitors’ rates
Research competitors’ office premium rates to assess levels of new products –
adjust assumptions then if deemed appropriate.

Assumptions and strategy

The values of the assumptions and the premiums that they produce will reflect the
company’s current and future strategy
An aggressive growth strategy may require assumptions stripped of margins.
A slow portfolio build strategy may permit more caution in the assumptions.

2(i) A long term health insurer must hold sums at least equivalent to the Minimum
Capital Requirement (MCR)
MCR = max (BCRR, LTICR + RCR)
BCRR acts as a form of minimum guarantee fund
Calculate in accordance with EU Directives
For most UK long term health insurers, 3.2m Euro for proprietary and 2.4m Euro
for mutual
LTICR – sum of the insurance death, health, expense and market risk capital
components
For Class IV business, e.g. IP, standalone CI and funded LTC business death
component is ignored
Accelerated CI may be split between classes
Health risk component is the highest of the premium amount , the claims amount
and the brought forward amount
Expense risk capital component is defined as 1% of the adjusted mathematical
reserves
Market risk capital component is defined as 3% of the adjusted mathematical
reserves
Adjusted mathematical reserves = gross of reinsurance mathematical reserves
multiplied by a reinsurance factor
Factor is higher of 85% and the ratio of net of reinsurance mathematical reserves to
gross of reinsurance mathematical reserves
RCR is calculated by identifying a range of assets backing the long term insurance
liabilities
These are subjected to a series market risk scenarios, specified by the FSA
RCR is the capital shortfall arising in the assets as a result of these scenarios
Scenario 1: A fall in equity values of at least 10% and no more than 25%
Scenario 2: A fall in property values of at least 10% and no more than 20%
Scenario 3: The more onerous of a fall or rise in fixed interest yields of 20% of the
long term gilt yield

Page 7
 Subject SA1 (Health and Care Specialist Applications) — September 2008 — Examiners’ Report

2(ii) General
Need to stress at 1 in 200 over one year (or equivalent)
Need to allow for correlations between the risks (e.g. between different asset types)
Need to allow for non-linearity of interaction between risks
Need to allow for the offset from mitigating actions (e.g. risk management under
operational risk)

Market and interest risk

Market risk will normally either be modelled stochastically
Or by selecting deterministic scenarios
Reduced market values of investments
Variation in interest rates and the effect on the market value of investments
Lower level of investment income than planned
Possibility of counterparty defaults
Possibility of a severe economic or market downturn or upturn
Currency devaluation
Extent of any mismatch of assets and liabilities, including reinvestment risk
Dramatic change in the spread between a market index of interest rates and the
risk-free interest rates
Fixed interest investments should be subject to stresses which allow for changes in
the shape of the yield curve
As well as to uniform changes of level
May test changes in volatility of some asset types
Corporate bond defaults

Operational risk
The likelihood of fraudulent activity occurring
Fraud may be internal (staff) or external (policyholder or other party)
That may impact upon the financial or operational aspects of the firm
The obligation a firm may have to fund a pension scheme for its employees
The technological risks that the firm may be exposed to regarding its operations
For example, risks relating to both the hardware systems and the software utilised
to run those systems
The reputational risks to which the firm is exposed
For example, the impact on the firm if the firm’s brand is damaged resulting in a
loss of policyholders from the underwriting portfolio
The marketing and distribution risks that the firm may be exposed to
For example, the dependency on intermediary business or a firm’s own sales force
The impact of legal risks
For example a non-insurance related legal action being pursued against the firm
The management of employees – for instance staff strikes
Dissatisfied staff may withdraw goodwill and may indulge in fraud or acts giving
rise to reputational loss
The resourcing of key functions
Both in terms of staff in appropriate numbers and with an appropriate mix of skills
such as underwriting, claims handling, accounting, actuarial and legal expertise
Disaster scenarios
Impact of human error
The rates of taxation applied, in particular where there is uncertainty over the tax
treatment

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Subject SA1 (Health and Care Specialist Applications) — September 2008 — Examiners’ Report

Unanticipated legal judgements and legal change with retrospective effect

specifically with regard to the impact on mathematical reserves
Need to look at both the potential cost and the likelihood in order to obtain an
estimate for an extreme scenario
Use of risk register to aid this assessment
Failure of internal controls
The risk of mis-selling
For example, the number of complaints or disputed claims

Credit risk/Reinsurance risk

Assessing potential credit risk events that may affect the firm’s solvency
Allow for the financial effect of non-payment of reinsurance
Considering the likelihood of non-payment of outstanding claims
And reinsurance cover purchased for underwritten risks may not be effective
The financial effect of non-payment of premium debtors such as intermediaries and
policyholders
The adequacy of the reinsurance programme
Whether the reinsurance arrangement is appropriate for the risks selected by the
firm
Whether it adequately takes account of the underwriting and business plans of the
firm
The collapse of a reinsurer or several reinsurers on the firm’s reinsurance
programme
The subsequent impact this may have on the firm’s outstanding reinsurance
recoveries
A deterioration in the creditworthiness of the firm’s reinsurers, intermediaries,
outsourcing or other counterparties
The degree of credit concentration. For example, the degree to which a firm is
exposed to a single counterparty or group
The degree of concentration of exposure to reinsurers of particular rating grades
The prospect of reinsurance rates increasing substantial
Possibility that reinsurance is unavailable for certain risks
Greater than anticipated losses from bad debts
Deterioration in the extent and quality of collateral
Failure or default of an outsourcing company
which could lead to renegotiation at a higher price
Default of a distributor who holds premiums
Allow for proportion that can be recovered (not always full amount)
Default of a hedge provider (e.g. derivative)
Use industry data on default rates to help set the required capital amount
The possible exhaustion of reinsurance arrangements, both on a per risk and per
event basis;

Mortality/morbidity risk
Mortality and morbidity risks can be divided into three broad categories
Large-scale events, the potential for catastrophic losses
Long-term adverse trends
Year-on-year volatility of non-homogeneous blocks of business
Need to correlate claim rates with economic environment
Sophisticated models could use stochastic modelling of mortality

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 Subject SA1 (Health and Care Specialist Applications) — September 2008 — Examiners’ Report

Large scale events include events which significantly increase claims globally or
nationally for a limited time period
Events which significantly increase claims only for the firm (e.g. as a result of
multiple claims under a group life or income protection policy).
Significant advances in the treatment of a significant critical illness of the aged
(e.g. cancer or heart disease)
The development of a commonly available treatment to significantly delay the
normal ageing process could be considered a ―large scale event‖ for a portfolio of
annuities or guaranteed annuity options.
Long-term adverse trends are particularly important where policy terms are
guaranteed
The ICA should consider firstly, with justification, how any historically observed
trends (including cohort effects) might continue, or might continue to accelerate or
decelerate.
Extreme adverse events should then be reasonably foreseeable worsenings of the
expected continuation or its rate of acceleration or deceleration
It may be necessary to assume different rates or even directions of change for
different groups of lives or at different ages
Analyse the potential for mathematical reserves subsequently to prove inadequate
compared with the current reserving level
The effect of claims experience being more costly than planned by analysing
historic claims experience, volatility and trends in experience
For underwriting risks, the adequacy of the firm’s pricing
For example, the firm should be able to satisfy itself that it can charge adequate
rates
The uncertainty of claims experience
The effects of a high level of uncertainty in pricing in new or emerging
underwriting markets
Due to a lack of information needed to enable the insurer to make a proper
assessment of the price of the risk
The geographical mix of the portfolio or whether any geographical or jurisdictional
concentrations exist
The appropriateness of policy wordings
For reserving and claims risks, the frequency and size of large claims
Possible outcomes relating to any disputed claims, particularly where the outcome
is subject to legal proceedings
The ability of the firm to withstand catastrophic events, increases in unexpected
exposures, latent claims or aggregation of claims
Social changes regarding an increase in the propensity to claim and to sue
Other social, economic and technological changes.
The adequacy and sensitivity of the mathematical reserves to variations in future
experience

2(iii) Advantages
The Pillar 2 framework requires companies to assess all of the risks to which they
are exposed.
It thus allows explicitly for a wider range of risks than Pillar 1.
For example, expense risk, persistency risk, group risk, liquidity risk, pension
scheme risk
(note – only give marks here for risks not given in part (ii))

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 Subject SA1 (Health and Care Specialist Applications) — September 2008 — Examiners’ Report

Unlike for the Pillar 1 RCR, the stress tests in the ICA are not prescribed and
should be selected as being most appropriate to the specifics of the company.
The framework can therefore be considered to be more flexible, and more equitable
between companies. (half mark for either ―flexible‖ or ―equitable‖)
The Pillar 2 calculation is a more sophisticated calculation, that allows the
company to take credit for (and thus reduce capital required in respect of):
the market consistent present value of future profits on the in-force business
company specific diversification benefits that exist between the various risks.
The calculation can help companies to raise the profile of risk management
processes internally and to embed risk management into their business.
It should also improve protection for policyholders.
If a company chooses to disclose the calculation to investment analysts, the
information might help to support share prices.
The calculations can be integrated into other parts of the operation, e.g. product
design and pricing, calculations of shareholder value.
There are similarities between the ICA framework and Solvency II proposals, so it
helps to prepare companies for the introduction of Solvency II.
The confidential nature of the ICA may be a good thing (e.g. information not given
to the market)

Disadvantages
The lack of prescription means that a wide range of different approaches could be
taken, so the standard of calculation may therefore not be consistent across all
companies.
Further, as ICA calculations are confidential, companies are not able to compare
with peers.
Some components of the ICA calculation are difficult due to lack of credible data.
This is particularly the case for the assessment of operational risks.
Companies may have required specialist assistance to develop and perform the
Pillar 2 calculations, in addition to their existing resources.
System changes may have been required, particularly to implement market
consistent valuations (e.g. time dependent discount rates).
Overall this increases costs to the company.
These costs could be passed onto consumers in the form of increased product
charges, but this would reduce the attractiveness of those products.
The introduction of Solvency II is due in a few years and will replace ICA, so some
of the work done to date to implement ICA could be perceived as being ―wasted‖.
Pillar 2 capital requirements might be higher than under Pillar 1, resulting in less
spare capital or a need to raise additional capital – which could be difficult or
costly for the company.
The introduction of the Pillar 2 assessment also places an increased burden on the
FSA, which has to review all ICAs and issue Individual Capital Guidance.
There might also be a burden on companies’ management in having to deal with
the FSA to discuss ICG allocations.
The ICG adds uncertainty

2(iv) EU’s review to establish a solvency system

Better matches the risks of insurers
Risk-based approach
The framework consists of three ―pillars‖

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 Subject SA1 (Health and Care Specialist Applications) — September 2008 — Examiners’ Report

Pillar 1 represents the quantitative assessment of minimum capital requirement

Key risks include insurance, market, credit and operational risks
Solvency Capital Requirement (SCR) is the key quantitative assessment
SCR will be based on the capital required to ensure solvency at a 99.5% confidence
level over a 1-year time horizon
SCR may not be lower than Minimum Capital Requirement (MCR)
MCR is the lower trigger for mandatory supervisory intervention
Pillar 2 represents the review process
It will address internal control, risk managements and supervisory practices
The review may lead to additional capital guidance
Pillar 3 represents the market discipline
This sets the information disclosure requirements
Information would include public disclosure and non-public disclosure
which could include their risks, business overview, governance, solvency valuation
basis, capital and risk management

END OF EXAMINERS’ REPORT

Page 12
Faculty of Actuaries Institute of Actuaries

EXAMINATION

27 April 2009 (pm)

Subject SA1 — Health and Care

Specialist Applications

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 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.

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 three 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 from the approved list.

© Faculty of Actuaries
SA1 A2009 © Institute of Actuaries
1 A UK health and care insurance company writes a range of health and care business,
including individual critical illness, income protection and long term care products
and group PMI business.

It is summer 2007. The company is concerned about the possibility of a sharp change
in the economic conditions. In particular, it feels that there are indicators to suggest
that credit spreads (the difference between the return obtainable on government bonds
and corporate bonds) may widen dramatically, and there may be a reduction in the
availability of loans from banks and other financial institutions. This will result in a
shortage of liquidity for many organisations. The company is also concerned about
the possibility of equity markets becoming very volatile and generally falling in value
as a result of the worsened credit situation and the economy moving into recession.
Consequently, the insurance company has decided to monitor new business volumes
very actively.

(i) Discuss the possible impact on the company’s new business if the economic
conditions described above do occur. [11]

(ii) Describe the new business monitoring activity that would be carried out,
highlighting the main complications that would arise and how these could be
addressed. [6]

(iii) Describe other changes in experience items that might result from the
predicted economic conditions. [8]

The company is considering the impact that the economic conditions described above
would have on the capital requirements for the company’s long term health and care
business. The company defines and calculates “realistic capital available” as the
excess of realistic assets over realistic liabilities, both being calculated on a market
consistent basis. It also performs Pillar 2 ICA calculations.

(iv) Describe how risk is allowed for under Pillar 2 ICA calculations. [7]

(v) Describe the possible impact on the realistic capital available to the company
and its ICA calculation if the economic conditions described took place. [10]

The finance director is concerned about managing the level of risk to the business in
the economic climate described above. He has therefore suggested that it would be
prudent to take the following actions:

• review the benchmark asset allocation, and increase the proportion of funds
invested in “less risky” asset classes

• disallow investment in subordinated debt

• restrict the investment managers so that they are forbidden from departing from
the benchmark asset allocation

(vi) Discuss these suggestions. [12]

[Total 54]

SA1 A2009—2
2 You are the actuary in charge of product development at a UK life and health
insurance company. Your company currently offers income protection insurance on a
group and individual basis. The minimum deferred period offered is 13 weeks.

It has been suggested by the sales manager that a new service should be developed
offering Sickness & Absence Management monitoring for companies irrespective of
whether they insure with your company. This monitoring requires all employees of
the client company to report their absence and the reason by telephone to a specially
created unit, from the first day of absence. The unit then monitors the absentees until
the employee returns to work. The unit will be staffed by nurses.

(i) Discuss the possible advantages and disadvantages to the insurance company
of developing such a service. [7]

(ii) Discuss the investigations required to price the Sickness & Absence
Management monitoring service if the proposal went ahead. [15]
[Total 22]

3 A large UK health and care insurer currently writes long term business on both
guaranteed and reviewable premium rates.

(i) Discuss the relative merits of offering policies on guaranteed and on

reviewable premium rates. [5]

(ii) Outline the policy conditions and practices that a company should adopt for
policies with reviewable premium rates in order to satisfy the requirements of
Treating Customers Fairly. [8]

(iii) List reasons that are unlikely to be considered valid for changing a premium
under a reviewable policy. [3]

(iv) State the main factors that need to be considered before undertaking a
premium review. [8]
[Total 24]

END OF PAPER

SA1 A2009—3
Faculty of Actuaries Institute of Actuaries

Subject SA1 — Health and Care

Specialist Applications

EXAMINERS’ REPORT

April 2009

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.

R D Muckart
Chairman of the Board of Examiners

July 2009

© Faculty of Actuaries
© Institute of Actuaries
 Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

General 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. 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.

Comments on individual questions

Question 1

Scripts often contained a lot of repetition, which naturally restricted the marks awarded.
Candidates could use the reading time to make a plan of their answer, or use sub-headings,
to ensure their answer contains sufficient breadth.

Question 2

Answers were not always sufficiently adapted to the situation in the questions – just repeating
standard bookwork without applying it to the situation described would not earn many marks
on this question. It was not always appreciated that the service would be offered to all
companies, and not just ones insuring with the insurer.

Question 3

This question was generally well answered, although many candidates did not provide many
factors in answering part (iv).

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 Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

1 (i) Impact on new business

New business volumes could fall due to fear about economy reducing
propensity to buy – inclination to hoard rather than spend, increased costs of
debt reducing disposable income to be spent on non-essential insurance,
reduced disposable income through increased unemployment
However, fear about the future could potentially increase new business
volumes
Overall the impact will be affected by the competitive position if market
volumes fall then some companies will compete on price, and some won’t
If budgets are tight then average premiums might be expected to fall as clients
purchase only the level of cover they really need
Also new business volumes may reduce if premiums increase as a result of
higher claims experience.

Mortgage business would be the worst hit, so CI would be hit worse than the
other lines of business mentioned
Fall in mortgage business is likely to reduce sales at younger ages and hence
average age of new business increases
Average sum assured may be affected, if changes in value of house purchases
or if only the most wealthy can afford insurance at all
Most expensive and “nice to have” products will be worst hit, so volumes of
IP and CI may fall significantly as likely to be seen as less essential than life
only cover
However, there may be increased demand for IP e.g. from self-employed

LTC policyholders don’t generally have mortgages and hence may be less hurt
by the economic situation
Their financial position depends on where their money is invested:
They may have substantial cash savings, which may benefit from rising
interest rates
But interest rates may also fall in a recession and if their money is in equities,
they could also be suffering the effects of this
However it is more usual for most of their wealth to be locked into residential
property
Immediate needs LTC is more essential and less “nice to have” so volumes
will be much less affected

Group business volumes will depend on the state of companies’ finances

If companies are struggling to service their debt they may not be able to afford
PMI cover
Companies may even be wound up
so number of new schemes may fall
Size of schemes may be relatively unaffected, depending on the industry
unless companies are laying off staff and reducing size of workforce
Companies may reduce benefit levels in order to cut costs, which would
reduce new business premiums
Similarly companies would be aware that there is less need to offer high
benefits to recruit and retain in a recession – again this could reduce business
levels

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 Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

These are all longer term effects than those for the individual business
So in the short term, there may be less effect than on the other lines of
business
An exception would be any contributory schemes, which may suffer from
reduced take up if the members are feeling the pinch

Mix of business may change if people move to buying through cheaper

channels
New business volumes for this company may fall if they themselves get into
financial trouble and confidence in them is lost

(ii) Monitoring

Monitor the level of new business sold by total premium income

and number of policies sold or average policy size or some new business index
such as annual premium plus single premium /10

• split by line of business

• split by channel
• or other splits that affect the profitability, such as if there are loss leading
tranches of business

Compare the figures against last month

Total market activity and market share
For group PMI can monitor the proportion of renewals actually taken up

Complications:

Seasonality will affect the comparison so take the figures for the same month
of last year
Project forward a year allowing for the trend
The data may be of poor quality (can improve this through systems
improvements, suitable IT etc)
Need to strip out new business cases that subsequently cool off
New business is slow to respond to changes due to the time taken to
underwrite and the time the application spends in pipeline so monitor quote
activity and/or application activity and amount of enquiries
Could also investigate causes of the quotes that were not converted into sales

(iii) Investment returns

Expect these to reduce for many asset classes, such as equities and corporate
bonds
Returns would be more volatile
If there is any investment in property, this is also likely to fall in value as
highly correlated to equities and loan interest rates
Cash returns may increase because banks require liquidity, and seek cash on
deposit
Also need to consider possibility that interest rates may fall if credit squeeze
turns into a recession

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Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

Future inflation rates

May increase in a high interest environment

May reduce if the credit squeeze is expected to develop into a recession
For PMI hospitals may increase charges to recover lost revenue

Lapses and renewal rates

Lapses may increase, and renewal rates decrease, because people might not be
able to afford the premiums if the cost of debt increases
Lapses would also increase due to mortgages/loans defaulting

Expenses

Per policy and renewal expenses may increase due to fixed elements
Investment expenses may increase, if more active trading is required in the
volatile market
If values fall then investment expenses as a % of fund values may rise
Expenses could decrease if company takes cost cutting measures in a
recessionary environment
Expenses could increase if need to do more underwriting and claims
management (e.g. to counter potential increases in fraud)

Claim inception rates

May rise, particularly for income protection due to increased stress working in
the current economic environment
and because companies try to put people on IP claims rather than make them
redundant
Similarly there may be increased claim activity under PMI under the “claim
while I still can” mentality
Could also increase due to lapses being largely selective
Critical illness and long term care inception rates may be relatively unaffected
For all claim types, the level of fraudulent claims is likely to increase
significantly in difficult economic conditions

Recovery rates

Depend on policy wording

People may be less motivated/unable to return to work in adverse economic
conditions
However, recovery rates could improve if IP claimants are worried about the
safety of their jobs and/or need to return to a full salary if other savings or
household income has reduced

Page 5
 Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

(iv) How risk is allowed for in ICA:

The principle is to cover all the risks to which the company is exposed

• market risk
• credit risk
• morbidity risk
• mortality risk
• expense risk
• lapse risk
• third party default risk
• operational risk
• liquidity risk
• group risk
• pension scheme risk

Some can be very hard to quantify e.g. operational risks

The amount of the risk to include should be consistent with a 99.5% certainty
of solvency over a one year timeframe or can use a lower confidence level
over a longer timeframe if it can be demonstrated that this is of overall the
same strength
Market consistent techniques should be used
This may involve stochastic modelling
Or in practice the risk could be allowed for by applying 1 in 200 shocks to the
risk factors identified allowing for 1 year’s worth of new business and the
possibility of closure to new business and recalculate the surplus capital
expected at the end of the period
Aggregation of the risks needs to be carried out, to reflect any diversification
benefits this may be done using a correlation matrix approach. noting that
correlations in extreme conditions can differ from those observed in “normal”
circumstances
Also need to test scenarios in which a certain subset of events can interact and
lead to a higher capital requirement than the basic 1 in 200 correlated
calculation.

(v) Effect on pillar 2

Impact on realistic capital available:

Realistic liabilities might increase due to higher claims as identified in (iii)

Credit spreads:

The expected credit spread widening would reduce the market value of
corporate bonds
The effect on assumed earned yields after the widening depends on the
company’s view of why credit spreads are expected to widen

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Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

If spreads widen as a result of increased chance of default then there would be

no change to the expected future risk adjusted yield so liabilities will be
unchanged
Hence the “capital available” will have reduced
If spreads widen but risk of default is assessed to be unchanged then the
“liquidity premium” part of the yield has increased and corporate bond assets
can be assumed to earn a higher risk-adjusted future yield so liabilities can be
assessed at a higher valuation rate and hence the “available capital” position
may be broadly unchanged
Effect depends on whether the company expects to hold its assets to maturity
and how well the asset and liability cashflows are matched
However, some companies choose not to anticipate liquidity premia as well as
default premia, in which case the position would be as above, i.e. reduced
capital available

Regarding the equity falls:

If equity markets fall then this will weaken the solvency position because asset
values fall but there would probably be no change to the market consistent
value of liabilities (unless unit-linked)
Note that we might hold equities if we have some long term real liabilities,
such as pre funded inflation linked long term care

Other impacts on capital available:

There may be other impacts if the anticipated conditions cause ripple effects
on other economic indicators e.g. changes in the risk-free rate or inflation

Additional considerations for the ICA calculation:

The company also needs to consider whether its view of the future “1 in 200”
risk events might have changed e.g. did it underestimate corporate bond
default risk events?
Did it underestimate extreme liquidity risk events?
Correlation assumptions might also increase due to greater understanding of
contagion effects
Volatility is important in pillar 2 because the calculation is based on an
extreme event
The co-efficient of equity volatility could be increased in the projections
This will increase the ICA
Note that following the events, the company would need to test based on a
further 1 in 200 position
This could be very onerous and may result in the company breaching its
capital requirements
The regulator may decide to act to protect the industry, for example by
granting waivers and temporarily reducing the onerousness of the ICA rules.
The impact will also depend on whether there has been a change in the
underlying “risk-free” rate; if this has fallen then this increases the ICA

Page 7
 Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

(vi) Review benchmark asset allocation

Principle of investment is to maximise the return taking due account of the

risk involved so if risk has genuinely increased, it may be sensible to consider
reviewing the benchmark
However, benchmark should be set considering matching by nature, term,
currency and certainty
If equities do become volatile it would then become less easy to sell, so we
may wish to sell now but if rising volatility is widely expected then this will
already be factored into prices
Need to consider timing issues
If equities are going to become generally depressed, would it be worth getting
out now while the going is good
If markets are generally risk averse at the moment, less risky assets may have
temporarily high prices, making it a bad time to buy
The predicted economic crisis might not happen, in which case it’s a bad idea
to incur lots of dealing costs
Reviewing the matching strategy may be a better solution than arbitrarily
moving into lower risk assets
For immediate needs products this may well be a solid block of low risk
government bonds
and for PMI business which is short term, cash based assets may be
appropriate
However, some business could be long term with liabilities increasing at real
rates, such as pre funded long term care. This business would be better
matched using equities
Also consider the effect on the reserves
If liquidity is currently an issue, it may be more important to review the
liquidity position and improving the liquidity position could also improve the
ICA
Carry out a full ALM study to identify the optimal asset allocation taking into
account the costs of any mismatching reserve
Corporate bonds could be as risky as equities in a widening spread
environment
Tax should be taken into account in setting the benchmark

Subordinated debt

Subordinated debt may be at higher risk of default than other classes, and if
the finance director wishes to reduce the risk of the portfolio then this action
may achieve that
However, some subordinated debt may offer healthy returns especially in the
current uncertain climate
Ruling out such investments may reduce the returns achievable
A more sensible approach might be to restrict the companies that can be
invested in – e.g. to BBB rated companies and above
or to restrict the percentage in any one counterparty
or even to link the amount that can be invested in a company to their credit
rating.

Page 8
 Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

Restrict investment managers

It is wise to ensure that investment managers don’t have carte blanche, as they
may look more for tactical opportunities, and think less about matching
but if markets are expected to be volatile, this may be a good time for tactical
investments
and if investment managers are too strictly managed, they may be unable to
seek good value investments
They may be unable to dump shares that start to go into freefall
However, if the benchmark is set in order to match then, in the long term,
departing from the benchmark would be dangerous
Maximum departure from the benchmark should be set as a percentage range,
because as asset values move, a single point benchmark is likely to be
breached and require a portfolio rebalancing.
Restricting investment managers could lead to loss of morale and loss of high
quality active managers

In each case,
Need to consider any regulatory restraints
More investigation would be required before any action taken

2 (i) Advantages

The service may be a profit centre if it is possible to charge more for the
administrative fees than the costs of administration
For policies taken out with the insurer it may reduce overall absence and
therefore claim cost
Might give insurer information on absence incidence and lengths of sickness
lasting fewer than 13 weeks
It may be possible to offer a discount to new and existing group IP
policyholders who take up the service
And hence increase group IP business
The proposal would help the company to expand its business in the health
arena
Using nurses to staff the unit ensures that they already have health
management training
May need to introduce this service in order to keep pace with competitors

Disadvantages

The insurance company may not be able to access the data, as the service
would have to be provided by a non-insurance subsidiary
It does nothing to help individual sales and may divert resources that could
have been used to enhance individual sales
Difficult to cost as the insurer currently does not receive notification of
sickness until the end of the deferred period hence it may no idea how many
periods of absenteeism lasting fewer than 13 weeks there might be and how
long they will last

Page 9
 Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

The proposal involves considerable set up costs and ongoing costs due to
possible high volumes of contacts for short periods
The service will use qualified health professionals with higher salary costs
than normal administrative staff and with an unknown level of new business
Possible legal complications as not insurance
The service could be hard to sell given the likely high cost
Employees may not like it, reducing the insurer’s reputation

(ii) Monitoring Costing Basis

Will need an estimate of:

• Frequency of contact
• Absence incidence
• Length of disability

Reporting Levels

Industry data e.g. from insurers’ associations

Data from reinsurers
Assess the adjustment needed to relate any published data to the particular
circumstances of the company, its products and target market.
Further adjustment may be needed to align different target market with that
underpinning the base data.
Investigate whether need to rate by industry/location
Need to allow for expected future trends also.

Expenses

Need to forecast volumes of new business

Based on relevant data
May need to build a bottom-up model for expenses
Need to derive manpower costs and expertise required
Lengths of phone calls of different types
Cost of outbound calls/helplines
Salaries and other benefits of staff and management
IT, management systems costs
Advertising costs
Property costs/floor space/rent
Absentee costs will be split between initial absentee validation and ongoing
absentee monitoring
Split costs into those that are member related and those that are per-contract.
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 client company 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.

Page 10
 Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

Projected inflation may possibly be measured as difference between

government fixed-interest and index-linked securities.
Allocation of company overheads

Estimated renewal rates based on lapse rates

Tax

Make suitable assumptions as to the insurer’s current and future tax position.
The tax position might be different as the service is not insurance

Profit

Include company profit criteria, commensurate with underlying risk of venture

— risk discount rate, PVFP, pay back period.
Cash flow projection results
Vary the charges to meet profit targets

Sensitivity analysis

Test the sensitivity of the final charges to adjustments in the individual

assumptions and refine inputs accordingly.

Competitors' rates

Research competitors’ charges

Assumptions and strategy

The values of the assumptions and the charges that they produce will reflect
the company’s strategy in launching into the new market:

An aggressive growth strategy may require assumptions stripped of margins.

A slow portfolio build strategy may permit more caution in the assumptions.

3 (i) Guaranteed rates

Policyholder has financial certainty and piece of mind

Easier for intermediary to explain at point of sale
May need to offer guarantees to compete with other companies who offer
them
ABI Statement of Good Practice on CI improving robustness of definitions
Reviewable products have a heavier burden of demonstrating TCF
Reviewable products may cause poor reputation if premiums are increased
materially on review
Easier administration
Lower selective lapsing

Page 11
 Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

Reviewable rates

The company can offer the product at lower premium rates than if guaranteed
Affordability leads to financial inclusion
Increased consumer choice
Encourages innovation
Reviewable premiums can go down – happy customers
Improved definitions to avoid doubts over unfairness
The company may find that when it comes to review the rates, TCF
considerations mean that it is unable to do so and thus effectively the rates are
guaranteed
Easier to get reinsurance
Reduced risk of losses to the insurer and therefore lower capital requirement

(ii) Option to end contracts or reduce benefit

The policy should state clearly when the reviews will take place
Set out any minimum and maximum limits (if appropriate)
State that the review applies to tranches of business only
State that the circumstances of individual policyholders will not be taken into
account
State that the premium review will be carried out in a fair and reasonable
manner
Valid reasons stated in the policy
Increases can be made due to events outside the control of insurers
Reviewability should be clearly explained at point of sale
Choice between guaranteed and reviewable should be fully explained
Should ensure do not change the premium for invalid reasons
Reviews should take place when specified
How the review process will work should be fully explained
Provide a complete list of assumptions that could change
Explain how these assumptions will be used to re-calculate premiums
Base premiums using assumptions appropriate for full term
Assumptions reviewed regularly and fully documented
Assumption values for in force should be consistent with those used for new
business
Practices used in the review should conform to current industry standards
Full documentation about how, when and what factors you will use to review
Explanation of what data source will be used
All customer literature will explain in plain English with no ambiguity
Reinsurance contracts and customer contracts should be perfectly aligned
Thorough staff training
Keep copies of all documentation sent to policyholders
Communicate the results of the review to policyholders, even if no change

(iii) The following are unlikely to be valid reasons:

Recouping losses incurred up to date of the review

Increasing profitability margins beyond those originally assumed
Unfairly targeting a particular group
Unfairly targeting an individual

Page 12
Subject SA1 (Health and Care Specialist Applications) — April 2009 — Examiners’ Report

Errors made in original pricing assumptions

Deliberate low initial price
Increasing reinsurance costs, unless based on valid reasons
One way only i.e. company will only consider increasing but never consider
reducing premiums
Changes in assumptions linked to internal company factors
One-off adverse experience unlikely to recur

(iv) Issues to consider:

Customer’s understanding at point of sale

Need to assess it there is adequate historical own experience in heterogeneous
groups
Interpreting reinsurer and industry experience data
Is it possible to justify changing expectations of the future; could this have
been foreseen at the outset
Alignment of interest between insurer and reinsurer
Materiality of reasons for review
Size of the likely premium change
Expected direction of premium change – the overall justification and
discussion process may be more straightforward if the intention is to reduce
premiums
Time
Costs
Resources
Legal opinion
External review
Discussed with ABI
Discussion with FSA to explain and discuss
Pilot the results of the review with sample customers
Actions of other companies with reviewable products
Likelihood and frequency of future reviews and changes
TCF legislation
Impact on persistency/selective lapsing
Opportunity to use the communication with the policyholder to increase
business
Systems capability
Impact on new business rates and volumes
Frequency and outcomes of past reviews

END OF EXAMINERS’ REPORT

Page 13
Faculty of Actuaries Institute of Actuaries

EXAMINATION

6 October 2009 (pm)

Subject SA1 — Health and Care

Specialist Applications

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 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.

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 four 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 from the approved list.

© Faculty of Actuaries
SA1 S2009 © Institute of Actuaries
1 You are the Actuarial Function Holder of a medium sized UK health and care insurer
writing critical illness, income protection and private medical insurance business. It
has been decided that the portfolio of in-force critical illness business will be
transferred to another health and care insurer. An application has been made to the
High Court for approval of an insurance business transfer scheme.

You are required to prepare a report as part of the submission to the High Court for
approval.

Outline the information that you would include in your report. [23]

2 A UK health insurer is considering the development of a new policy condition within

its current private medical insurance contract in the individual market. This policy
condition will be added at the next renewal date on existing policies and would also
be included in all new policies. In each case, there would be no medical underwriting.

The proposal is to reimburse in full the cost of medically approved drugs currently not
provided by the National Health Service in some areas of the country as the drugs are
too expensive or are only effective for some patients.

You are the pricing actuary in the product development team.

(i) Discuss the research that has to be undertaken in order to price the risk for this
policy condition. [5]

(ii) Discuss the issues that might arise from the inclusion of this policy condition
and how they might be mitigated. [14]

The product development team feels that the contract should be partially reinsured.

(iii) Discuss the factors, other than those related to the cost of risk, to be
considered by the reinsurer when offering terms. [4]

It has been suggested that this additional policy condition could form the basis for a
stand alone contract with medical underwriting.

(iv) Discuss the additional issues that might arise if this approach were adopted. [4]
[Total 27]

SA1 S2009—2
3 (i) Outline the factors that may affect how a financial adviser chooses which
income protection product to recommend. [4]

A health and care insurer currently writes a wide range of long term health and care
business sold only through insurance intermediaries. The intermediaries are
remunerated on a commission basis, with some earning more commission per policy
than others.

(ii) Suggest possible reasons why the insurer has decided to pay different rates of
commission to different intermediaries. [6]

There are two types of commission available: initial commission, which is paid at the
outset of a policy, and renewal commission, which is paid quarterly to the
intermediary as long as the policy stays in-force. A combination of these types may
also be paid.

The regulator would like to discourage the commission method of remunerating

intermediaries, and would like them to move instead to a fee-based business model.
Under this model, intermediaries would not receive commission for the business they
provide to the insurer, but would directly charge their clients a fee. The fee charged
could be an initial fee, paid by the client to the adviser around the time the policy is
taken out, together with an annual maintenance fee, or just an annual maintenance fee.
The initial fee an adviser could charge a client is likely to be much lower than the
levels of initial commission currently paid.

(iii) Discuss the proposed new fee-based business model from the point of view of
the customer. [3]

(iv) Discuss the possible effects on the intermediaries of the move to a fee-based
environment. [5]

(v) Discuss the possible effects of the proposed change on the persistency
experience of the insurer. [4]

(vi) Suggest possible courses of action that the insurer could take in order to
maintain new business levels after the planned changes. [7]
[Total 29]

SA1 S2009—3 PLEASE TURN OVER

4 The country of Actuaria is considering the introduction of a new solvency capital
requirement regime for its health and care insurance companies. Under the new
regime, companies are given the option to calculate their solvency capital requirement
by either using:

• Standard formulae that will be set by the regulator.

OR

• An “internal model” that will be individually designed and developed by

companies that opt for this option. The model must be individually approved by
the regulator. Although most companies have been using some form of model
under the current solvency capital requirement regime, the regulator has indicated
that any existing models are NOT likely to be good enough to be used as internal
models.

(i) Discuss the advantages and disadvantages for companies that opt for the
“internal model” approach. [10]

(ii) Suggest the key requirements that the regulator might impose on a company
that decides to design and develop its own “internal model”. [11]
[Total 21]

END OF PAPER

SA1 S2009—4
 Subject SA1 — Health and Care
Specialist Applications

September 2009 Examinations

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.

R D Muckart
Chairman of the Board of Examiners

December 2009

Comments for individual questions are given with the solutions that follow.

©Faculty of Actuaries
©Institute of Actuaries

19/02/2010
 Subject SA1 (Health and Care Specialist Applications) — September 2009 — Marking Schedule 

General 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. 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.

Comments on individual questions

Question 1

Candidates did not always differentiate whether they were talking about the transferring company,
the company to which the policyholders were being transferred, the policyholders being transferred
or those remaining with the transferring company. Marks were often lost through a lack of different
points being made. Candidates who had practised techniques for generating a large number of points
for long questions may have found this question easier to answer.

It is often helpful to use subheadings when answering this type of question.

Question 2

Generally the attempts at this question were good, especially for parts (i) and (iii).

Question 3

Parts (i), (ii) and (vi) were generally well answered; the other parts less so. Knowledge of current
market developments would certainly have given candidates an advantage here. Thinking logically
about the situation this would put advisers in would help. As is frequently the case, if candidates were
 Subject SA1 (Health and Care Specialist Applications) — September 2009 — Marking Schedule 

struggling to think of sufficient points, considering the short and long term position separately would
give rise to some additional points.

Question 4
This was generally well-answered.
 Subject SA1 (Health and Care Specialist Applications) — September 2009 — Marking Schedule 

1 Purpose of Report

To describe the impact of the Scheme on the policyholders, how the transfer would
affect the security of their benefits and how it would affect their reasonable benefit
expectations

Sets out how the Scheme is consistent with the requirements to treat customers fairly.

Background

Names of the parties

Brief description of both companies

Date on which the application is being made to the High Court for approval

Business to be transferred

Fund structure of the transfer

Fund structure of the transferee

Statement that the receiving company is authorised to transact this business

Advice and opinions

State own role in the company. i.e. the Actuarial Function Holder

Advice received from external actuarial advisers

Their conclusion/opinion on the likely impact of the transfer on the company’s risk
profile and on the capital requirements

The conclusion from the Board stating whether they believe the proposed transfer
would be beneficial for both transferring policyholders and for the remaining
policyholders

Signatories/signatures

Disclosure

Specify own qualification. e.g. FIA/FFA etc.

Date of appointment as the AFH

Declare whether currently is an employee of the company

Declare whether currently is a director of the company

Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

Declare whether currently is a policyholder of the transferring company and/or the

transferee

Declare whether currently hold any shares of the transferring company and/or the
transferee

Overview of the company

History/authorisation of the company

Nature of business written in the company

Types of business (eg ACII, CI)

Distribution channels

Terms and conditions

Details of the transferring business

Number of current policyholders

Size of sum assured

Size of premium income

Value of liabilities

Any discretionary elements eg reviewable premiums

If so, details of how the discretion has been applied in the past and how it is planned
to be applied following the transfer

Stringency of claims management

Quality and availability of rehabilitation services

Continued availability of options and maintenance of current terms

What liabilities will remain with the seller (e.g. IBNR, claims not settled)?

Underwriting

Data quality

Any existing legal cases/complaint cases and how dealt with post transfer

Existing reinsurance and plans on transfer

Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

Profile of policyholders. e.g.

Age/sex distribution

Socio-economic mix/occupation

Smoker/non-smoker split

Average policy size

Proportion of rated cases

Details of the transfer

Rationale behind the transfer

Proposed date of transfer

Assets attributable to the transferring business:

amount relative to statutory reserves

types of assets

Financial position before and after the transfer

Separate considerations for transferring business and remaining business

Capital position before and after transfer

Individual Capital Assessments before and after

Security of the benefits of the policies before and after

Credit ratings of both companies

Policy terms and conditions not expected to be affected as a result of the transfer

Quality of administration and client services of both companies

Any tax implications

Other

Notification of policyholders

Discussion and opinion of the FSA

The costs of implementing the Scheme

 Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

How these costs will be met

Any monopoly considerations

2 (i) As the pricing actuary you are not expected to possess a detailed medical knowledge
on the areas where drugs have been developed that are approved but not used by all
areas of the NHS.

So you will need access to your Company Medical Officer and other specialist
doctors

Other sources of relevant drug information are:

Reinsurers CMO

Specialist Medical Societies

Medical journals

Consultants

Overseas

The research would use the following steps:

Identify the current drugs and drugs that might be added to (or removed from) this list
in the future

Estimate the incidence split by normal rating factors (eg age, sex) and cost per drug

Estimate the length of treatment and therefore cost of treatment

Investigate which Primary Care Trusts (PCTs) provide what benefits and exclude
others and the expectation of future trends in this

Data should be split by region

Allow for inflation of drug cost

Any secondary costs due to using the drug

Any competitors and what they charge

Allow for heavy margins in your estimates due to anti-selection by the policyholder
 Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

Allow for expected impact that introducing the new benefit will have on sales (eg due
to likely increase in premium; this is needed to price for spreading the fixed/initial
cost)

2 (ii) Problems that arise (P); M Mitigation

P How do you control the drug list so that any claim is managed

M Only cover drugs available in the UK

P Special drugs may be increasing in price faster than expected.

P Increased propensity to prescribe

M Medics must be trained in prescription levels

P There can be heavy anti-selection

M So you will need to have a pre-existing condition exclusion backed up by a claim

control system alerted to this possibility and a waiting time before cover commences

M Make sure pricing allows for anti-selection

M Put back medical underwriting

M Apply an excess or some other form of co-insurance

P There will be concentration of these claims in some areas

M In time, differential pricing by post code / PCT might be needed

P Not all drugs suit everybody

M Monitor and stop treatment

M Ongoing research needed from the claims area

P This means that claim expenses will be higher

P The qualifying drug list will change quite quickly

M Medical research into what drugs are about to be medically approved

P Some claimants will be able to self select more expensive drugs against that
normally provided under the contract

M On-going research

P Often the drugs concerned can be purchased on the internet so it needs to be

resolved as to who buys these drugs
Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

M The drugs are purchased by the Medics or the policyholder under guidance from
the medics

P There is no control on the internet on the drug strength or is it the right version for
the patient

M The patient requires a prescription

P The drug coverage will change as the PCT includes or excludes new and existing
drugs from the list

M Liaise with PCTs

P Experience can change quickly

M Monitor and reprice

P Additional claim payments over and above that originally included in the premium
basis

P Limited pricing data

M Increase the margins in the contract

P This is a contract where external advice might be needed (eg pricing, claims
control)

M Use of reinsurance and / or consultants

P Existing reinsurers might not like it

M Liaise with them or find alternative reinsurers

P General disputes/lack of policyholder understanding

M Clear policy wording or clear guidelines at point of sale

P Reduced sales and/or increased lapses as price increases

M Offer as an option/increase marketing

P Big change in government policy

P Complexities from users moving between regions

P Systems and admin changes and complexity

M Staff training

P Risk of change in mix of business by postcode

M Price for mix of claims by postcode

P Increased capital requirements due to uncertainty

 Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

2 (iii) Existing Reinsurance Arrangements

Details required of existing arrangements

Profitability to reinsurer

Attitude of the Reinsurer

View of the existing arrangement, including view of the direct writer's risk
management

Is this a valued client to be accommodated

Interested in this extension in this area/diversification

The reinsurer's capacity to accept business

Will the price and terms offered reflect concern over potential competition

The volatility of the risk

Administrative requirements to take in this element of reinsurance

A new reinsurer in the market will be tempted to offer good terms in order to build a
business relationship

How will the risk be shared eg proportion to be reinsured

Quality/credibility of pricing data

Capital /reserving requirements and ability to accept risk

Opportunity to provide technical assistance

2 (iv) Stand alone policy

How to distribute the product

Impact on existing business

The need for margins on risk cost will be greater than in a comprehensive policy

Possible to produce a simple contract but great care needed to spell out the policy
restrictions to the potential policyholder

Need to ensure treatment has prior insurer approval or non-approval

 Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

Declinature will attract media attention

There will be a high rate of declinature of initial proposals

Need to develop new underwriting approach

Reinsurance may be needed to remove the concentration of risk

Will there be enough demand for this policy

Consideration would need to be given to the premium level generated compared with
insurer costs

Will sales volumes be high enough to recover development costs

Heavy anti-selection likely on this policy

Need to take this into account when setting both pricing and reserving bases

Greater impact of changes eg in NHS policy

3 (i) Factors affecting how to choose which IP to sell:

Whether or not they are tied to a particular company’s products

The benefits offered by the product

Value for money / price

Bundling – what else is included with the product

Underwriting process

Claims management process

Ease of use – e.g. do they offer internet applications

Ease of use – are they listed on price comparison services (i.e. portals)

Quality of customer service

Quality of sales literature or marketing material

Sales regulations

The amount of remuneration available and the structure

Clawback arrangements

Product range coverage

Complexity of product
 Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

Financial security of provider

Specific customer requirements/needs

3 (ii) Why differing rates of commission

Most likely they see a difference in the quality of the business

This may be in the form of the morbidity experience or the lapse experience or even
the underwriting administration experience where the morbidity experience is seen to
differ between adviser this could be passed on via the premium or the commission

Alternatively:

Different commission structures

It may be that some intermediaries get other sources of funds, e.g. they may get a
fixed sum per month from the insurance provider on top of the commission paid

Some advisers may already charge partial fees so that they don’t require full
remuneration via commission

The insurer may have a strategic aim to increase market share in some areas and so
might have increased commission in those areas eg the insurer may wish to increase
the number of large size policies they write or they may wish to reduce risk
concentration and focus on smaller policies

Different advisers will target different population segments and so will have more of
one sort or another

The adviser may have a different mix of business by product type/term – e.g. one
adviser may mainly sell immediate needs policies, this would have a different
commission rate to the critical illness policies sold

The insurer may have had to agree to a higher rate of commission with some advisers
in order to retain their business, because they were tougher negotiators

May pay higher where the insurer is in some form of a tie or on some kind of 'hot list'

Insurers may have put in place volume deals, whereby they agree to pay higher
commission to brokers who bring in over £xm of business

Some brokers may do more admin (reducing the burden on insurers)

 Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

3 (iii) Advantages to the customer

Enables them to see what they are paying for advice

Enables them to compare the services offered by different advisers, and the fees
charged for those services

Customers can feel assured that the choice of products is right for them and not
influenced by commission rates

Disadvantages to the customer

Customers may now find they need to find cash for an initial fee which previously
they would not have had to do

If customers lapse their policy they may lose some of the value invested in the initial
fee

More administration, as they have outgo to both the insurer and the adviser

May be shocked by how much advice costs

3 (iv) Effect on intermediaries

Effect depends very much on whether they currently take initial or renewal
commission

For initial commission based advisers, the move is likely to result in a one-off hit to
their income

May need to find working capital from elsewhere

This will be countered by an ongoing stream of income, increasing over time (as the
volume of business they have done in this way increases) so in the long run their total
income could be unchanged

Fee based business may be harder to sell, because the amount the customer is paying
for advice is transparent

A shift to higher net worth individuals/increased pressure on FIAs to obtain

recognised qualifications and the customer may even get the advice but then go off
and buy the policy directly

They will need to adapt to new sales methods and will need to reassess the products
in the market to identify the new competitive winners and losers

Advisers moving from initial commission business will now have an income stream
that is more dependent on retaining their existing customers rather than identifying
 Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

new ones so they will have to redesign their business model, focussing on customer
service, and with less emphasis on customer attraction

In the long run they may find their income stream is less volatile under the new
regime, as they can predict more easily what fees they will receive, and will have
more control over whether they do in fact receive those fees.

There may be an overall fall in the advised-sales market, as more customers seek
more cost effective methods of obtaining cover so they may lose business to direct
written products, and cheap and cheerful solutions such as bancassurers or white-
labelled products sold in supermarkets.

Harder to sort out non-payments

3 (v) Effect on persistency

If the amount received upfront by the broker is lower than under the previous model,
as would be expected (as noted above), long term persistency should improve but if
customers seek out a new adviser under the new model, they may still be moved to a
new provider, as they will not be willing to pay an initial fee for keeping the same
policy

Change in shape of persistency curve; loss of spikes in offs ahead of clawback period

A change in business mix(eg more financially sophisticated) will also affect

persistency (eg improve it as less likely to be unable to afford to continue premiums)

Under the new regime, we might find that more policies will be sold based on true
need and affordability, and this should improve the level of offs due to finding that
the policy was not, in fact, suitable and if the new regime does prompt a move
towards customer service focus, customers may be happier with their adviser, and so
they may be less likely to seek out a new adviser with a consequent revision of their
health and care provision

The advice based drivers for persistency will be most seen in products with a varying
charge with age, eg unit-linked products with risk charges calculated for different
ages

For long term business with fixed levels of premiums, the effect would be much less
marked, eg CI, where customers “overpay” at short durations, and “underpay” at later
durations.

3 (vi) Possible courses of action

The insurer could seek to buy in sales by offering to fund advisers who are struggling
to finance themselves through the change in regime
 Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

This would mean that those advisers would no longer offer products from the whole
of the market and would instead commit to a multi-tie or a single tie to that insurer

This would depend on being within the regulator’s rules

The insurer could seek to expand into other distribution channels, such as direct
business, or underwriting bancassurer business.

It would also provide welcome diversification

The insurer could redesign its products to make them more attractive in the new
regime or lower its prices

A “low start” premium product could be designed that would offset the cost of the
initial fee to the customer or it could offer other services to make life easier for the
adviser such as offering help with the underwriting process or providing computer
admin systems that enable the adviser to see details of their customers products and
fee arrangements together and the company could generally differentiate itself from
the rest of the market by providing high quality customer service, or it could invest
more in brand name awareness/advertising so that customers “know” the product
when suggested by the distributor

Lobby against the change

Increased broker relationship management

Enter the PMI market or other market or expand overseas

4 (i) Pros

Can tailor specifically to the risk profile of business

Formula can suffer from inflexibility

The standardised approach will most likely be calibrated conservatively

Internal models could produce lower capital requirements

Hence advantages in capital management and pricing

The development of internal models is likely to improve risk modelling and provide
additional insights in risk profile

This should give those firms which use them a competitive advantage

An internal model is likely to be an important part of most companies’ risk

management framework (i.e. it helps to embed a risk management culture)

Internal model may be based on existing model so may reduce training requirements
 Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

More control over periodic reviews

Getting regulator approval helps give credibility to internal management info (ie it
gets senior management buy-in to the output)

Cons

Internal will need to be approved and reviewed

Need to get peer review or audit and regulatory approval can take a long time

Regulatory approval can take a long time if there is a backlog of initial applications

There may also be minimum requirement of its use within the company – the use test

It will take significant time to develop which will add to costs and cause strain on
resources

Could be particularly a strain for smaller companies

The benefit could be marginally lower or even higher calculation requirement

Unlikely to have expertise in house

Designs and standards of model could diverge widely from one company to another

Having spent the upfront costs, the model might not be accepted

It could prove difficult to explain the model to senior management/board

Could be harder for external analysts e.g. credit rating agents to compare between
companies

Difficult to set calibration of risk stresses specific to the particular company and
similarly the correlations between risks, particularly how correlations behave under
stressed conditions

May not have good data on which to base an internal model, for example for
operational risks

May need to get reapproved regularly (eg when a new product is launched)

4 (ii) Model must be widely used within the company. eg pricing, reserving etc

One model (or at least models that are consistent) used throughout the business

It must play an important role in risk management and decision-making

The design must be based on sound actuarial and statistical techniques

Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

Data accurate, complete and appropriate and reflective of the business

Covers all material risks

It must be able to produce analysis of causes and sources of profits and losses

The company must be able to demonstrate how the categorisation of risk is carried
out

There must be regular cycle of model validation

The company must avoid over-reliance on external model providers

New users should be able to understand the operation of the model relatively easily ie
no black boxes

The model should have the ability to look at various risk measures and levels of
confidence

There should be detailed breakdown of risk

market risk

interest rate risk

credit/reinsurance risk

operational risk

mortality and morbidity risk

persistency risk

expenses risk

risks attaching to the firm's pension scheme

liquidity risks

group risk

Comprehensive documentation of model which should cover

theory

design

assumptions

results

operation

compliance
Subject SA1 (Health and Care Specialist Technical) — September 2009 — Examiners’ Report

shortcomings/approximations

future developments

May specify calibration of the model (eg minimum shock tests/specified correlation
assumptions)

Use of stochastic models in some circumstances

Specify treatment of new business

Regular regulator reviews after initial approval

Staff who work directly with the model should be thoroughly trained

There should also be a reasonable understanding of the model by the Board and
senior management

The model must be able to produce formal, detailed reconciliation of results

Internal review of model and processes

Processes in place to keep models up to date

There should be segregation of duties

Independent external review should be carried out

The model should be signed off by internal and/or external auditors

Might specify minimum level of confidence to be achieved in specified time period

Disallow switch back to formula approach if have an approved model (to avoid
capital arbitrage)

Set a minimum capital requirement

Set deadlines/time limits for approval applications

Require submission of a comparison with the formula approach

Require sign off by a nominated person

Disclosure requirements

END OF EXAMINERS’ REPORT