[FAP Interim Assessment]
Instructions: You must enter your answers to each assessment question in the sections
noted below, and must not change any information contained within the black brackets [].
[Question 1]
noitseuq
The required monthly premium per $1000 of covered salary is 0.252.
A. By receiving the full 3-year premium up front, Sensible is able to invest the
premium that has not yet been used to pay claims. Assuming an annual effective
investment income rate of 3.00%, Sensible could achieve a 3.00% profit target
with a premium of 0.240 per $1000 of covered salary.
B. At a rate of 0.240 per $1000 of covered salary, an additional $5B of covered
salary would result in a premium of $8,411,130 payable in month 30 for 7 months
of coverage through month 36. Claims, commission, tax, and internal expense are
expected to increase proportionally with the dollars of covered salary. Assuming
an annual effective investment income rate of 3.00%, the addition of the Pacific
Pro Shopper group reduces the profit/claims ratio for the entire Mammoth Mart
group from 3.00% to 2.84%. The final cash position would be reduced from
$4,760,575 to $4,693,807. The premium paid in month 30 reduces the average
length of time that each dollar is invested across the entire 36-month period,
resulting in less investment income per dollar of claims than in the original
scenario. A premium rate of 0.240 is only expected to generate 3.00% profit
margin if 100% of premium is paid in month 1.
IA – page 1
,[Question 2]
noitseuq
Key external factors
1. Cultural/Social - Sensible is primarily concentrated on the east coast of the
US, while Mammoth Mart is distributed nationwide with the potential for expansion into
Canada soon. Cultural values and attitudes differ between the average Sensible client’s
employees and Mammoth’s, and between Sensible’s account managers and Mammoth
Mart’s key decision makers. Understanding those differences could make or break the
relationship between the two organizations.
2. Demographics - The demographic mix of Mammoth Mart could change over
the course of the contract. Age/gender band mix could shift due to an ageing population,
turnover, or mergers and acquisitions. The underwriting assumptions used to quote the
group at the beginning of the 36-month period are essentially locked in for the duration
of the contract, so changes to demographic mix could cause claim frequencies to differ
from what was assumed in the underwriting models and net profit to come in above or
below target. Additionally, Mammoth Mart’s experience could differ from the Sensible
rate manual, and this would not be known until the contract is in effect due to lack of
historical data.
3. Physical Environment - Natural or human disaster could result in catastrophic
losses, reducing profitability. Mammoth would be such a large portion of Sensible’s total
block of business that solvency could be an issue if there was a high mortality rate in a
short period of time.
4. Investment returns affect the profitability of a contract to extent that realized
returns differ from the rate of return that was assumed for underwriting purposes. This is
a key driver of profitability, and investment returns are highly uncertain over a short
period of time such as a three-year contract with Mammoth Mart.
5. As we saw with Pacific Pro Shopper, acquisitions or divestitures during the
contract term affect overall profitability. Premium true-ups payable after the initiation of
the contract are invested for a shorter period and result in less investment income
(assuming a constant, positive return on investment). As mentioned above, M&A activity
also affects the demographics of the group
6. Regulations governing group term life policies at the state and national level.
Given Sensible’s concentration on the east coast, an appropriate response to a restrictive
new state-level regulation in California may be for Sensible to pull out of that market and
decline to renew contracts for clients with employees in California. This would not be
feasible with Mammoth Mart as a client, as it would affect over half of Sensible’s total
covered lives. At the national level, Mammoth Mart’s expansion into Canada would force
Sensible to ensure compliance with Canadian regulations. Any additional work done by
Sensible employees to react to changing regulations or to comply with regulations in new
markets could increase internal costs.
7. Competitive landscape – in a competitive market, conservative pricing
assumptions may lead to a key client leaving for a competitor. On the other hand,
aggressive pricing may lead to losses that cannot be recouped at the following renewal.
IA – page 2
, [Question 3]
noitseuq
Sensible’s investment strategy must balance expected return versus risk, while keeping a
sufficient percentage of investments in short term, liquid assets. For expected return, we
focus on geometric average of historical returns (simple average does not tie to
cumulative returns). For risk, we focus on standard deviation. The method used to
determine the ideal mix of assets was to maximize geometric average of returns and
minimize standard deviation by varying weights of all five assets classes. Two additional
constraints were applied: 1) no individual asset class can comprise more than 40% of the
portfolio, and 2) short term, liquid assets (short term treasury bills, stocks, and
commodities) must comprise a majority of the portfolio. The ideal mix was found to be
40% short term treasury bills, 40% long-term treasury bonds, 8% long term corporate
bonds, and 12% stocks. Commodities should not be a part of Sensible’s investment
strategy, because they provide high volatility without sufficient returns. The geometric
average annual return of this portfolio from 2000-2009 was 6.8%, only 1.3% lower than
a portfolio of 100% stocks. The minimum return over that period was 3.1%, and the
maximum was 9.1%. The minimum average return for 3 consecutive years was 4.8%,
while the maximum was 7.4%.
This strategy takes advantage of an apparent negative correlation between long term
treasury bonds and stocks, and to a lesser degree between long term treasury and
corporate bonds, to create a portfolio with relatively reliable, solid returns, and a
sufficient level of liquidity. If this data can be refreshed annually, this analysis should be
repeated using the most recent data and the portfolio should be rebalanced accordingly.
If new data is not available, the portfolio can be rebalanced to the same mix every year.
Based on this investment strategy, I would feel comfortable with an investment income
rate assumption of 3.7%. This was chosen by averaging the three worst years of the
proposed portfolio (2004, 2005, and 2008). This was chosen as a conservative
alternative about 1% lower per annum than the minimum return across three
consecutive. An aggressive position on investment strategy or on the investment return
assumption is not recommended given the underwriting risk associated with a new
manually rated group that will comprise over 50% of the block of business.
IA – page 3
Instructions: You must enter your answers to each assessment question in the sections
noted below, and must not change any information contained within the black brackets [].
[Question 1]
noitseuq
The required monthly premium per $1000 of covered salary is 0.252.
A. By receiving the full 3-year premium up front, Sensible is able to invest the
premium that has not yet been used to pay claims. Assuming an annual effective
investment income rate of 3.00%, Sensible could achieve a 3.00% profit target
with a premium of 0.240 per $1000 of covered salary.
B. At a rate of 0.240 per $1000 of covered salary, an additional $5B of covered
salary would result in a premium of $8,411,130 payable in month 30 for 7 months
of coverage through month 36. Claims, commission, tax, and internal expense are
expected to increase proportionally with the dollars of covered salary. Assuming
an annual effective investment income rate of 3.00%, the addition of the Pacific
Pro Shopper group reduces the profit/claims ratio for the entire Mammoth Mart
group from 3.00% to 2.84%. The final cash position would be reduced from
$4,760,575 to $4,693,807. The premium paid in month 30 reduces the average
length of time that each dollar is invested across the entire 36-month period,
resulting in less investment income per dollar of claims than in the original
scenario. A premium rate of 0.240 is only expected to generate 3.00% profit
margin if 100% of premium is paid in month 1.
IA – page 1
,[Question 2]
noitseuq
Key external factors
1. Cultural/Social - Sensible is primarily concentrated on the east coast of the
US, while Mammoth Mart is distributed nationwide with the potential for expansion into
Canada soon. Cultural values and attitudes differ between the average Sensible client’s
employees and Mammoth’s, and between Sensible’s account managers and Mammoth
Mart’s key decision makers. Understanding those differences could make or break the
relationship between the two organizations.
2. Demographics - The demographic mix of Mammoth Mart could change over
the course of the contract. Age/gender band mix could shift due to an ageing population,
turnover, or mergers and acquisitions. The underwriting assumptions used to quote the
group at the beginning of the 36-month period are essentially locked in for the duration
of the contract, so changes to demographic mix could cause claim frequencies to differ
from what was assumed in the underwriting models and net profit to come in above or
below target. Additionally, Mammoth Mart’s experience could differ from the Sensible
rate manual, and this would not be known until the contract is in effect due to lack of
historical data.
3. Physical Environment - Natural or human disaster could result in catastrophic
losses, reducing profitability. Mammoth would be such a large portion of Sensible’s total
block of business that solvency could be an issue if there was a high mortality rate in a
short period of time.
4. Investment returns affect the profitability of a contract to extent that realized
returns differ from the rate of return that was assumed for underwriting purposes. This is
a key driver of profitability, and investment returns are highly uncertain over a short
period of time such as a three-year contract with Mammoth Mart.
5. As we saw with Pacific Pro Shopper, acquisitions or divestitures during the
contract term affect overall profitability. Premium true-ups payable after the initiation of
the contract are invested for a shorter period and result in less investment income
(assuming a constant, positive return on investment). As mentioned above, M&A activity
also affects the demographics of the group
6. Regulations governing group term life policies at the state and national level.
Given Sensible’s concentration on the east coast, an appropriate response to a restrictive
new state-level regulation in California may be for Sensible to pull out of that market and
decline to renew contracts for clients with employees in California. This would not be
feasible with Mammoth Mart as a client, as it would affect over half of Sensible’s total
covered lives. At the national level, Mammoth Mart’s expansion into Canada would force
Sensible to ensure compliance with Canadian regulations. Any additional work done by
Sensible employees to react to changing regulations or to comply with regulations in new
markets could increase internal costs.
7. Competitive landscape – in a competitive market, conservative pricing
assumptions may lead to a key client leaving for a competitor. On the other hand,
aggressive pricing may lead to losses that cannot be recouped at the following renewal.
IA – page 2
, [Question 3]
noitseuq
Sensible’s investment strategy must balance expected return versus risk, while keeping a
sufficient percentage of investments in short term, liquid assets. For expected return, we
focus on geometric average of historical returns (simple average does not tie to
cumulative returns). For risk, we focus on standard deviation. The method used to
determine the ideal mix of assets was to maximize geometric average of returns and
minimize standard deviation by varying weights of all five assets classes. Two additional
constraints were applied: 1) no individual asset class can comprise more than 40% of the
portfolio, and 2) short term, liquid assets (short term treasury bills, stocks, and
commodities) must comprise a majority of the portfolio. The ideal mix was found to be
40% short term treasury bills, 40% long-term treasury bonds, 8% long term corporate
bonds, and 12% stocks. Commodities should not be a part of Sensible’s investment
strategy, because they provide high volatility without sufficient returns. The geometric
average annual return of this portfolio from 2000-2009 was 6.8%, only 1.3% lower than
a portfolio of 100% stocks. The minimum return over that period was 3.1%, and the
maximum was 9.1%. The minimum average return for 3 consecutive years was 4.8%,
while the maximum was 7.4%.
This strategy takes advantage of an apparent negative correlation between long term
treasury bonds and stocks, and to a lesser degree between long term treasury and
corporate bonds, to create a portfolio with relatively reliable, solid returns, and a
sufficient level of liquidity. If this data can be refreshed annually, this analysis should be
repeated using the most recent data and the portfolio should be rebalanced accordingly.
If new data is not available, the portfolio can be rebalanced to the same mix every year.
Based on this investment strategy, I would feel comfortable with an investment income
rate assumption of 3.7%. This was chosen by averaging the three worst years of the
proposed portfolio (2004, 2005, and 2008). This was chosen as a conservative
alternative about 1% lower per annum than the minimum return across three
consecutive. An aggressive position on investment strategy or on the investment return
assumption is not recommended given the underwriting risk associated with a new
manually rated group that will comprise over 50% of the block of business.
IA – page 3
