; Role of the Actuary
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Role of the Actuary


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									           Role of the Actuary

•   Actuaries manage risk in financial institutions
•   Involves managing assets and liabilities jointly
•   Investment policy requires an understanding of the nature of
    liabilities of a financial institution – the interaction of assets
    and liabilities is crucial for understanding investment risk
•   We will begin by taking a basic look at the liabilities of non-
    bank financial institutions
•   In financial institutions a high proportion of assets and
    liabilities are financial assets and liabilities giving rise to cash
    flows under contract at particular times – the institution must
    have assets to meet the liabilities at the appropriate times.
                 Life Annuities
•   Series of payments for life in return for a single premium
•   Initial cash inflow, followed by a long series of cash outflows
•   Number of payments and length of payment stream depends
    on length of life
•   Deferred annuity: premium paid some time before annuity
    starts, can be very long term
•   Annuities can be subject to level compound increases or
    increases in line with an index (e.g. RPI)
    •    This changes the pattern of cash flows and also changes the
         risks in the case of RPI-linked annuities
•   Lighter mortality increases total payments and lengthens the
    payment stream
•   Term assurance: regular premiums in return for a benefit
    paid on death, within the term of the policy
    •    Incoming cash flows each year whilst life is alive, one
         outgoing cash flow
•   Whole life assurance: premiums continue for life, benefit paid
    whenever death takes place
•   Endowment assurance: premiums paid for term of policy;
    benefit paid on death or on survival to the end of the term.
    Negative net cash flows in early years.
•   Higher mortality leads to reduced number of premiums and
    increased cash outflows (term assurance) or earlier payment
    of benefit (whole life assurance and endowment assurance)
                         Example of cash flow pattern

                             Cash flows from insurance portfolio

cash flo ws

              100                                                            Cash flow level annuity
                                                                             Cash flow increasing annuity
               50                                                            Cash flow term assurance
                                                                             Cash flow portfolio
                    1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39
        Example of Cash Flow Pattern (2)

                     Cash flows from insurance portfolio
cash flows

                                                              Cash flow level annuity
             150                                              Cash flow increasing annuity
             100                                              Cash flow term assurance
              50                                              Cash flow portfolio
                                                              Cash Flow Portfolio Two
             -50 1   4   7 10 13 16 19 22 25 28 31 34 37 40

    Non Profit, With Profit, Unit Linked
•   We can classify products by their contingent nature of by
    whether they are non profit, with profit or unit linked
•   Non profit: outgoing cash flows fixed in nominal or real terms
•   With profit
    •    sometimes a fixed minimum benefit based on a low rate of
         interest earned on premiums
    •    annual and terminal bonuses paid out of profits (e.g.
         investment returns above the low level on which minimum
         benefit is based)
    •    once an annual bonus is awarded, it becomes fixed, like non-
         profit benefit
•   Unit linked
    •    benefits linked to performance of a given investment fund
    •    can include contingent products and pure investment products
    Cash Flows and Pension Schemes
•   Consider final salary schemes: three main types of liabilities
•   Active members
    •    Accrue an entitlement based on a given fraction of salary at
         retirement. Value of entitlement increases in line with salaries
    •    Very long term and depend on unknown future wage levels
•   Deferred pensions
    •    Members who have left have entitlement to pension based on
         given fraction of salary on leaving uprated by an index until
         nrd. Can also be long term; generally lpi linked
•   Pensions in payment
    •    Can be fixed in monetary terms, with discretionary increases
         or index linked (depends on scheme rules). Long term and
         either real or nominal.
•   Pattern of liabilities will change as fund matures or if it closes
            Non-life insurance

•   Motor insurance example
    •    Policy term one year
    •    Most claims arise and notified and many settled within one
    •    Incidents can be reported and not settled until after the year
    •    Incidents may be “incurred but not reported”: example of
         employers’ liability
•   Non life, general points
    •    Indemnity – amount paid on insurable event not fixed
    •    Can increase with inflation
    •    Short term and “real” but with some longer tail liabilities

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