COURSE 8: Fall 2002 - 1 - GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-5 pertain to the Case Study.
** BEGINNING OF EXAMINATION **
MORNING SESSION
1. (6 points) LifeCo’s CEO has asked you to analyze the profitability of the Institutional
Pensions – GIC line of business and the drivers of its profitability.
Asset yields are effective annual, earned, net of investment expenses.
The average industry required return on capital: 12.0%
The Lehman aggregate bond index, 1999: 6.7%
The Lehman aggregate bond index, 1999, adjusted to duration of 3.3: 6.4%
The Lehman aggregate bond index, 1999, adjusted to duration of 3.1: 6.3%
(a) List the benefits of an integrated asset/liability performance attribution process.
(b) Explain the two benchmarks you will use to construct a performance attribution
system using the above indices.
(c) Define each of your performance attribution components and explain their
function.
(d) Calculate the return of each performance attribution component using the
summary information from the balance sheet for this line of business.
Course 8V
Fall 2002
COURSE 8: Fall 2002 - 2 - GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-5 pertain to the Case Study.
2. (11 points) LifeCo is considering purchasing a P&C company. You are a consulting
actuary that has been retained by LifeCo to help analyze the implications of such an
acquisition on LifeCo’s ALM process.
(a) Explain how ALM can improve decision- making and enhance the ability to view
LifeCo’s businesses from multiple perspectives.
(b) Describe the main components of a DFA as typically used by a P&C insurer.
(c) Compare LifeCo’s ALM process to DFA.
(d) Detail the tasks that LifeCo management must perform in implementing a new
ALM process.
(e) Recommend the best practices that LifeCo should consider adopting in its new
ALM process.
COURSE 8: Fall 2002 - 3 - GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-5 pertain to the Case Study.
3. (5 points) You are in charge of setting an investment strategy for the surplus account of
LifeCo. The primary investment objective of the surplus account is to safeguard
principal while seeking to maximize the total rate of return over time. One of the tasks is
to determine the asset allocation among various asset classes.
As a member of LifeCo’s Portfolio Rebalance Subcommittee you have just completed a
full evaluation of capital market information in terms of expected returns, standard
deviations and correlations among asset classes. Next, you want to decide on a risk
measure to be used to construct an efficient portfolio.
One of the Subcommittee members has suggested selecting portfolio standard deviation
(as used by Harry Markowitz in his quadratic optimization) as the risk measure.
(a) Evaluate the appropriateness of using standard deviation as the risk measure for
the surplus portfolio.
(b) Describe and compare two other alternatives to using standard deviation as the
risk measure, and evaluate how the use of each would impact the financial
objectives of LifeCo.
(c) Propose the most suitable risk measure for LifeCo and justify your choice.
(d) Formulate a mathematical optimization program to construct an efficient portfolio
using the risk measure chosen in (c).
COURSE 8: Fall 2002 - 4 - GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-5 pertain to the Case Study.
4. (10 points) The management of LifeCo is concerned about the duration mismatch
reported in the December 31, 1999 ALM report for its traditional and non-traditional life
products segments. It has directed the Corporate Actuarial Department and the
Investment Department to investigate the mismatch and to evaluate the possibility of
using Z-bonds to reduce it.
(a) Criticize the use of modified duration as a measure of interest rate sensitivity for
the two liability segments and the underlying invested assets.
(b) Compare the following interest rate sensitivity measures with modified duration:
(i) effective duration
(ii) effective key-rate duration
(c) For equities:
(i) interpret the reported modified duration
(ii) describe how the Franchise Factor Model can be used to model the interest
rate sensitivity of equities
(d) Compare the payment profile of the following types of accrual bonds:
(i) Z-bonds
(ii) Z-PAC
(iii) Tricky Z
(iv) Jump-Z with cumulative sticky trigger
(e) Rank the accrual bonds presented in (d) according to their suitability to help
reduce the duration mismatch of the traditional life product segment. Justify your
answer.
COURSE 8: Fall 2002 - 5 - GO ON TO NEXT PAGE
Investment
Morning Session
Questions 1-5 pertain to the Case Study.