Sa2 Pu 14 PDF

SA2: CMP Upgrade 2013/14 Page 1
Subject SA2
CMP Upgrade 2013/14
CMP Upgrade
This CMP Upgrade lists all significant changes to the Core Reading and the ActEd
material since last year so that you can manually amend your 2013 study material to
make it suitable for study for the 2014 exams. It includes replacement pages and
additional pages where appropriate. Alternatively, you can buy a full replacement set of
up-to-date Course Notes at a significantly reduced price if you have previously bought
the full price Course Notes in this subject. Please see our 2014 Student Brochure for
more details.
As there have been a large number of changes to Subject SA2 for 2014, wed
particularly recommend that you consider purchasing a reduced price replacement set of
up-to-date materials this year, rather than manually updating using this note. However,
this upgrade should still be useful to give an indication of the changes to look out for.
This CMP Upgrade contains:
all changes to the Syllabus objectives
significant changes to Core Reading
changes to the ActEd Course Notes, Series X Assignments and Question and
Answer Bank that will make them suitable for study for the 2014 exams.
The Actuarial Education Company IFE: 2014 Examinations

Page 2 SA2: CMP Upgrade 2013/14
1 Changes to the Syllabus objectives

Syllabus objective (b) has been amended so that it now reads (note that deposit
administration has been deleted):
(b) Describe the major products of interest to UK life insurance companies,

additional to the generic coverage in Subject ST2, and whether currently sold or
not, in terms of:
the main types of products issued
the benefits, guarantees, and options that may be provided
the purpose and risks of the products to the policyholder and the insurer.
The products under this Syllabus objective are:
term assurance
income protection insurance
critical illness insurance
conventional with-profits
accumulating with-profits
property-linked
index-linked
mortgage endowment
single premium bonds
personal pension, including self-invested personal pension
group personal pension
stakeholder products
annuities
life insurance products related to occupational pension schemes
wraps
variable annuities
equity release products
Takaful insurance
microinsurance.
IFE: 2014 Examinations The Actuarial Education Company

There have been a number of additions and deletions to syllabus objective (e) so that it
now reads:
(e) Describe, in terms of the following, the regulatory environment for UK life
insurance companies, and how this environment affects the way these companies
carry out their business in practice, including the related analyses and
investigations:
1. The taxation of the UK business of life insurance companies and the effect
of taxation on the benefits and premiums paid under UK life insurance
contracts.
2. The supervision of the UK business of life insurance companies under

the relevant regulatory handbooks with regard to:
the valuation of assets, liabilities and solvency capital
requirements
the supervisory reports to be submitted
transfers of surplus, including the requirements of surplus
distribution systems.
3. The principles underlying the Solvency II regulatory regime.
4. The transfer of liabilities from one life insurance company to another.

.
5. The capital management of a life insurance company, including
determining and improving available capital, projecting future solvency,
the principles of asset-liability management and the use of derivatives.
6. An analysis of surplus on a supervisory basis reasons for carrying out

the analysis, how to do it, and using the results.
7. Profit and value reporting under the Companies Act legislation, EU

approved IFRS, and embedded values, including market-consistent
embedded values.
8. An analysis of the change in the embedded value of a proprietary UK life

insurance company, using the results to reassess the design of the
companys contracts or actuarial bases.
9. The Conduct of Business rules with regard to Treating Customers Fairly,

disclosure and, for with-profits business, the Principles and Practices of
Financial Management (PPFM), including the Consumer Friendly PPFM.

10. The management and controls to be exercised by a life insurance

company in order to conduct its affairs responsibly and effectively with
adequate risk management systems.
11. The principles underlying the requirements of the professional standards

and guidance relevant to actuaries practising in or advising UK life
insurance companies.
12. The roles of the Actuarial Function Holder, the With-Profits Actuary, the
Reviewing Actuary and the Appropriate Actuary.

2 Changes to the Core Reading and ActEd Course Notes

Chapter 0
Page 7
The first paragraph of ActEd text has been amended to read:
Professionalism and the general commercial and economic environment do not strictly
form part of the control cycle. However, a sound understanding of the environment in
which UK life insurers operate is crucial to understand the risks and potential problems.
The Actuaries Code and the relevant Technical Actuarial Standards and Actuarial
Profession Standards should be considered when formulating any solution to an
actuarial problem.
Page 10
The last bullet point of Core Reading has been amended to read:
other recommended references on the Life practice area of the Institute

and Faculty of Actuaries website.
Page 12
The following papers have been added to the list for Chapters 11 to 15:
Demystifying the risk margin: theory, practice and regulation

Brown, A
SIAS, 2012
http://www.sias.org.uk/siaspapers/listofpapers/view_paper?id=SIASPaperMay2012b
Dynamic management actions
Clark, D; Kent, J; Morgan, E

SIAS, 2012
http://www.sias.org.uk/siaspapers/listofpapers/view_paper?id=SIASPaperMar2012
The web address for the TASs (Chapter 16) is now:
http://www.actuaries.org.uk/regulation/pages/technical-actuarial-standards-tass-online-
learning-materials

Page 13
The following paper has been added to the list for Chapters 21 and 22:
Insurance accounting: a new era?

Foroughi, K et al
BAJ (2012) 17(3): 562-649
http://www.actuaries.org.uk/research-and-resources/documents/insurance-accounting-new-era
Page 14
The following paper has been added to the reading list:
Chapters 25 and 26 Surplus distribution
Equity between with-profits policyholders and shareholders

OBrien, C
BAJ (2012) 17(2): 435-474
http://www.actuaries.org.uk/research-and-resources/documents/equity-between-profits-
policyholders-and-shareholders
Page 16
The first bullet point has been amended to read:
The regulators www.bankofengland.co.uk/pra and www.fca.org.uk/

The PRA and FCA are the regulators for the insurance industry in the UK. You
will find updates to the regulatory Handbook and details of all current
consultations.
The last bullet point has been amended to read:
The IFRS Foundation and the IASB www.ifrs.org

This site contains information on progress towards an international accounting
standard.

Chapter 1
Page 6
The second paragraph of ActEd text has been amended to read:
The FTSE 100 share index climbed back above the 6,700 mark towards the end of 2007,
but by March 2009 it had fallen back to 3,530. It then recovered to just above the 6,000
mark at various points in 2011 before falling yet again. The FTSE 100 has performed
strongly over the last year and is currently (June 2013) standing at around 6,400.
Page 7
The second paragraph of Core Reading has been amended to read:
The adverse publicity has included the lack of transparency in the product and
there is increasing pressure for companies to disclose more about the assets
supporting a with-profits fund and the rationale for distributing bonuses in the
various ways that are available, including the smoothing policy. These
pressures culminated in a regulatory requirement to produce a document
Principles and Practices of Financial Management that prescribes details an
insurer must provide about the way it operates its with-profits fund (this is
covered in more detail in Chapter 10).
Page 17
All references to the FSA returns have been replaced by supervisory returns (see the
first paragraph of ActEd text on page 17 for example). We do not list all such changes
in this upgrade, but you should apply this change throughout the course.
Page 33
Terminal illness, which does not pay out on diagnosis of a specified

disease but instead the claim definition involves the severity of a
condition and its effect on life expectancy (eg any condition that is
expected to result in the persons death within a twelve month period).

Chapter 2
Page 17
The last two paragraphs of Core Reading have been deleted.
Section 6
This section has been deleted.
Page 39
The following two paragraphs of Core Reading have been updated as follows:
The pension scheme will pay the counterparty (eg reinsurance company) a fixed
series of payments reflecting the expected annuity amounts based on agreed
mortality rates, and hence its liability is known. In exchange, the counterparty
pays a floating series of annuity payments reflecting the actual experience.
Hence the counterparty meets any excess (or benefits from any shortfall) of
actual required annuity payments relative to the agreed mortality basis due to
increases (or reductions) in longevity.
The counterparty may also charge a fee in addition to the fixed leg.
Section 13
A new section on microinsurance has been added. See replacement pages 53 to 56.
Page 55
The summary of deposit administration contracts has been deleted.

Page 56
A new summary for microinsurance has been added:
Microinsurance
Microinsurance is targeted at low income groups, particularly in the developing world.
Data is often limited. Profit margins are low, so very high sales volumes are required
for profitability.
Microinsurance offers protection to those who cannot afford traditional insurance.

Policyholders often have limited familiarity with formal insurance.
Chapter 3
Page 3
The following has been added at the end of the list of bullet points:
industry bodies.
This point has also been added to the first set of bullets in the Summary on page 39.
Page 6
The first paragraph of Core Reading has been amended to read:
From 1 January 2013 a new set of regulations came into force under the Retail
Distribution Review (RDR). These new rules changed significantly the way in
which life insurance investment products are sold and the way in which
financial advisers are established (including the level of qualifications required)
and remunerated. The definition of investment products includes pensions,
bonds, ISAs, annuities and similar products.

Page 10
The following paragraph of Core Reading has been added at the end of Section 1.3:
The low interest environment, changes in outlook for inflation and poor
performance of the stock market have also encouraged the UK regulator to
review how policy proceeds are illustrated in quotations given to customers.
The maximum permitted projection rates have been reduced to ensure that
returns remain consistent with the prevailing economic environment, with
providers being required to use projection rates that are appropriate for the
product subject to these maxima. This has led to further regulatory driven
change activity for life insurance companies, with associated cost.
Page 11
The following paragraph of Core Reading has been added at the end of Section 1.4:
The national press has, however, also given a lot of coverage to the issue of
pensions provision in the UK, as the government reviews the role that it plays in
retirement funding. This is likely to benefit the life insurance industry, which has
struggled for many years to raise the profile of the need for individuals to take
responsibility for their own pension provision.
The first paragraph of Core Reading in Section 1.5 has been amended to read:
Notwithstanding the bursting of the technology bubble in stock market terms in

2000, technology is increasingly affecting everyones lives, arguably for the
better, and there is huge scope for improving the processing and administration
of life insurance products, and their sales. As well as the internet being used for
providing general information about companies and their products, some have
introduced facilities for applying for life insurance products and obtaining their
current values online, and it should be expected that these advancements will
increase rapidly in the years ahead. Wrap accounts (see Chapter 2) are a good
example of the use of technology.
Page 14
The final two paragraphs have been amended to read:
NEST has contribution caps in place to limit direct competition with insurance
companies who provide group pensions.

Currently the contribution cap is set at 4,500 pa, but the government is considering
removing the cap in 2017. Given that average earnings are around 25,000, many
people may not want to contribute more than the cap, so NEST may still be a significant
competitor to insurance companies.
Page 15
A new Section 1.8 has been added. Replacement pages 15, 15A and 16 are attached.
Page 23
The following has been added to the note under the table:
Independent Financial Advisers (IFAs) and Whole of Market Advisers (WMAs)

were two different categorisations of financial advisers prior to the
implementation of the RDR.
The penultimate paragraph has been shortened so that it now reads:
The proportion of new business generated by the direct salesforce channel has been
declining steadily.
Page 28
The penultimate paragraph of Core Reading has been amended to read:
TCF affects all aspects of the business from designing products that meet
customer needs without misleading them, to the sales processes that ensure
customers are only advised to buy products that are suitable for them (bearing in
mind their risk appetite), to ongoing management of in-force contracts. The
latter includes dealing fairly with customers when exercising discretion on the
level of benefits that should be granted or charges that should be imposed.
Page 31
The last paragraph of Core Reading has been amended to read:
The inherited estates within established companies with-profits funds can also
be used as a source of capital, eg to fund future new business, whilst bearing in
mind regulatory responsibilities to ensure that existing with-profits policyholders
are protected and treated fairly.

Chapter 4
Page 8
The Financial Services and Markets Act 2000 (FSMA) contains the fundamental
rule that only those authorised by the PRA (see Chapter 9) to do so, or exempted
by FSMA itself, may carry on insurance business in the UK.
The third paragraph of Core Reading has been amended to read:
The Board of the FSCS is independent of the regulators (PRA and FCA see
Chapter 9), although accountable to them and ultimately to the Treasury. The
Board has the power to raise funds by imposing levies (in accordance with PRA
and FCA rules) on insurance companies and intermediaries in order to
compensate certain policyholders who might be prejudiced by the default of an
insurer or intermediary authorised by the PRA/FCA.
Please note that the FSA has been replaced by the PRA and FCA. As a result, most
references to the FSA have been removed from the notes (as in the examples above) and
replaced with an appropriate reference to the PRA and/or the FCA, or in some cases just
to the regulators in general. We do not list all such changes in this upgrade, but you
should apply make appropriate changes throughout the course.
Page 16
The first two paragraphs have been amended to read:
The Unfair Terms in Consumer Contracts Regulations 1999 give some

regulators and consumer bodies powers to challenge firms that are using unfair
terms in their standardised consumer contracts. The regulations do not offer
redress to individual consumers, but do give the FCA the power to challenge
firms that are using unfair terms.
When challenged by the FCA in these circumstances, most firms will co-operate. But if
not, and the FCA thinks the case is a serious one, it might consider going to court to try
to force the firm to stop using the term.
As noted above, the FSA has been replaced by the PRA and FCA. As a result, most
references to the FSAs regulation as regards to TCF have been removed from the notes
(as in the examples above) and replaced with an appropriate reference to the FCA. We do
not list all such changes in this upgrade, but you should apply similar changes
throughout the course.

Page 21
The third and fourth paragraphs of Core Reading have been amended to read:
In March 2011, the European Court of Justice gave its ruling on the legality of the
insurance opt-out provision, concluding that it is not valid and should therefore
be removed with effect from 21 December 2012. From that point, insurance
companies have no longer been able to use gender as a rating factor for new
business.
Reviewable premiums are not treated as new business for the purpose of this
legislation. However, insurance companies do need to be careful to avoid the use
of proxy rating factors (ie highly correlated to gender) that might be deemed to
be indirect discrimination and thus also not permitted.
The second paragraph of ActEd text (that previously was in between the above two
paragraphs) has been deleted.
Page 22
Clearly, the inability to differentiate between gender when setting premium rates
has significant implications for insurance pricing, particularly for annuities and
protection products where there are material observed differences between
mortality (and morbidity) experience according to gender. Rather than simply
averaging premium rates, additional contingency loadings are needed for the
risk of business mix by gender not being as expected within the unisex pricing.
Chapter 5
Page 13
There is also an annual limit on how much can be contributed in total by an

individual and his or her employer. Contributions are measured over a period
which is normally a year and can be aligned with the tax year. This limit is the
annual allowance which was 255,000 for the tax year commencing April 2010,
but was reduced to 50,000 with effect from April 2011 and further to 40,000
with effect from April 2014. However, there is a facility to carry forward any
unused annual allowance from the preceding three tax years. Contributions in
excess of the annual allowance, including any unused amount carried forward,
are not eligible for tax relief.

Page 14
The final two paragraphs have been amended to read:
A main change under the new tax regime (from April 2006) was the introduction
of the lifetime allowance. An individuals pension is based on the total funds
built up under all pension arrangements with a limit of 1.5m for the tax year
commencing 6 April 2006. The limit increased in stages to 1.8m in 2010, but
then reduced to 1.5m with effect from April 2012 and further to 1.25m with
effect from April 2014.
The total of the values of all an individuals pensions is tested against the lifetime
allowance. There are special arrangements available for individuals who already have
pension funds in excess of the lower limits (or who believe the value of their pension
funds will rise above the limits through investment growth without any further
contributions) to enable them to retain a personalised lifetime allowance at the higher
level providing they cease accruing benefits.
Page 16
Under the current rules, the income limit is 120% of a rate set by the Government
Actuarys Department that is roughly comparable to the current market annuity
rate. The policyholder can vary the income on a year by year basis and may
choose to take no income at all.
Page 20
The second bullet point has been amended to read:
the annual allowance which limits the sum of the amounts an individual and
his or her employer can contribute to the individuals pension in a tax year
(255,000 for the tax year commencing April 2010, but reducing in stages to
40,000 from April 2014).

The last paragraph has been amended to read:
Tax advantages are limited to a lifetime allowance on the size of total fund(s) (1.8m
for the tax year commencing April 2010 but reducing in stages to 1.25m with effect
from April 2014). Any amount in excess of the lifetime allowance that is used to
provide a pension will be taxed at 25% (and the pension will also be subject to income
tax) and any that is taken as cash will be taxed at 55%.
Chapter 6
Section 1.1
A large number of changes have been made to this section. In particular, the coverage
of GRB has been substantially reduced. Replacement pages 1 to 4 are attached.
Page 8
The first four paragraphs under the heading of I-E computation have been amended
to read:
The IE computation is performed for BLAGAB business only.
The rate of tax is the policyholder rate (20% as at April 2013) unless any part is
deemed to be shareholder profit. In a mutual, it would not be expected that any
part would be shareholder profit.
In a proprietary company, the shareholder profit would be expected to be

material and further calculation is required because HMRC requires part of the
profit to be taxed at the more usual rate of corporation tax (23% as at April 2013).
The rate of corporation tax has reduced in recent years. The government has announced
plans to reduce the rate of corporation tax further each year so that it will be 20% in
2015.
The last paragraph on page 8 has been deleted.
Please note that the rate of corporation tax has been changed from 24% to 23% throughout
this course. We do not list all such changes in this upgrade, but you should apply
similar changes throughout the course.

Page 11
The third paragraph of Core Reading, including the equation, has been amended to read:
The taxable trading profit is derived from figures from the statutory accounts,
broadly as follows:
P + I' + A' E C (V1 V0) + (D1 D0) L
Definitions for D1 and D0 have been added as follows:
D0 = value of OLTB DAC assets at beginning of year (see

Chapter 21)
D1 = value of OLTB DAC assets at end of year
The following paragraph has been added immediately after the definitions:
[Other accounting adjustments may be necessary, but further knowledge of such

adjustments is not required for this subject.]
Page 12
The paragraphs on this page have been updated as follows:
Note that before 1 January 2013, this calculation was based on figures from the
supervisory Returns.
It is possible that further changes to the determination of OLTB profit may result
from implementation of Solvency II and/or IFRS developments.
Part of the reason for bringing in the changes to the tax rules was that the completion of
the supervisory Returns under the current regime would stop once Solvency II came
into operation. The delay in implementing Solvency II means that the tax rules have
actually changed before the solvency rules have changed.
Since the move from taxable surplus within the supervisory Returns to
accounting profit would tend to give rise to an immediate profit or loss,
transitional arrangements were put in place to bring this into tax over a period of
ten years.
This will come as a great relief to any companies that would have been facing a giant
tax bill if the change had triggered a sudden jump in profits, eg because their statutory
accounts have much lower reserves than in the supervisory Returns.

Pages 15 and 16
A number of changes have been made to the Summary. Replacement pages 15 and 16
are attached.
Chapter 7
Page 9
The final paragraph has been amended to read:
You may find it helps you to understand the above circumstances better if you recall
that profit is essentially:
(P C) + (I E) (V1 V0) + (D1 D0).
Thus IE is actually a part of a profits calculation, although the definitions of I and E

may not be quite the same in the two calculations. Therefore anything that affects
BLAGAB premiums or claims or change in reserves or change in DAC, but not IE,
will tend to change the balance between an IE assessment and a minimum profits
assessment. Equally, different treatment of I or E in the two assessments will affect
their relative sizes.
Page 14
The second paragraph has been corrected to read:
A company may also temporarily become XSE as a result of the minimum profits test
for the following reasons:
Chapter 9
A large number of changes have been made to this chapter following the reorganisation
of the FSA into two new regulators: the PRA and FCA. A replacement chapter is
attached.

Chapter 10
Page 1
The first paragraph has been amended to read:
This chapter is mainly concerned with the Conduct of Business Sourcebook (COBS),
one of the Block 3 standards of the regulatory Handbooks, introduced in Chapter 9.
COBS contains rules and guidance on issues such as:
Please note that all references to the FSA handbook have been changed to the regulatory
Handbooks as above. We do not list all such changes in this upgrade, but you should
apply similar changes throughout the course.
The last paragraph on page 1 has been deleted.
Page 3
The last paragraph of ActEd text has been replaced by the following two paragraphs:
The initial disclosure document (IDD) makes clear whether the firm offers the products
of a single provider, or the products of a limited number of providers, or the products of
a range of providers. The IDD also invites customers to ask for a copy of the list, or
range, of providers on which advice is offered.
The IDD will also state whether the firm is offering independent advice, restricted
advice or no advice.
Page 4
The first three paragraphs of ActEd text have been deleted.

Page 6
The first two paragraphs of ActEd text and the table have been replaced by the
following three paragraphs and a table:
The current (June 2013) annual monetary rates of return to use in projections, as
specified by the FCA in COBS 13, are shown in the following table:
Lower rate Central rate Higher rate
Taxed life business 4% 6% 8%
Pensions business 5% 7% 9%
However, lower rates of return should be used if the rates shown above overstate the
investment potential of the product, eg if assets are invested in government bonds.
The regulator has announced plans to cut these projection rates to 2%, 5% and 8% for
pensions business from April 2014.
Page 8
The first bullet point of the TCF rules has been shortened to read:
Detail on the circumstances in which MVRs can be applied (COBS 20.2.16)
A firm must not apply an MVR unless the market value of the assets is less than the
assumed value on which the face value of units has been based
Page 13
The bullet points have been amended to read:
Other amendments included:

Strengthening safeguards for with-profits policyholders in relation to new
business plans and strategic investments
improvements to the ways in which conflicts of interests are identified
and managed.

Chapter 11
As noted previously, the FSA has been replaced by the PRA and FCA. As a result, most
references to the FSAs regulation as regards to solvency have been removed from the
notes and replaced with an appropriate reference to the PRA. This is the case throughout
this chapter. We do not list all such changes in this upgrade, but you should apply
similar changes throughout the course.
Page 1
The Financial Services and Markets Act 2000 gives the financial services
regulators the power to make rules and issue guidance, which are consolidated
within the PRA and FCA Handbooks. These are broken down into a number of
different manuals or sourcebooks, as introduced in Chapter 9. The General
Prudential sourcebook (GENPRU) and the Prudential sourcebook for Insurers
(INSPRU) currently contain the prudential and notification requirements for
insurers.
Page 9
The MCR is then subject to a minimum of the Base Capital Resources

Requirement (BCRR), a fixed amount defined in EU Directives. As an example,
for a proprietary life insurer, the BCRR that applies from 31 December 2012 is
3.7m this is therefore likely to affect only very small insurance companies.
Page 10
The equivalent figure for a mutual is 2.775m, ie 75% of the figure for a proprietary.
These amounts are subject to increase in line with the change in the European index of
consumer prices.

Page 23
A new section 6.5 has been added as follows:
6.5 ICAS+
Delays in the proposed implementation of Solvency II (see Chapter 14) have

resulted in the UK regulator announcing its intention to allow companies to use
their preparatory Solvency II models to meet the requirements of the Individual
Capital Adequacy Standards (ICAS) framework.
This should save a considerable amount of work by combining the models used to
calculate the ICA and to prepare for the introduction of Solvency II. Companies will
also be able to use some of their Solvency II documentation in their ICA submission.
However, some extra work is required to reconcile the old ICA model to the new
ICA/Solvency II model.
Further knowledge of this ICAS Plus or ICAS+ approach is not currently

required for the Subject SA2 examination.
Chapter 14
Page 1
All information included in Chapters 14 and 15 is current as at the time of writing

(April 2013). However, since Solvency II remains under development during 2013
and potentially also 2014, some of the details may have been amended or
replaced by the time of the examination. Although the examination questions
will be based on the details as included in this Core Reading, students are
encouraged to be aware of and monitor the ongoing developments, and answers
that reflect such developments will be given equivalent credit.
The PRA has a dedicated Solvency II area of its website which is an excellent source of
information (see http://www.bankofengland.co.uk/pra/Pages/solvency2/default.aspx).
There are several other good Solvency II portals online, not least those of the large
professional services / actuarial consultancy firms.

Page 2
The Core Reading bullet points have been amended to read:
Solvency II is intended to address these shortcomings, with its key objectives

being to:
increase the level of harmonisation of solvency regulation across Europe
protect policyholders
introduce Europe-wide capital requirements that are more sensitive (than
the minimum Solvency I requirements) to the levels of risk being
undertaken
provide appropriate incentives for good risk management.
Page 3
The entry for Level 2 in the table has been amended to read:
Level 2 Developing more detailed implementing measures (delegated acts

and technical standards)
EIOPA (the European Insurance and Occupational Pensions Authority, one of the
EUs main financial supervisory bodies and which developed from the body
previously known as CEIOPS) has provided technical advice and support to the
European Commission for the development of the delegated acts under Level 2,
and is responsible for producing some of the technical standards and the Level 3
additional guidance.
The fifth paragraph of Core Reading has been amended to read:
The timetable for implementation is currently uncertain. At the time of writing

(April 2013) it is planned to be operative from the beginning of 2014, but a delay
to this date is widely considered to be likely.

The final paragraph of Core Reading has been amended to read:
Transitional arrangements may be available for some aspects, although any

such transitional arrangements adopted must be at least equivalent in effect to
the Solvency II proposals and should be in place for up to a defined maximum
period only. The intention is to avoid unnecessary disruption of markets and
availability of insurance products. Full compliance with the new regime should
be encouraged and achieved as quickly as possible.
Page 8
The ORSA is one of the elements considered by the supervisor when

determining whether a further capital add-on is required.
Page 15
The first two paragraphs have been amended to read:
The key objectives of Solvency II are to:

increase harmonisation of solvency regulation across Europe
protect policyholders
introduce capital requirements that are more sensitive to the risks undertaken
provide incentives for good risk management.
It is currently planned to be operative from the beginning of 2014, although a delay is

expected by most people. Transitional arrangements may be available for some aspects.
Chapter 15
Page 6
It is also noted that the method used to determine the discount rate needs to be
consistent between different currencies, including those without an active
government bond or swap market, or where the market is not active for as long a
duration as the liabilities.

Page 7
An illiquidity premium is defined as the additional compensation that investors

gain by bearing the risk from holding an illiquid asset. The extent to which the
risk-free discount rate used to discount technical provisions can include an
allowance for the illiquidity premium remains under consideration, with a
number of different possibilities having been suggested. Under QIS5 (a field
test of the development of Solvency II, performed in 2010), insurance
companies could allow for a specified proportion of the illiquidity premium,
where the proportion varied depending on the extent to which the future liability
cashflows were themselves illiquid.
The third and fourth paragraphs have been replaced by the following four paragraphs:
The final framework might instead adopt the use of counter-cyclical premiums,
allowing firms to use a higher discount rate for liabilities only in times of
financial stress, as determined by EIOPA.
When asset values fall substantially, insurance companies (and banks) may need to sell
these assets and buy safer assets in order to protect their solvency. These sales will lead
to further price falls and so will make the cycle of boom and bust worse. Market values
may then become unreliable and may no longer represent the underlying worth of the
asset.
So the idea of counter-cyclical premiums is to allow firms to place a lower value on

their liabilities in times of general economic stress. This would reduce the need to sell
certain assets during a crisis and should help dampen the effect of the cycle on asset
prices.
In June 2013, EIOPA issued its advice that counter-cyclical premiums should be
replaced by a simpler and more predictable measure called the volatility balancer.
EIOPA believes that the volatility balancer will be a better way to deal with the
distortions caused by excessive price volatility.
The final paragraph has been replaced by:
These aspects continue to be worked on, and more details are expected as the
framework develops.

Page 20
The second paragraph of Core Reading has been replaced by:
The overall capital requirements resulting from the use of an internal model will
generally differ from the outcome of the standard formula calculation, and may
be either higher or lower depending on how the firms tailored risk profile
compares against the assumptions underlying the standard formula.
Page 20
The first three paragraphs of Core Reading have been replaced by the following four
paragraphs:
The quality of data and assumptions can also be an issue. A key challenge is
that historic data available to calibrate extreme events is limited. In practice, it is
likely that some industry consensus will emerge over some of the core
stresses, eg 99.5th percentile equity fall based on a commonly used index and
method. It will be important for companies to allow for their own specific
features however, eg the extent to which their actual equity holdings are more or
less volatile. Similarly, setting dependency structures and correlation factors
that apply under extreme conditions is challenging.
Furthermore, an internal model can be structured in any way that the company
chooses, provided the above tests are met. It does not have to follow the
structure of the standard formula, and can for example be based on stochastic
simulations rather than stress tests plus correlation matrices, perhaps using
copulas to model dependency structures. Calibration of such models will also
require care and expertise.
A copula is a function that can be used to create a joint distribution function from the
marginal distribution functions of random variables. So, for example, we can use a
copula to model the joint behaviour of interest rates and inflation and so calculate the
probability of high inflation occurring at the same time as low interest rates say.
A tight deadline has been imposed of just six months from the supervisory
authority receiving an application for internal model approval to communication
of the decision. Many regulators (eg in the UK) have therefore chosen to set up a
more informal approach (called pre-application), encouraging companies to
engage with them early on in their model development and refinement
processes.

The following paragraph has been added at the bottom of the page:
It is UK firms in the IMAP process who have the option of entering ICAS+ enabling
them to use their Solvency II work to meet the current regulatory requirements. ICAS+
is not available to companies adopting the standard formula approach for their
Solvency II SCR.
Page 26
The following paragraph of ActEd text has been added after the first paragraph of Core
Reading:
So to clarify the Core Reading, own funds consists of two items: firstly the assets in
excess of the technical provisions, and secondly the subordinated liabilities.
Chapter 16
A number of changes have been made to this chapter, eg the FRC has replaced BAS, the
profession has changed its name and there is new guidance on conflicts of interest.
Some of the Core Reading has also been edited down. A replacement chapter is
attached.
Chapter 17
Page 2
The first paragraph of Core Reading has been deleted. The next four paragraphs have
been replaced by the following two paragraphs (note that the bullet points are
unchanged):
The concept of Treating Customers Fairly (TCF) is enshrined within regulation:

a firm must pay due regard to the interests of its customers and treat them
fairly. It is clear that the responsibility for satisfying the TCF requirements rests
with the Board and senior management of a life insurance company.
Compliance with TCF requirements is regulated by the FCA. Senior management

is expected to incorporate its approach to treating customers fairly into the
firms corporate strategy, and to support delivery of the strategy with an
appropriate framework of controls. Effective delivery will include ensuring that
the firm:

Page 4
The following paragraph has been added before the final paragraph on the page:
As noted earlier, compliance with TCF requirements is the responsibility of the

life insurance companys Board.
Treating customers fairly is a key focus for the FCA, also forming part of the
regulatory visiting programme.
Page 5
Guidance given by the Financial Reporting Council in the Insurance TAS states
that reports which require projection of cashflows under alternative scenarios
shall describe how any changes in the assumption about the way discretion is
exercised in the alternative scenarios considered are consistent with the fair
treatment of the policyholders affected.
Page 6
Payouts (including regular and terminal bonus rates) relative to a firms

past record and the whole industry.

Page 9
The section on Legislative background has been amended to read:
The concept of Treating Customers Fairly (TCF) is enshrined within regulation: a firm
must pay due regard to the interests of its customers and treat them fairly. The
responsibility for this rests with the Board of directors and senior management.
Compliance with TCF requirements is regulated by the FCA.
Six consumer outcomes have been identified, which explain what the FCA wants TCF
to achieve for consumers.
Specific references to TCF are contained in the Conduct of Business Sourcebook

Section 20 and also in the Prudential Sourcebook for Insurers INSPRU 1.2.
Chapter 18
Page 3
The following three paragraphs have been added at the start of Section 1:
In determining the capital position of a company, one needs to consider the

perspective from which the capital strength is being assessed. Typically this
would be from the policyholder, regulator or shareholder perspective.
Typically, policyholders and regulators are most interested in the companys

ability to meet their obligations in extreme circumstances. Shareholders,
however, may also be concerned about whether the company has sufficient
capital to target a particular rating (eg to be AA rated) and/or to continue to
write new business going forward.
The most onerous perspective will vary from company to company. For some
companies, the shareholders will require more capital than the regulator. For other
companies, the regulatory capital will be more onerous. It all depends on the nature of
the business in force and the companys plans for the future.
The fourth paragraph of Core Reading has been amended to read:
For a proprietary company, the available capital is a measure of the

shareholders capital currently invested in the company, although this can be
more complex within with-profits funds. Excess assets within a with-profits fund
cannot normally be used to support business outside of the fund.

The penultimate paragraph of Core Reading has been amended to read:
Required capital represents the amount of assets required in excess of liabilities

so that policyholder claims (or shareholder requirements) can be met with a high
degree of certainty when they fall due. Holding sufficient assets to meet this
capital requirement is one way of recognising and addressing policyholders
concerns about risk.
Page 4
The Core Reading definitions of the three types of capital have been amended to read:
Economic capital: An internal determination of the capital required, based

on a companys risk profile, risk appetite and the needs
of its ongoing business strategy.
Regulatory capital: Solvency requirements prescribed by the regulators,

which define the regulatory value of the companys
assets, liabilities and the associated capital
requirements as described in earlier chapters. All
companies need to calculate and cover their regulatory
capital requirements.
Rating agency capital: This represent the view of rating agencies, whose
capital adequacy standards are important for companies
who wish to achieve or maintain a particular credit
rating.
The first paragraph of Core Reading beneath these definitions has been amended to
read:
All three approaches consider policyholder protection to some extent, as there is

clearly a link between the ability to meet policyholder claims as they fall due and
the broader risk appetite of the company. The relationship between these is
discussed further in Section Error! Reference source not found. of this chapter.
The following paragraph of Core Reading has been deleted:
Regardless of the preferred measure of required capital for driving key strategic
decisions, companies have to ensure that they have adequate capital to cover
their regulatory capital requirement and may want to manage their capital to
maintain their credit rating. In practice, many companies will therefore calculate
required capital using all three of the approaches described.

Page 6
The two paragraphs of Core Reading on this page have been replaced by the following
two paragraphs:
The introduction of the Pillar 2 ICA encouraged companies to perform economic

capital assessments, looking at all the risks to which the company is exposed.
As a result, companies have become more aware of the capital employed in the
business and the need to manage their capital, and the return on it, more
effectively.
The capital modelling required under Solvency II should further increase companies
awareness of the need to manage their capital effectively.
Page 7
The following bullet point has been added at the start of the bullet points:
It allows the company to understand and monitor the evolution of its risk
profile.
Page 8
The final two bullet points have been amended as follows:
Solvency projections can also be used to estimate the pattern of capital

releases. This information can then be used to assess whether the
company is achieving a suitable return on its capital. It can also be used
to assess the cost of holding required capital when calculating the
embedded value of the company (see Chapter 22).
More broadly, such projections play a role in successful risk

measurement and risk management within the company. They can be
used in conjunction with stress testing and reverse stress testing (ie
starting from a known outcome, such as breaching a particular regulatory
capital requirement, and working out what events could lead to that
outcome), in order to help companies understand the risks faced and
hence enable more effective risk management.
Sufficiently well thought out risk management processes can play a key role in
reducing a companys ICA figure. The identification of risk management
processes is also a key element of the ORSA.

Page 9
In an insurance context, the difference between the value of assets and the value
of liabilities is the available capital. However, as discussed below, the definition
of the value of assets and liabilities needs to be clarified as it may differ between
economic, regulatory and rating agency assessments.
Page 10
The paragraph of Core Reading below the bullet points has been amended to read:
It is important to recognise that the availability of capital can be viewed from

both a regulatory and a realistic perspective. For example, consider without-
profits business written in a regulatory-basis only life firm for which Pillar 1
capital requirements are more onerous than Pillar 2. From a regulatory
perspective there are margins for prudence in the Pillar 1 valuation, but the value
of future expected profits from that business would not generally be admissible
to meet the statutory capital resource requirements. However, from a realistic
(eg Pillar 2) perspective, these expected future profits do form part of the
available capital of the company. This is covered further in Section 3.2 where we
discuss assessing the available capital.
Page 14
Techniques for assessing the available capital (ie the difference between assets
and liabilities) have evolved in recent years. It is generally regarded in the UK
that the most appropriate measure of the assets and the liabilities is their market
value.
Page 15
The last paragraph of ActEd text has been amended to read:
However, someone accepting such a liability is likely to require some compensation for
the risk that mortality, say, might be worse than expected, and so margins are likely to
be included in the insurance-related assumptions (or some other form of risk margin
will be taken), leading to a higher value of liabilities than best estimate assumptions
would produce.

Page 17
The first paragraph of Core Reading has been replaced by the following three
paragraphs:
The capital requirements of a life insurance company cannot be assessed

adequately by simply considering the current value of liabilities and the assets
available to meet them.
Life insurance companies operate in a sometimes volatile environment, typically

in relation to market risk elements. Companies need to be able to meet their
liabilities in these circumstances and this drives the need for capital.
In addition, the company will need to fund the ongoing business strategy. This
requires information on the projected solvency of the company that allows
appropriately for both the size and probability of downside risks, as well as
estimating the capital needed to support the future new business strategy of the
company.
The last paragraph of ActEd text has been deleted.
Page 18
The following sentence in the middle of the penultimate paragraph of Core Reading has
been deleted:
The purpose of economic capital is to protect policyholders against risk.
Many of the larger UK insurance companies are using economic capital to help
manage the business, and once Solvency II comes into force all UK insurance
companies (above a minimum size) will have to assess the economic capital
position through their ORSA (as described in Chapter 14).

Page 20
This raises practical difficulties, since in theory the probability of regulatory

insolvency can require stochastic calculations to calculate the regulatory
balance sheets at future points in time within a stochastic real world model of
future investment conditions (stochastic within stochastic or nested
calculations). Some companies have developed techniques to simplify these
calculations (eg the use of closed form solutions to estimate the regulatory
balance sheet or the use of replicating portfolios).
Page 23
The following three paragraphs of Core Reading have been deleted:
Some of the methods work on the basis of capitalising the value of expected
future profits.
As mentioned in Chapter 15, Solvency II allows credit to be taken in the balance

sheet for such future profits (with limits, eg as imposed by contract boundaries).
Other Peak 1 related concepts (eg admissibility of assets) will also disappear.
They have been replaced by:
The change to Solvency II means that companies will be able to release at least
some of the prudence in the current technical provisions and concepts such as
the admissibility of assets will disappear.
Page 24
Capital can be raised by issuing subordinated debt in the capital markets. The
repayment of the debt is guaranteed only after the need to meet policyholder
claims when they fall due, with appropriate allowance for the requirements for
TCF and to manage any with-profits business in accordance with the companys
published PPFM. Therefore, the debt ranks behind policyholders in a wind-up so
no reserve needs to be held for its repayment. The debt increases the
companys free assets from a policyholder perspective. However, from a
shareholder perspective such loans would be considered a liability.

Page 33
The bullet points have been amended to read:
A review of the insurers asset-liability matching position, which may

release capital, either by replacing inadmissible assets with admissible
ones or by allowing smaller reserves to be held (eg by reducing the cost
of options and guarantees).
A release of capital by weakening the Peak 1 reserving assumptions

(ie reducing any prudential margins) provided this is not an arbitrary
change against the valuation rules.
Page 35
economic capital capital required to support the ongoing business strategy,

reflecting the risk profile and risk appetite of the company
The following has been added to the final set of bullet points:
To understand and monitor a companys risk profile over time.
Page 36
The following paragraph has been amended to read:
Economic capital Realistic capital can be determined using a number of scenarios,

using either stochastic modelling or stress tests. The time horizon considered could be
either a one-year period or the full run-off of the in-force business.

Chapter 19
Page 1
In this chapter, asset-liability management is explored in the context of UK life

insurance companies. An important (but not the only) part of asset-liability
management is the use of asset-liability models to determine an appropriate investment
strategy for the company. The model used may be deterministic or stochastic. Before
proceeding, we had better make sure that we are clear what asset-liability modelling
means.
Page 2
The following paragraph of Core Reading has been added at the start of Section 1:
For life insurance companies, market risk typically represents the most
significant risk exposure and hence asset-liability management (ALM) can be
used to help manage the required capital.
Chapter 20
Page 22
An analysis of movement in the working capital of a with-profits fund is required

as part of Peak 2 regulatory reporting.

Chapter 21
Page 2
Since 22 December 1994, regulations have been made under the Companies Act
which require life insurance company accounts to be produced according to the
rules of the EU Insurance Accounts Directive. The Directive requirements are
spelt out in more detail by the ABI in its Statement of Recommended Practice
(SORP). This SORP describes how life insurance business should be accounted
for in order to comply with the Generally Accepted Accounting Principles in the
UK (UK GAAP). The UKs Accounting Standards Board (ASB) (now the
Accounting Council of the Financial Reporting Council) is required to confirm
that the SORP complies with its own reporting rules. This is termed as reporting
on the Modified Statutory Basis. The Regulations are now overruled in certain
cases by the need to comply with IFRS.
Page 4
The following paragraph of Core Reading has been added at the end of this page:
It should be noted that, for accounting periods beginning on or after 1 January

2015, current UK GAAP will be replaced by three new Financial Reporting
Standards: FRS 100, 101 and 102 (new UK GAAP). As for any such accounting
standards, early adoption is permitted.
Page 5
Phase II is a comprehensive project on accounting for insurance contracts

addressing, on a fresh-start basis, all issues unique to insurers. This is taking
many years to complete. An Exposure Draft of a Phase II standard was first
published in the summer of 2010, and an updated Exposure Draft was published
in June 2013.

Page 17
For without-profits funds, there may be a different profit profile, as the

supervisory basis does permit transfers to and from an investment reserve
where one exists, allowing only so much profit as the directors determine to be
realised. However, new investment reserves are generally not created and the
profit determined by the directors usually follows an economic basis. Also,
differences in technical provisions may exist and acquisition costs do not need
to be explicitly deferred under the supervisory reporting basis (although may be,
at least in part, through adjustment).
In a similar way, all references to FSA returns have been changed to supervisory returns
in this chapter.
Chapter 23
Page 3
The following bullet point has been added at the end of the list:
to validate the data and calculation process.
This point has also been added to the first list on page 19.
Solution 23.4
The explanation in the solution has been expanded as follows:
The company has just sold a contract worth 400 to it, so the embedded value of the
company rises by 400.
The embedded value is made up of the free surplus plus the PVIF. Free surplus falls by
300, made up of the 200 negative asset share plus a further 100 to set up the reserve.
So PVIF must rise by 700 to give an embedded value of 700 300 = 400 as required
(so we have made a loss of 300 at outset, but will make future profits of 700, giving
us the overall profit of 400).

Chapter 24
Page 22
Some companies use base asset share (see below) as a guide to the minimum
value that should meet policyholders reasonable expectations (PRE).
Another main use for asset shares is in establishing realistic solvency positions
that have to be published under the Prudential sourcebooks. Since asset shares
are used to determine payouts, they are therefore held as a liability on the
realistic balance sheet, and are also projected to determine the future policy-
related liabilities such as the market-consistent cost of guarantees in excess of
asset share.
Page 5
A typical definition would be that an asset share is the premiums paid, less
deductions, plus allocations of miscellaneous profits, all accumulated at suitable
rates of investment return, with allowance for any tax payable. In some cases,
the company may also wish to distribute some of the estate to policyholders and
may do this via an increase to asset shares.
The following has been deleted from the bullet points:
allocations from the estate
Page 6
In practice, the majority of companies have tended to use a managed fund

approach in terms of which a fund of assets is identified which backs the with-
profits portfolio. The asset share of each policy is deemed to be invested pro-
rata in the fund, regardless of duration in force and term to run. Different
products may have different funds backing them in order to reflect the products
different characteristics, particularly the level of inherent guarantees.

Page 7
The last two paragraphs of Section 3.1 have been replaced by the following four
paragraphs:
Some companies may allocate smoothed investment returns to asset shares.

Bonuses derived from these asset shares would automatically allow for any
smoothing policy. However, this would mean that asset shares allowing for both
smoothed and unsmoothed investment returns would need to be monitored in
order to understand the smoothing costs, as this approach would not
automatically result in smoothing costs which were neutral to the fund.
Unsmoothed asset shares are also required in order to monitor payouts relative
to the target range.
We covered the need for target ranges in the discussion of COBS 20 in Chapter 10.
As noted in Chapter 10, the investment strategy for the with-profits fund will be
set out in the PPFM, although there is normally some flexibility. The equity
backing ratio will usually depend on the solvency of the fund and, as noted
above, the level of guarantees.
Other decisions to make in calculating the asset share will include the allowance to
make for dealing costs and the frequency of calculation of investment return, eg yearly
or quarterly.
Page 12
Shareholders transfers are applicable to proprietary companies and are usually

1/9th of the cost of the bonus on the supervisory valuation basis (ie on a 90/10
basis). Many (but not all) companies deduct shareholders transfers from policy
asset shares.
the cost of smoothing

Page 14
Most of the points mentioned above for conventional with-profits are equally
relevant for unitised with-profits contracts. However unitised with-profits
contracts often allow single and regular premiums to be paid, and regular
premiums to be revised upwards and downwards. This makes the calculation of
asset shares for this business more complicated than for conventional with-
profits contracts.
There are three distinct methods for calculating asset shares for unitised with-
profits business and these are described under the following sections, including
how the allocations and deductions may differ from those for conventional with-
profits contracts.
Some companies accumulate the asset share after deducting product charges
rather than actual expenses. This is primarily done for unitised with-profits
business written on a 0/100 basis where the difference between product charges
and expenses accrues either in the with-profits estate or outside the with-profits
fund (thereby forming the shareholder transfer). Some companies may then
credit back any excess of these charges over actual expenses.
The following paragraph of Core Reading has been added at the end of the page:
Some companies still determine shareholder transfers on a 90/10 basis under

this method, in which case the charges less expenses need to cover these
transfers.
Solution 24.1
expenses incurred and any commissions paid

Chapter 25
Page 1
Regulatory handbook restrictions on transfers of surplus (Section 2)
Page 3
The following paragraph has been added at the beginning of Section 1:
Subject ST2 covered surplus distribution generically. The sections that follow
are more detailed and relate to practice in the UK.
Page 9
The following paragraph has been added at the beginning of Section 3:
The FCA is the regulatory authority which has the responsibility to oversee
decisions on bonuses and charges, and on managements approach to treating
customers fairly. The PRA has responsibility for assessment of an insurance
companys ability to meet its liabilities and, where that is threatened, it has the
power to veto decisions on with-profits bonuses and distribution of estate.
Page 10
The following section has been added at the end of the page:
Treating with-profits policyholders fairly
As mentioned above, this topic was covered in more detail in Chapter 17.
The requirements of treating customers fairly include the following aspects

which may affect a companys surplus distribution philosophy:
Except in adverse conditions, policyholders will typically expect a

company at least to maintain its current reversionary bonus rates (after
some significant reductions in reversionary bonuses in past years in the
UK, rates have tended to level out).
In addition, it is necessary to assess whether it is equitable to give the

same rate of reversionary bonus to all contracts.

Page 14
A new Section 4.5 has been added. Replacement pages 13 to 15A are attached. This
Section is similar to the old Section 3.6 in Chapter 26 which has now been deleted.
The solution to the new Question 25.8A is:
Falls in the unit price are smoothed, so the situation can still arise where the unit price
times the number of units is higher than the asset share. So an MVR might still be
needed to protect the company against the effect of selective withdrawals.
Chapter 26
Page 3
Although there are many reasons why insurance companies might favour
distribution of a greater proportion of surplus as terminal bonus, a proprietary
company will also be concerned to maximise the transfers that it can make to its
shareholders. The method of distributing surplus as bonus will affect the pace
at which transfers can be made. Maximisation of shareholder transfers implies
deferring the emergence of surplus as little as possible, as the rate of return
required by shareholders will usually exceed the rate at which undistributed
surplus accumulates within a life insurance company.
Page 4
The first two paragraphs of Core Reading have been replaced by the following
paragraph:
A key aspect of smoothing is to limit the change in payouts over time, in

accordance with policyholder expectations (and as described in the PPFM).
Page 9
The last paragraph of Core Reading has been deleted.

Page 10
The first and third paragraph has been deleted.
The fourth and fifth paragraphs have been amended to read:
A global investigation into supportability can be done by carrying out a gross-

premium valuation of the existing with-profits business, on realistic
assumptions, incorporating the current rate or rates of reversionary bonuses
and making an assumption as to the terminal bonuses to be declared. The most
important assumption will be the rate of investment return, which should be a
realistic assessment of rates that may be earned in the future maybe using
different rates for the initial years as compared with later years.
This value of the liabilities should be compared with a realistic value of the
assets backing the with-profits business. A realistic value is likely to mean
market value, although a discounted value of asset proceeds could be used
(where, for example, the majority of assets held are fixed in nature). Aggregate
earned asset shares would usually be used to compare to the liabilities, with any
intended distribution of the estate being considered in a separate investigation.
Page 11
The following Core Reading has been deleted:
Whether a company would then reduce reversionary rates will depend on:
policyholders expectations as regards such a reduction and the speed at

which it can be done, and
competitive considerations.
Page 12
The first bullet point of Core Reading has been amended to read:
a revision of the premium rates or charges

Page 13
Conventional with profits bonus rates tend to be declared for all contracts in a
cohort, irrespective of size, and so specimen contracts can be chosen to model
the business maturing in the near future. Companies also look at the actual
asset shares of individual policies maturing in the near future to check that the
specimen contracts reflect the true cost. For each model point, its earned asset
share can be compared with the maturity benefit excluding any terminal bonus.
The excess of the former over the latter will indicate the scope for terminal
bonus.
Page 21
The first three paragraphs have been amended to read (the bullet points are unchanged):
A reversionary bonus distribution may result in a reduction in the companys

free assets, depending on the extent to which it has already been anticipated in
the reserves. The free assets are, however, there to ensure the ongoing
solvency of the company and enable it to support its investment, new business
and other strategic policies.
Of course, with-profits contracts are meant to have bonuses. The point being made,
though, is that the act of granting a bonus may reduce the companys free assets, and
this should be considered before deciding what bonus to declare.
Prior to a distribution of surplus, the insurance company therefore needs to

consider the effect the proposed distribution, and its continuation, will have on
the free assets. In particular:
The three questions above can all be investigated using cashflow and solvency
projections. This will involve projecting the assets on the basis of a set of future
investment assumptions and assuming that the current investment strategy
continues. On the liabilities side the in-force data will be projected at the end of
each year again on a set of assumptions. The valuation reserves required to
satisfy supervisory requirements can then be calculated, either assuming that
the company continues to use the current basis and method for such reserves,
or using a dynamic approach.

Chapter 27
Page 4
New text on the three lines of defence has been added here. Replacement pages 3 and
4 are attached.
Page 6
The last bullet point has been amended to read:
the level of collateral or other risk mitigating arrangements (eg credit

insurance or derivatives such as credit default swaps).
Credit risk management is closely related to the issue of capital management in

the life insurance industry. Management information will reflect the importance
of credit risk monitoring to a firm and will generally contain measures related to
credit risk. This may include, for example, analysis of corporate bond and
reinsurance exposures by credit rating.
The following paragraph of Core Reading has been added at the end of the page:
It should be noted that there is no universally agreed definition of credit risk

in particular, there are often differences between companies in the classification
of credit spread risk, which is the risk of changes in the value of an asset arising
from changes in the expectation of future failure of counterparties to perform
their obligations. For traded assets (eg corporate bonds) credit spread risk is
reflected in the market price, therefore is often considered as market risk.
Other companies choose to define it as credit risk, since the underlying
features are the same as those described above.
Page 8
A firm should ensure that it has sufficient controls to identify when the volatility
of claims payments and the options available to policyholders, including the
circumstances in which they are likely to be exercised, might cause a mismatch
between short-term cashflows and in particular when they might lead to a
situation where the firm does not have sufficient cash to make contractual
payments to policyholders. In the event of this situation arising, a firm may have
to realise assets at a loss. In general, the annual investigations into the financial
condition of the insurance funds will generate this information.

The following four paragraphs have been added at the end of the page:
Other areas where liquidity monitoring is necessary are in respect of the

investment operations of the firm, such as advance commitments to investment
drawdown schedules, capital calls and collateral requirements associated with
derivative transactions. These may require monthly, weekly or even daily
monitoring of the available collateral and liquidity pool.
An insurance company may use derivatives, such as interest rate swaps, to match its
liabilities more closely. However, if the value of a derivative moves against the
company, it may need to post collateral (or margin) immediately to cover the losses it
now expects to make in the future. Cash will be needed to meet these calls for margin.
As for the other risk types, liquidity risk should be appropriately considered in
the companys risk policy, and requirements for monitoring, measuring,
reporting and limiting the liquidity risk should be set out.
Where liquidity risk is considered to have a potentially material adverse impact

on the solvency position of the firm it is appropriate to incorporate liquidity risk
assessment within the risk-based capital framework.
Page 10
This is an example of a processing risk. A company that issues unit-linked

contracts will need to calculate the prices at which it will allocate and redeem
units. The process by which it does these calculations can lead to risks for the
company. [Note that some companies might classify these with other
operational risks and some might consider unit pricing risks separately; it is,
of course, important not to double count them.]
Page 14
As for other types of risk, there is no universally agreed definition of insurance

risk. It normally includes fluctuations in the timing, frequency and severity of
insured events, relative to the expectations of the firm at the time of
underwriting. Insurance risk can also refer to fluctuations in the timing and
amount of claim settlements. Examples include variations in the mortality and
persistency rates of policyholders, or the possibility that guarantees could
acquire a value that adversely affects the finances of a firm and its ability to treat
its policyholders fairly. More generally, it includes the potential for expense
overruns relative to pricing or provisioning.

Pages 15 to 18
A number of changes have been made here. Replacement pages are attached.
The solution to the new Question 27.7A is as follows:
Some of the people with heavier mortality would now choose to buy an impaired life
annuity, so the mortality experience of the remaining lives would be lighter, ie the
mortality of the non-underwritten lives would be worse from the insurance companys
point of view.. As a result, the insurance company would need to charge more for the
non-underwritten annuities.
Page 20
In August 2006, new mortality tables (the 00 Series), based on insured lives
experience during 19992002, were produced by the Continuous Mortality
Investigation (CMI).
The third paragraph of Core Reading has been deleted.
Pages 21 to 32
A number of changes have been made here. Replacement pages 21 to 32A are attached.
Page 34
The directors would need to put in place arrangements for tightly-managed

internal audit controls (third line of defence). The manager responsible for
internal audit might be the Chief Financial Officer or, as is more common, might
be positioned separately from the finance function with clear reporting lines to
the Board of the insurer.
Page 35
The first paragraph of Core Reading has been replaced by the following two
paragraphs:
Larger companies would also be likely to have a separate risk function (with a
Chief Risk Officer) to monitor the management information produced and ensure
that risk limits and controls were being followed (second line of defence).

As noted in Chapter 14, under Solvency II all insurance companies are required
to have a risk management function, actuarial function, compliance function and
internal audit function, with clear separation of accountabilities.
Chapter 29
Page 2
A number of changes have been made to Section 1. Replacement pages 1 to 2 are

attached.
Page 3
Thus the surrender value is typically based on the prospective reserve calculated on a
basis somewhere between the pricing basis and the best estimate. It should be reduced
for the surrender expenses involved. It may also be subject to a maximum of asset
share to protect against past experience being worse than that assumed in the premium
basis.
Page 11
The first point has been amended to read:
In addition to the principles outlined in Subject ST2, with-profits surrender values

should take into account the companys philosophy as outlined in its PPFM.
Solution 29.1
The sixth point has been amended to read:
take account of surrender values offered by competitors (and possibly also

auction values, where available)
Chapter 33
The following terms have been deleted: ARROW, Board for Actuarial Standards, FSA
Handbook.

The following definitions have been amended or added:
Achieved Profits Method (APM)*
This is a traditional embedded value approach which has been used in the past
for supplementary reporting in statutory accounts.
Most of the UK listed insurance companies that had adopted the Achieved Profits
Method have since moved to adopt the European Embedded Value Principles, and
subsequently there has been movement to Market Consistent Embedded Value
Principles.
Actuarial Function Holder*
There is a statutory requirement for a UK life insurance company transacting

long-term business to have an Actuarial Function Holder (AFH).
The AFHs main responsibility is to advise the firms management on the risks
being run by the firm and the capital required to support the business. This
includes advice on the methods and assumptions underpinning the firms
solvency calculations.
Appropriate Actuary*
Some friendly societies have to appoint an Appropriate Actuary to meet

regulatory requirements. The main responsibilities of the Appropriate Actuary
are to carry out actuarial investigations in accordance with the rules in the
regulatory Handbooks and applicable professional guidance, to report on those
investigations, to prepare an abstract of the report for publication, and to provide
the certificate or statement required.

Credit and counterparty risk*
There is no universally accepted definition of credit risk and counterparty risk.
The Core Reading in the Course Notes defines credit (or counterparty) risk as being
incurred whenever a firm is exposed to loss if a counterparty fails to perform its
contractual obligations including failure to perform them in a timely manner.
Credit risk may be defined as the probability that a borrower (or reinsurer) will
fail to make payment of interest and/or the principal amount (or the reinsurance
claim recoveries).
Counterparty risk may be regarded as the risk that a counterparty will not honour
its obligations. If a default occurs before the date when settlement of the
underlying transaction is due, the party that has been let down will be exposed
to the replacement risk of having to bear any costs of replacing or cancelling the
deal.
Economic and regulatory (and rating agency) capital*
Economic capital is an internal determination of the capital required, based on a

companys risk profile, risk appetite and the needs of its ongoing business
strategy.
Regulatory capital is the amount of capital required to protect policyholders

based on the view of the regulators whose solvency capital rules define the
regulatory value of its assets and liabilities and the associated capital resources
requirement.
A third capital requirement is also included in the Core Reading along with the above
two:
Rating agency capital This represents the view of rating agencies, whose capital
adequacy standards are important for companies who wish to achieve or maintain a
particular credit rating.
Enhanced Capital Requirement (ECR)*
The ECR is the sum of the Long Term Insurance Capital Requirement (LTICR)
and the With-Profits Insurance Capital Component (WPICC) under Pillar 1 of the
current regulatory reporting regime.

Financial Conduct Authority (FCA)*
The FCA is the UK regulator responsible for regulation of conduct in financial

markets (and the infrastructure that supports those markets) and the prudential
regulation of financial services companies that do not fall under the scope of the
PRA (eg insurance brokers and smaller investment firms).
Financial reinsurance
Financial reinsurance is reinsurance where the main purpose is to provide a

capital benefit to the ceding company. For the arrangement to be effective from
a UK regulatory balance sheet perspective, it must involve a genuine transfer of
risk.
Financial Reporting Council (FRC)*
The FRC has responsibility for the regulation of the Institute and Faculty of
Actuaries, including setting technical actuarial standards.
General Prudential sourcebook (GENPRU)*
The UK regulatory Handbooks are broken down into a number of different

manuals or sourcebooks. GENPRU and the Prudential sourcebook for Insurers
(INSPRU) contain the prudential and notification requirements for insurers.
Individual Capital Assessment (ICA)*
Pillar 2 of the existing regulatory reporting regime is the Individual Capital

Assessment (ICA), which covers a confidential assessment of solvency for the
regulator (the PRA), recognising all the risks to which a firm is exposed, not just
the prescribed risks of the Pillar 1 rules.
Individual Capital Guidance (ICG)*
Firms submit their own confidential ICA calculations to the PRA, which then
reviews them and issues Individual Capital Guidance (ICG). If the PRA is happy
with a firms ICA calculations, the ICG will simply equal the ICA. However, if the
PRA believes that a firm has not adequately assessed all the risks to which it is
exposed, it will set the ICG as higher than the ICA that the firm has calculated.

Internal unit-linked fund
An internal unit-linked fund consists of a clearly identifiable set of assets, for

example equities, property, fixed interest securities and deposits. The fund is
divided into a number of equal units consisting of identical sub-sets of the
funds assets and liabilities. Responsibility for unit pricing rests with the
company, subject to any relevant policy conditions.
Long Term Insurance Capital Requirement (LTICR)*
In addition to its mathematical reserves, under Pillar 1 of the existing regulatory

reporting regime both realistic and regulatory-basis only life firms must hold
sufficient additional capital to cover the Long Term Insurance Capital
Requirement (LTICR), which is calculated by multiplying defined measures of
capital at risk by fixed percentage factors.
Minimum Capital Requirement (MCR)*
For regulatory-basis only life firms (under Pillar 1 of the existing regulatory
reporting regime) the MCR is the sum of the Long Term Insurance Capital
Requirement (LTICR) and Resilience Capital Requirement (RCR) subject to a
minimum of the Base Capital Resources Requirement (BCRR), which is the
minimum guarantee fund in accordance with EU Directives. For realistic-basis
life firms the MCR is the higher of the LTICR and the BCRR. [The MCR
terminology is also used in the proposed Solvency II framework, although the
calculation approach differs.]
Modified Statutory Basis of reporting*
Life insurance company accounts have to be produced according to the rules of

the EU Insurance Accounts Directive. The Directive requirements are spelt out in
more detail by the ABI in its Statement of Recommended Practice (SORP). This
SORP describes how life insurance business should be accounted for in order to
comply with the Generally Accepted Accounting Principles in the UK (UK GAAP).
This is termed as reporting on the Modified Statutory Basis (MSB). (These
requirements are now overruled in certain cases by the need to comply with
IFRS.)
Multi-tied adviser*
This is a type of adviser that can recommend products from only a limited
number of insurers chosen by the adviser.

Pillar 1 and Pillar 2*
The General Prudential sourcebook (GENPRU) and Prudential sourcebook for

Insurers (INSPRU) set standards for capital management and introduce the
concept of two Pillars:
Pillar 1, which covers public solvency information that appears within the
regulatory Returns on the basis of prescriptive rules.
Pillar 2, the Individual Capital Assessment (ICA), which covers a confidential

assessment of solvency for the PRA, recognising all the risks to which a firm is
exposed, not just the prescribed risks of the Pillar 1 rules.
Principles and Practices of Financial Management*
The Conduct of Business Sourcebook (COBS) (a module of the regulatory

Handbooks) specifies the information that a product provider must make
available in respect of with-profits business, particularly the production of the
Principles and Practices of Financial Management (PPFM). Any firm that has any
in-force UK with-profits business must establish and maintain a PPFM document
setting out how such business is conducted.
Prudential Regulation Authority (PRA)*
The PRA is a subsidiary of the Bank of England and is the UK regulator

responsible for the prudential regulation of all deposit-taking institutions,
insurance providers and large investment firms.
Prudential sourcebook for Insurers (INSPRU)*
See General Prudential sourcebook (GENPRU) above.
Qualifying life insurance policy*
Qualifying in this context means whether the benefits payable under a life
assurance contract generally qualify for not being taxed in the hands of the
policyholder.
Contracts can be divided into those that are qualifying, ie satisfy certain rules
(which depend on the type of contract), and those that are non-qualifying. Tax
payable on benefits depends on the qualifying status of a contract.

Realistic balance sheet*
A realistic-basis life firm is required to carry out a market-consistent valuation of

its with-profits business under Peak 2 as part of its annual PRA Returns. In most
cases this will require the use of stochastic techniques. Within this framework,
the underpinning basis is that economic assumptions should be market
consistent and non-economic parameters should be best estimate, as
opposed to containing margins for adverse deviation as are required under
Peak 1. Results under Peak 2 are referred to as the realistic balance sheet.
Regulatory Handbooks*
The Financial Services and Markets Act 2000 gives the UK regulators the power
to make rules and issue guidance. These are contained within the PRA and FCA
Handbooks, which, in turn, are broken down into a number of different manuals
or sourcebooks.
Solvency*
A life insurance company is solvent if its assets are adequate to enable it to meet
its liabilities and solvency capital requirements. The PRA has rules on the
values that a company can place on its assets and liabilities and the levels of
capital requirements, for the purpose of demonstrating supervisory solvency.
Solvency II*
Solvency II is an updated set of regulatory requirements for insurance firms in

the EU, based on a three pillar approach, which is planned to replace the current
Solvency I regime at some future date (at the time of writing, the implementation
date is not yet clear). The aim of EU solvency rules is to ensure that insurance
undertakings are financially sound and can withstand adverse events, in order to
protect policyholders and the stability of the financial system as a whole.
Technical Actuarial Standards (TAS)*
Technical Actuarial Standards are professional standards issued by the

Financial Reporting Council, which cover both generic and specific areas of
actuarial work. Each TAS is mandatory for all members of the Institute and
Faculty of Actuaries when undertaking work that is within the scope of that TAS.

Treating customers fairly (TCF)*
The concept of Treating Customers Fairly (TCF) is enshrined within UK

regulation: a firm must pay due regard to the interests of its customers and
treat them fairly. It is clear that the responsibility for satisfying the TCF
requirements rests with the Board and senior management of a life insurance
company.
The FCA expects senior management to incorporate their approach to treating

customers fairly into their firms corporate strategy, and to support delivery of
the strategy with an appropriate framework of controls.
Unfair contract terms*
The Unfair Terms in Consumer Contracts Regulations 1999 give some

regulators and consumer bodies powers to challenge firms that are using unfair
terms in their standardised consumer contracts. The regulations do not offer
redress to individual consumers, but do give the FCA the power to challenge
firms that are using unfair terms.
Unitised contracts
After deducting an amount to cover part of its costs, each premium under a
unitised contract is used to buy units at their offer price. These units are added
to the contracts unit account. When the insured event happens, the amount of
the benefit is the then bid price value of all the units in the contracts unit
account. This may be subject to a minimum amount specified in monetary
terms.
The price of the units may either relate directly to the value of the assets
underlying the contract, or may be related to an investment or other index, or
may be based on smoothed asset values, perhaps with a guarantee that the price
of the units will not fall.
Unitised contracts include unit-linked and (some) index-linked contracts, and

those accumulating with-profits contracts that are written on a unitised basis.
With-Profits Actuary*
There is a statutory requirement for a life insurance company transacting with-

profits business to have a With-Profits Actuary.

The main responsibilities of the With-Profits Actuary are to advise management

on key aspects of the discretion exercised affecting with-profits business and
produce a report to the firms governing body covering this advice at least once
each year; to advise management whether the assumptions used to calculate the
With-Profits Insurance Capital Component (WPICC) are consistent with the
Principles and Practices of Financial Management (PPFM); to produce a publicly
available annual report for policyholders.

3 Changes to the Q&A Bank

Mark allocations have been amended to reflect the actual exam marking. For example,
some points that previously scored a half mark have been changed to score a full mark.
These changes are not listed here. In the Subject SA2 exam, it is always safest to
assume that each valid point you make will score half a mark.
We have also updated the question and solutions for the changes in the Core Reading
and ActEd text. The key changes are listed below:
Q&A Bank Part 1
In the solution to Question 1.3(i), the references to GRB in brackets have been deleted.
In the solution to Question 1.3(iii), the formula for profit now includes the DAC, so that
point 1. now reads:
1. A weakening of the valuation basis used. [1]
On non-participating business, this increases taxable profit because the profit

calculation is in essence P C + I E (V1 V0) + (D1 D0), and so a lower V1
increases profit. [1]
So IE is unchanged whilst profits are higher, so its more likely that the
minimum profits test bites. []
The number of marks in Question 1.6 have been reduced to 12 for part (i) and 15 for
part (ii).
The following point has been deleted from the solution to Question 1.6(i):
The company should consider the impact on both channels of the FSAs Retail
Distribution Review. []
Q&A Bank Part 2
The following point in the solution to Question 2.1(i) has been amended to read:
If a principle is to be changed, three months advance written notice must be given

(although in extreme cases, the company can apply to the FCA for a waiver in respect of
this notice period). []

In the solution to Question 2.2, all the references to the FSA have been changed to the
PRA except for the following three points:
sent to all policyholders involved a short formal notice in a form approved by

the PRA (which will also consult with the FCA for this purpose). In practice,
this would involve sending to policyholders and, in the case of a proprietary,
shareholders a statement: []
Although it is usually not formally required by the Court, a ballot of members may be
needed to secure regulatory approval. A 75% vote in favour is seen as a good mandate.
[]
The PRA and FCA may also invoke a right to be heard by the Court. The regulators are
not formally required to approve a scheme. However, if the scheme would go against the
requirement to treat customers fairly (including PRE), the FCA may intervene and make
representations to the Court that would almost certainly result in the scheme not being
approved. [1]
The number of marks in Question 2.3 have been reduced to 5 for part (ii) and the
question has been amended as follows:
(ii) Investigations of the basis initially proposed for the supervisory valuation have
indicated a valuation interest rate for without-profits business slightly higher
than the overall maximum allowed under the PRA rules. The initial proposal
was the same as last years basis. Discuss how this situation could have arisen
and describe possible courses of action that might be adopted. [5]
The following point has been deleted from the solution to Question 2.3(ii):
If reducing the rate of interest does cause a problem with the valuation position,
then the company would have to take other actions, such as using implicit items
to cover part of its CRR. [1]
The following point has been amended in the solution to Question 2.4:
Assets
Market value of admissible assets (as per PRA rules)

Fund value also published. [1]
The number of marks in Question 2.8 have been reduced to 3 for part (i).

The following point has been added to the solution to Question 2.12 under the heading
Processes and documentation:
The PRAs ICAS+ approach allows insurers to use some of their Solvency II models
and documentation to meet the requirements for the ICAS framework. []
Q&A Bank Part 3
The following point in the solution to Question 3.1(ii) has been amended to read:
However, in 2010 the regulator introduced a number of rigorous tests that have to be
met in order to achieve any regulatory balance sheet benefit, making virtual capital
arrangements more difficult to implement. []
The following points in the solution to Question 3.2 have been amended to read:
This is an internal determination of the capital (ie assets in excess of liabilities)

required. []
It will reflect a companys risk profile, risk appetite and the needs of the companys on-
going business strategy. [1]
This follows the solvency requirements prescribed by the regulators, which define the
regulatory value of the companys assets, liabilities and the associated capital
requirements. [1]
The regulatory capital required by a UK life insurance company is calculated in line

with the rules and guidance of the PRA Prudential sourcebooks which includes the
Pillar 1 and Pillar 2 requirements. [1]
This is the view of the rating agencies on the amount of required capital. It is important
for companies who wish to achieve or maintain a particular credit rating. [1]
The following points in the solution to Question 3.4(i) have been amended to read:
reserving requirements must also change to allow for the guarantee [1]
ideally the companys pricing models should reflect the future Solvency II
requirements (rather than just the current PRA regime) [1]

Q&A Bank Part 4
The number of marks in Question 4.2 has been reduced to 10.
The following point in the solution to Question 4.6(i)(d) has been amended to read:
Otherwise estimates based on any published data, eg supervisory Returns, regulators

persistency reports, press comment. This would also be based upon experience and
judgement.
The following point in the solution to Question 4.7(v) has been amended to read:
You will have to consider your Articles of Association, which may set out limits on the
split of profits between with-profits policyholders and shareholders. Legislation,
marketing implications and the opinion of the FCA will also have to be considered.
[3]
Q&A Bank Part 5
The following point in the solution to Question 5.5 has been amended to read:
Non-disclosure of smoker status has historically been a problem within the industry. To
allow for this, mortality assumptions underlying standard rates could be adjusted to
allow for the expectation that a certain proportion of applicants will lie about this.
[1]
The following point has been added to the solution to Question 5.5 (immediately after
the amended point above):
However cotinine testing can be used to assess smoker status whenever a medical
examination is requested. []
The following point has also been added to the solution to Question 5.5 (just above the
point on genetic testing):
It has also become commonplace for insurers to conduct random sampling of cases after
acceptance, where medical reports are again obtained. []

The following point in the solution to Question 5.6(iii) has been amended to read:
This is not a company-specific issue. Has there been any guidance from, for
example, the Institute and Faculty of Actuaries or the FRC, the regulators or the
ABI? Has there been any legal opinion? []
Q&A Bank Part 6
The information at the top of page 2 of the solutions now reads:
To put the bases given below into context, we give some current (July 2013) financial
data.
UK Equities: The FTSE-100 is around 6,600. Its gross running yield stands at around
3.5% pa and its P/E ratio is around 13.
Gilts: Yield on a 15-year gilt is 3.0% pa (compares with historically low base
rates of 0.5% pa).
Inflation: Latest figures show RPI headline inflation running at 3.3% pa.
The following point in the solution to Question 6.2 (under the heading of inflation) has
been amended to read:
3.0% pa, say, consistent with interest (real yields on index-linked bonds are currently
negative for terms up to 15 years). []
The reference to the FSA in Question 6.5 has been changed to the FCA.
Question 6.10(i) has been amended to read:
(i) Describe how the company should determine the amount of initial expenses that
it should assume for the new contract. [9]
The following point in the solution to Question 6.10(ii)(a) (under the heading of
expenses) has been amended to read:
There would be no commission on this contract post RDR. []

Q&A Bank Part 7
The following point in the solution to Question 7.1(i) has been amended to read:
As a result of the Retail Distribution Review (RDR), commission may not be paid to
brokers in the UK. [1]

4 Changes to the X assignments

Mark allocations have been amended to reflect the actual exam marking. For example,
some points that previously scored a half mark have been changed to score a full mark.
These changes are not listed here. In the Subject SA2 exam, it is always safest to
assume that each valid point you make will score half a mark.
As with the Q&A Bank, we have updated questions and solutions for the changes in the
Core Reading and ActEd text.
We only accept the current version of assignments for marking, ie those published for
the sessions leading to the 2014 exams. If you wish to submit your script for marking
but have only an old version, then you can order the current assignments free of charge
if you have purchased the same assignments in the same subject the previous year (ie
sessions leading to the 2013 exams), and have purchased marking for the 2014 session.
A summary of the key changes is given below.
Question X1.2
The tax rate in part (ii) has been changed as follows:
the rate of corporation tax is 23% throughout the relevant period
Solution X1.2
In part (i), the following points have been amended:
Tax is paid on any amount liable to tax at a rate equal to the policyholders marginal tax
rate less the lower rate (charged on savings) of tax (as at April 2013 the lower rate is
20%). []
Usually Chargeable Gains Tax is payable only by higher-rate tax payers whose
marginal rate of tax is 40% (April 2013) giving a Chargeable Gains Tax rate of 20%
(those whose earnings are in excess of 150,000 are subject to the higher tax band,
which is 45% from April 2013). Basic-rate tax payers are not charged. [1]
In part (ii)(b), the following points have been amended:
BLAGAB tax paid in year X = 23% on 400 + 20% on 300 = 92 + 60 = 152 []

Year X total tax paid = 152 + 0 = 152 []
OLTB tax paid in year X+1 = 23% on 100 = 23 []
BLAGAB tax paid in year X+1 = 23% on 350 = 80.5 []
Year X+1 total tax = 23 + 80.5 = 103.5 []
Solution X2.1
In part (iii)(b), the following point has been amended:
3% pa gross, subject to PRA maximum. []
Question X2.2
Part (ii) has been reworded as follows:
(ii) Discuss the factors that affect which of the two valuation peaks will be the more
onerous (the most onerous peak will be the one with the lowest surplus). [7]
Solution X2.2
Assets are valued in accordance with the PRAs asset valuation rules, ie:
Mathematical reserves are also calculated in accordance with PRA rules. []
In part (iii), the following points have been amended:
Senior management and directors are expected to have an understanding of the nature
of the calculations underlying the capital assessments and the implications of the
models used. (This is necessary for the certification required by the regulators.) So,
these people will need to invest more time in this area. [1]
The PRA may require increased disclosure of these decision rules so that it can assess
the extent to which actual management action is consistent with that assumed in the
model. []

closing to with-profits business or limiting new business volumes to such an extent that
with-profits liabilities fall back below 500m. The company could then apply to the
PRA for a waiver to go back to being a regulatory-basis-only life firm [1]
Solution X2.3
In part (ii), the three references to FSA have changed to PRA.
Solution X3.1
The Principles and Practices of Financial Management of with-profits business are a

specific requirement of the FCA that expands on what it means to treat customers fairly
and describe how the company will exercise its discretion in various areas. []
Regulation requires firms to treat their customers fairly and makes clear that the
responsibility for satisfying the TCF requirements rests with the Board and senior
management of the company. []
The FCA has published six consumer outcomes which explain what it wants TCF to
achieve for consumers. []
The PRA rules relating to the calculation of mathematical reserves requires a firm to use
methods and assumptions that take into account its regulatory duty to treat customers
fairly. []
In part (ii), the following points have been amended:
When projecting possible benefits, the company must use FCA growth rates and its own
charges. []
This new asset mix is likely to produce returns at around the lowest FCA growth rate
(or even lower), so the company might consider highlighting this on its illustration
documents []
Solution X3.2
In part (i), the reference to the FSA has been deleted from the following point:
These distribution risks may be exacerbated as the retail distribution review

regulations come into force, making the actions of distributors more difficult to
predict. []

In part (i), the following point has been deleted:
These pricing risks are also potentially made worse by the timing of the
proposed introduction of the new products. The implications of the ECJ ruling
prohibiting the use of gender as a rating factor in terms of how market
participants and prospective policyholders react are sources of uncertainty. [1]
In part (ii), the following point has been amended:
commission (for the term assurance)
Solution X4.1
In part (v), the following point has been amended:
In particular, the EEV disclosure requirements to publish the sensitivities of the result to
variations in the assumptions and to provide an analysis of change in the EEV each
year, should enable analysts to make better assessments of the value of the company
than assessments based solely on other information such as primary accounts or
supervisory Returns. [1]
Solution X4.2
Working capital is defined (for the purpose of supervisory returns) as the market value
of assets in the with-profits fund, less the realistic value of the liabilities before allowing
for any Risk Capital Margin. [1]
As this company has a with-profits fund, performing an analysis of the movement in the
working capital of that fund is a regulatory requirement, since the company is a
realistic-basis life firm (as its large and the majority of its business is with-profits). As
part of their reporting to the PRA, realistic-basis life firms must provide the analysis in
addition to the realistic balance sheet (RBS) required as part of their Pillar 1 solvency
calculations. [1]

Solution X5.1
In part (ii), the following point has been amended:
FCA rules relating to treating with-profits policyholders fairly require all companies
writing with-profits business to specify a target range around unsmoothed asset share
within which payouts must lie. []

5 Other tuition services

In addition to this CMP Upgrade you might find the following services helpful with
your study.
5.1 Study material
We offer the following study material in Subject SA2:

Mock Exam
Additional Mock Pack
ASET (ActEd Solutions with Exam Technique) and Mini-ASET
MyTest (coming soon).
For further details on ActEds study materials, please refer to the 2014 Student
Brochure, which is available from the ActEd website at www.ActEd.co.uk.
5.2 Tutorials
We offer the following tutorials in Subject SA2:

a set of Regular Tutorials (lasting three full days)
a Block Tutorial (lasting three full days)
a Revision Day (lasting one full day).
For further details on ActEds tutorials, please refer to our latest Tuition Bulletin, which
is available from the ActEd website at www.ActEd.co.uk.
5.3 Marking
You can have your attempts at any of our assignments or mock exams marked by
ActEd. When marking your scripts, we aim to provide specific advice to improve your
chances of success in the exam and to return your scripts as quickly as possible.
For further details on ActEds marking services, please refer to the 2014 Student
Brochure, which is available from the ActEd website at www.ActEd.co.uk.

6 Feedback on the study material

ActEd is always pleased to get feedback from students about any aspect of our study
programmes. Please let us know if you have any specific comments (eg about certain
sections of the notes or particular questions) or general suggestions about how we can
improve the study material. We will incorporate as many of your suggestions as we can
when we update the course material each year.
If you have any comments on this course please send them by email to SA2@bpp.com
or by fax to 01235 550085.

All study material produced by ActEd is copyright and is sold
for the exclusive use of the purchaser. The copyright is owned
by Institute and Faculty Education Limited, a subsidiary of
the Institute and Faculty of Actuaries.
Unless prior authority is granted by ActEd, you may not hire

out, lend, give out, sell, store or transmit electronically or
photocopy any part of the study material.
You must take care of your study material to ensure that it is

not used or copied by anybody else.
Legal action will be taken if these terms are infringed. In

addition, we may seek to take disciplinary action through the
profession or through your employer.
These conditions remain in force after you have finished using

the course.

SA2-02: UK-specific products (2) Page 53
13 Microinsurance
13.1 Overview
Microinsurance is insurance that is targeted towards those who are working, but
with low incomes.
The International Labour Organization (an agency of the United Nations) defines
microinsurance as a mechanism to protect poor people against risk (accident,
illness, death in family, natural disasters, etc.) in exchange for insurance
premium payments tailored to their needs, income and level of risk.
It is characterised by limited benefits and very low premiums, for reasons of

affordability. It is not a product type in itself; it is the fact that it is aimed at those
on low incomes that makes it microinsurance.
Insurance premiums can be for as little as $1 per month.
In terms of relevance to Subject SA2, both life (eg funeral expense) and health
insurance products can be sold as microinsurance.
Often microinsurance is sold alongside microfinance. So someone can borrow a small

sum to help set up a business and can insure the repayments against death or sickness.
Banks may only be willing to give such loans if insurance is in place.
It is generally based on a pooling or a community rating approach, and in some

countries can be compulsory.
By its nature, microinsurance is particularly important for the developing world

and is currently well developed in India and some parts of Africa.
For example, there are microinsurance schemes operating in Senegal, Uganda, Zambia,
Bangladesh and Vietnam.
Although microinsurance is not sold in the UK as such, the concept is of interest

to UK life insurance companies, particularly those with existing overseas
operations.
13.2 Insurers perspective

Microinsurance can provide an insurance company with the opportunity to break
into new markets and hence generate more profits.

Page 54 SA2-02: UK-specific products (2)
The potential market for microinsurance is huge. Four billion people live on less than
$8 a day. However, less than 5% of these people are currently insured.
There is also a wider social benefit in providing access to insurance cover for
such socio-economic groups. This more inclusive approach might form part of
an insurance companys ethical strategy.
There may be grants available from development funds and governments to

support microinsurance initiatives, in order to generate an insurance culture
within the lower income sector.
Such institutions provide these grants in the belief that microinsurance can help to
reduce poverty by helping people to avoid debt and providing them with more stable,
predictable costs that enable them to invest for the future.
The main issues for the insurance company will relate to pricing and profitability.
Risks can be very specific to the local target market, and pricing needs to reflect
this. However, with microinsurance being a relatively new market, there is
generally only limited suitable existing data available. It can be difficult to set
the premium and benefit levels accurately, and the design needs to be kept
simple.
Given the low premium / benefit nature of microinsurance, margins per policy are
generally also low and so insurance companies need to aim for high sales
volumes. Achieving this may not be straightforward: in some countries, there
may be limited or no trust in insurance companies.
It may take several years before a company builds sufficient scale to be profitable.
Distribution of products and collection of premiums can be more difficult and

expensive than for traditional insurance. Therefore having a low-cost operating
model is also vital in order to achieve adequate profitability levels.
Microinsurers need to adopt very efficient methods of selling policies and collecting
premiums. One approach has been to use mobile phone companies to sell insurance and
to collect premiums when pay-as-you-go phones are topped up. This can be an efficient
method of distribution as the number of people with a mobile phone is often more than
ten times greater than the number of people with insurance.

SA2-02: UK-specific products (2) Page 55
Other challenges in designing, pricing and monitoring microinsurance include:
Difficulty in recording member and claims information, and hence in

performing experience monitoring.
Normal insurance definitions may not be applicable, eg the definition of

a household, and so new definitions and designs need to evolve to suit
the circumstances of the microinsurance client.
Coping with potentially huge volumes of small policies.
13.3 Policyholders perspective

Microinsurance enables individuals who would not otherwise be able to afford it
to purchase some degree of financial protection. It helps to avoid the need for
those individuals to rely on money-lenders, who may be expensive and
unscrupulous.
Traditional insurers may find it unprofitable to offer policies with the very small
premiums and benefits typically needed by people on very low incomes. If left
uninsured, these people may instead be forced to borrow, often at very high rates of
interest, if a family member dies or falls ill. So, microinsurance can be a much better
way for these people to manage their risks.
Those on low incomes are more vulnerable to adverse events, having fewer
savings to support themselves in times of need. Some provision of health cover
can be especially reassuring to families, particularly in countries where the State
welfare support system is limited.
The main issue that may arise for the policyholder is the ability to continue to
pay premiums, since income may be low and irregular. This is especially the
case for those working in the informal economy. Policyholders also may not
have access to bank accounts and, even if they do, may not always bank their
income. They typically have short term planning horizons and manage their
risks through a number of informal means, including social networks.
Policyholders often have limited familiarity with formal insurance. There is,
therefore, potential for not understanding the nature of the contract sufficiently,
and expecting more than is actually provided by the limited benefits. Financial
literacy is often low in microinsurance target populations, and insurance
companies in some instances collaborate with regulatory and other
organisations to deliver financial education. This can be particularly difficult in
areas with low basic literacy rates, so in some cases pictures and acting is used
to explain how insurance works.

Page 56 SA2-02: UK-specific products (2)
Aside from not always understanding how insurance works, policyholders may
also not understand how it compares to other personal risk management tools,
such as savings. They may believe that insurance is only for the rich and often
dont trust insurance companies, being highly suspicious of their motives.

SA2-03: UK general business environment Page 15
NEST may also be used by employers to complement a traditional group pension

scheme and could work with life insurance companies rather than competing
directly. However, the nature of the relationship between NEST and the life
insurance industry is something which is likely to change and develop over time.
Access and information on all of the options available has improved, in part due
to the internet, but also as non insurance companies effectively target customers
and distributors. The large amount of money invested in insurance companies
funds, especially in with-profits funds, is viewed as a substantial prize for fund
managers, as well as the targeting of genuine new investment money into the
market.
The tax treatment of life investment products has been a source of advantage for
insurance companies in the past, but as this is eroded they will need to continue
to defend their products from competing types of provider.
1.8 Industry bodies
Industry bodies issue guidance for members from time to time.
For example, the ABI (Association of British Insurers) produces a wide range of
codes of practice, statements of best practice and guidance notes, ranging in
classification from voluntary to compulsory for ABI members. These often cover
aspects such as product design and distribution.
The ABI has over 300 member companies which accounts for 90% of insurance
premiums written in the UK.
One example is the Code of Conduct on Retirement Choices (implemented in

2013), which sets out rules that ABI members must follow when communicating
directly with a new or existing customer purchasing an immediate annuity. The
intention is to ensure that customers have access to sufficient information to
enable them to make an informed decision about annuities appropriate to their
needs and lifestyle in retirement, eg impaired life annuities, and to increase
awareness of the opportunity to shop around between providers. This clearly
has implications for competition and also potentially the design and pricing of
immediate annuity products.
Pensions savings vehicles include an open market option that permits policyholders to
shop around and buy an annuity from any provider (rather than being forced to stay
with the same insurer as their pension savings vehicle).

Page 15A SA2-03: UK general business environment
In 2011, only 45.5% of new annuities were purchased through a different provider than
the consumers existing pension provider. Research suggested that the difference
between the cheapest and most expensive annuity quotes can be up to 20%.
The ABI Code of Conduct aims to give better information to policyholders concerning
their retirement income and will encourage policyholders to shop around. For example,
insurers will no longer include their own application forms with the information they
send in an attempt to stop policyholders sticking with their current insurer by default.

SA2-03: UK general business environment Page 16
2 Distribution of products
2.1 Propensity of consumers to purchase products
In the UK, it has always been said that life insurance products are sold, not
bought. Although people know they should take out life insurance policies to
provide lump sums or an income for the benefit of their dependants, or should
save regularly to provide a pension when they retire, many have been reluctant
to do this.
Question 3.6
Suggest possible reasons for this.
People would often rather spend their money as they earn it on more tangible
benefits cars, holidays, houses, eating out, entertainment than provide for a
future that they know will happen but which they cannot bring themselves to
think about.
A consumers inclination to save is increased if there is an incentive.
This could be tax-related with tax relief on premiums or contributions, or

tax-free benefits.
This could be to protect an inheritance.
It could be loan-related, with the consumer being more willing to effect a

life policy that will repay an outstanding loan on death, if effecting the
policy makes it more likely that the lender will provide the loan.
It could be employer-related, if contributing to a company pension

scheme means that the employer will also contribute.
With the introduction of auto-enrolment, many employees are likely to opt (by
default) into buying a pension through an employer sponsored scheme.
Better education on the need to save, or on the consequences of not saving, might also
improve the inclination to save.
Employers are starting to take a more active role in encouraging saving from
their employees. Certain group pension schemes will now offer employees the
opportunity to purchase add-ons such as SIPPs and share dealing facilities,
and this trend is likely to increase over time.





the course.

SA2-06: Life insurance company taxation (1) Page 1
Chapter 6
Life insurance company taxation (1)
Syllabus objective
investigations:
1. The taxation of the UK business of life insurance companies and the

effect of taxation on the benefits and premiums paid under UK life
insurance contracts.
(Taxation of mutual life insurance companies is covered in this chapter.)
0 Introduction
In this chapter we concentrate mainly on the calculation of corporation tax for mutual
life insurance companies. Most of the framework for mutuals also applies to
proprietary companies. The next chapter will describe the two main differences for a
proprietary.

Page 2 SA2-06: Life insurance company taxation (1)
1 Taxation funds
1.1 Introduction
Since 1 January 2013, for tax purposes a UK life insurance company has to treat
the following as separate businesses:
Basic Life Assurance and General Annuity Business (BLAGAB)
Other Long-Term Business (OLTB).
Prior to 2013 there were separate tax funds for BLAGAB, Gross Roll-up Business
(GRB) and PHI Business. You dont need to know the old tax rules for the exam, but
you may see references to these old tax funds in past exam questions and your wider
reading around the course.
BLAGAB covers life assurance and annuity contracts, excluding the following:
pensions business, ISAs, child trust funds, life reinsurance business, overseas
life assurance business and PHI business. In other words, BLAGAB comprises
the contracts described in Chapter 5 as life assurance and general annuity
contracts.
However, BLAGAB does not include life assurance protection business written
on or after 1 January 2013.
This change in the taxation of protection business does not apply to existing business to
maintain consistency with the way that this business had been priced. This is
particularly important for XSI insurers (well explain what this means later in this
chapter) who may have priced this business assuming net expenses and so would have
otherwise made a loss following the tax change.
For this purpose, protection business is broadly defined as any long-term

insurance contract under which the benefits payable cannot exceed the amount
of premiums paid, except on death or in respect of incapacity due to injury,
sickness or other infirmity.
There had been concerns that the pre-January 2013 taxation of protection business in
the BLAGAB fund created a barrier to entry. A new insurer selling protection business
would have needed to price using gross expenses and so would be at a disadvantage to
some other insurers that could have priced using net expenses. As we will see later in
this chapter, from 1 January 2013 all insurance companies are taxed in the same way for
protection business (on their trading profits).

The OLTB category incorporates all other business, and so it covers:
pensions business
ISAs
child trust funds
reinsurance of life assurance
business sourced from overseas
PHI business and life assurance protection business written on or after

1 January 2013.
Individual Savings Accounts (ISAs) are tax-exempt savings schemes where

policyholders may contribute money into one or more of two components, subject to
certain annual limits. The components are cash and stocks and shares. The latter
may include life insurance products (eg with-profits savings vehicles) and it is these that
come within the ISA tax fund mentioned above. Knowledge of this business is not
needed for Subject SA2.
Child Trust Funds (CTFs) are tax-exempt savings accounts set up by the government
for all children living in the UK born between 1 September 2002 and 2 January 2011.
Although children born after 2 January 2011 do not qualify for a CTF, it is still possible
to contribute to accounts already open. Knowledge of this business is not needed for
Subject SA2.
It should be noted that life insurance companies which have only ever written
protection business may elect to have all of their business classified as OLTB.
So instead of having their protection business taxed as BLAGAB for old policies and
OLTB for new policies, the company can simplify the process so that all business is
taxed as OLTB. The impact for these companies of having old business taxed on OLTB
trading profits is likely to be negligible as they would probably have been taxed on
profits under the BLAGAB system too.
1.2 Apportionment between funds
There will not usually be separate sets of assets for the different types of business
described above (especially where non-linked business is concerned).
The company has to allocate its trading profit and all component parts of its
revenue account between the different categories of its business.

Rules on the apportionment of investment return have been subject to much

revision over past years. From 1 January 2013 the allocation of trading profits
and investment returns between the two categories must be determined on a
commercial rather than a prescribed basis.
So, for example, if the company matches its annuities with bonds, then HM Revenue
and Customs (HMRC) would expect the investment return from the bonds to be
allocated to the annuities for taxation purposes too. This is in contrast to the previous
system where complex rules set by HMRC were used to determine the allocation.
More detailed knowledge of the apportionment approach is not needed for this
Subject.
As the Core Reading says, for examination purposes you can assume that somehow each
item of the revenue account (eg investment return) is allocated to each of the tax funds.

Chapter 6 Summary
Tax funds
From 1 January 2013, for tax purposes a UK life assurance company has to treat the
following as separate businesses:
Basic Life Assurance and General Annuity Business (BLAGAB)
Other Long-Term Business (OLTB).
OLTB includes business from the following sources:

pensions business
ISAs
Child Trust Funds
reinsurance of life insurance
business sourced from overseas
PHI business and life assurance protection business written from 1 January
2013.
BLAGAB
BLAGAB is taxed at the lower rate of income tax on IE (currently 20%).
BLAGAB I is:
Investment income from real estate, gilts, bonds and deposits
Chargeable gains on real estate and equities, allowing for the effects of
indexation
with special rules for authorised unit trusts, UCITS or OEICs
Capital movements in gilts, bonds and derivatives
Miscellaneous income (eg reinsurance income).

BLAGAB dividend income (both UK and overseas) is received with no further liability
to tax.
BLAGAB E is:
non-acquisition BLAGAB expenses
1/7 of acquisition BLAGAB expenses
postponed acquisition expenses from previous years
unrelieved expenses brought forward (if any)
income component of general annuities.
If I > E , corporation tax at the lower rate of income tax is paid on the excess.
If E > I , the excess expenses are carried forward unrelieved to the following years
calculation.
OLTB
OLTB is taxed on trading profits. The basic formula used to assess profit can be
expressed as follows:
P + I '+ A '- E - C - (V1 - V0 ) + ( D1 - D0 ) - L
where
P = premiums
I' = investment and other income brought into account
A' = change in value of the assets brought into account
E = expenses
C = claims
V1 = reserve at end of year
V0 = reserve at start of year
D1 = DAC at end of year
D0 = DAC at start of year
L = absolute value of any loss brought forward
There are circumstances where a OLTB trading loss may arise. If this happens, the loss
is carried forward to future calculations in this fund.

SA2-09: UK regulatory environment (1) Page 1
Chapter 9
UK regulatory environment (1)
Syllabus objective
investigations:
2. The supervision of the UK business of life insurance companies under the

relevant regulatory handbooks with regard to:
the supervisory reports to be submitted
4. The transfer of liabilities from one life insurance company to another.
12. The roles of the Actuarial Function Holder, the With-Profits Actuary, the
Reviewing Actuary and the Appropriate Actuary.
0 Introduction
The material in this chapter covers the Prudential Regulation Authority (PRA), the
Financial Conduct Authority (FCA) and the regulatory Handbooks. It includes a
summary of the content of the forms used in the UK supervisory returns, which UK life
insurance companies have to submit at least annually to the PRA. Most of the Core
Reading material here is very knowledge-based and there is therefore little additional
ActEd material in most sections of this chapter.

Page 2 SA2-09: UK regulatory environment (1)
1 Financial Services and Markets Act 2000

From 1 December 2001, UK insurers have been subject to regulatory
requirements under the Financial Services and Markets Act 2000 (FSMA). At that
time, the Financial Services Authority (FSA) assumed its full powers and
responsibilities as the single regulator for all financial services companies. The
FSMA is mainly enabling legislation with rules made by the regulator(s) covering
much of the detail.
The Financial Services Act 2012 has made substantial changes to FSMA which
largely came into effect on 1 April 2013. In particular, the FSA was replaced by
two new regulatory bodies:
The Prudential Regulation Authority (the PRA) is a subsidiary of the Bank

of England and is responsible for the prudential regulation of all deposit-
taking institutions, insurance providers and large investment firms.
The Financial Conduct Authority (the FCA) is responsible for regulation of

conduct in financial markets (and the infrastructure that supports those
markets) and the prudential regulation of financial services companies
that do not fall under the scope of the PRA (eg insurance brokers and
smaller investment firms).
Accordingly, insurance companies are now dual regulated in the UK: the PRA is
responsible for their prudential regulation, while the FCA is responsible for their
conduct regulation.
Therefore, the PRA is the regulatory body concerned with solvency and capital
requirements and the FCA is the regulatory body concerned with ensuring customers
are treated fairly amongst other things.
The regulatory environment described in this chapter and the next is that current
as at the time of writing (April 2013). All actuaries and students should of course
keep up-to-date with regulatory changes, although for the purposes of the
Subject SA2 examination answers based either on what is described here or on
more up-to-date regulation will in principle be acceptable.
Part VII of FSMA has content relevant to Subject SA2. It covers the transfer of
long-term insurance business between insurance companies see Section 4 for
further detail.

2 Regulation
2.1 Objectives
The PRA has the following objectives in respect of insurance company

supervision:
promoting the safety and soundness of the companies that it supervises
contributing to securing an appropriate degree of protection for those
who are or may become policyholders.
A key feature of the PRAs approach is risk-based supervision. The PRA

assesses the risk that a particular firm, activity or issue poses to the PRAs
objectives and concentrates its supervisory effort on high-risk areas. It is not
the PRAs role to ensure that no insurance company fails.
So the firms that represent the greatest risk (perhaps because of their large size or lack
of capital) will be subject to the greatest scrutiny by the PRA.
The FCAs key objective is to ensure that the relevant markets function well,
under-pinned by:
securing an appropriate degree of protection for consumers
promoting effective competition in the interests of consumers
protecting and enhancing the integrity of the UK financial system.
The FCA intends to take early action to prevent problems occurring for consumers,
rather than taking action against firms after the event. So the FCA will be concerned
with the product lifecycle right from the start at the design stage and can even ban
products where necessary.
Prior to this separation of regulatory responsibilities, the FSA used the ARROW
framework (Advanced Risk Responsive Operating Framework) to operate its
integrated approach to risk management, including regular assessment visits.
Under the new regime two separate risk mitigation programmes operate, with
each of the PRA and FCA performing supervisory reviews of insurance
companies.
2.2 Regulatory Handbooks
The two regulatory Handbooks contain all the rules and guidance issued by
either the PRA or FCA respectively.

The regulatory Handbooks are available on the internet at

http://fshandbook.info/FS/index.jsp.
In line with the previous single FSA Handbook, each is divided into Blocks and
each Block is subdivided into modules. A module may be either a sourcebook
(containing mandatory regulatory obligations) or a manual (containing
provisions relevant to the relationship with the regulator, such as enforcement
and fees).
The Blocks and modules which are most relevant to Subject SA2 are as follows:
Block 1: High Level Standards
Block 1 deals with the overarching requirements for all authorised companies
and approved persons .
Block 2: Prudential Standards
Block 2 contains the detailed prudential rules that apply to regulated insurance
companies (largely in the PRA Handbook).
IPRU-INS (Interim Prudential Sourcebook for Insurers) has been largely repealed
but retains the reporting requirements for insurance companies.
There is also a sourcebook specifically covering friendly societies: IPRU-FSOC

(Interim Prudential Sourcebook for Friendly societies).
GENPRU (General Prudential Sourcebook) and INSPRU (Prudential Sourcebook

for Insurers) cover the remainder of the detailed prudential rules that apply to life
Block 3: Business Standards
Block 3 sets out the requirements that will affect companies in their day to day
business, particularly market conduct (largely in the FCA Handbook).
COBS (Conduct of Business Sourcebook) contains the conduct of business

rules that apply to insurance companies, including the specific rules for the
conduct of with-profits business.
ICOBS (Insurance: Conduct of Business) covers the regulation of sales of pure

protection life insurance products and general insurance products; its primary
concern is the latter.

Block 4: Regulatory Processes
Block 4 describes the operation of the regulators supervisory and disciplinary

functions .
Block 5: Redress
Block 5 covers the rules for dealing with complaints from, and paying
compensation to, customers.
Parts of the Handbook that are of particular relevance to life insurance

companies are covered in the following section.

3 Prudential Supervision
3.1 Prudential Sourcebooks
GENPRU and INSPRU cover aspects such as capital adequacy, mathematical

reserves, capital resource requirements, the With-Profits Insurance Capital
Component and the Individual Capital Assessment (see Chapters 11, 12 and 13)
and the management of various risks (see Chapter 27).
3.2 Interim Prudential Sourcebook for Insurers (IPRU-INS)
The main sections of IPRU-INS that have not been replaced by INSPRU relate to
financial reporting.
IPRU-INS comprises two volumes with any contents remaining:

Volume 1 Rules
Volume 2 Appendices to the Rules.
Volume 1 contains the accounts and statements rules that require insurance
companies to produce annual accounts and returns to the PRA in a prescribed
format and to produce an annual actuarial valuation of the long-term business.
The reporting of group capital adequacy is also covered.
In addition, the rules relating to the periodic actuarial investigations and to

changes in the proportion of profits distributed to policyholders are included in
Volume 1.
Volume 2 sets out the detailed format of the annual returns to the PRA. The
forms that have to be submitted are covered under a series of Appendices and
those applying to long-term business are as detailed in the tables below.
Appendices 9.2 and 9.5, which arent mentioned below, relate to general insurance
business and so are not relevant for this subject. Realistic-basis life firms (which are
defined in Chapter 11) actually have to produce Forms 2, 18 and 19 twice each year.
Students who are studying Subject SA2 are required to have a good knowledge
of the content of these forms and should study them by accessing the PRA
website.
The forms are available from the PRA website at

http://www.bankofengland.co.uk/pra/Pages/regulatorydata/formsinsurance.aspx. You
may also find it useful to take a look through the supervisory Returns from your own
company (if you work in a UK life insurance company) and ideally those of one or two
other companies.

Appendix 9.1: Balance sheet and profit and loss account
Form Contents
2 Statement of solvency long-term insurance business
3 Components of capital resources
10 Statement of net assets
13 Analysis of admissible assets
14 Long-term business liabilities and margins
16 Profit and loss account (non-technical account)
17 Analysis of derivative contracts
18 With-profits insurance capital component for the fund
19 Realistic balance sheet
Out of all the Forms, Form 2 is probably the most looked at as it contains information
on the solvency of a company.
Appendix 9.3: Long-term insurance business revenue accounts and

additional information
Form Contents
40 Revenue account
41 Analysis of premiums
42 Analysis of claims
43 Analysis of expenses
44 Linked funds balance sheet
45 Revenue account for internal linked funds
46 Summary of new business
47 Analysis of new business
48 Non-linked assets
49 Fixed and variable interest assets
50 Summary of mathematical reserves
51 Valuation summary of non-linked contracts (other than
accumulating with-profits contracts)
52 Valuation summary of accumulating with-profits contracts
53 Valuation summary of property-linked contracts
54 Valuation summary of index-linked contracts
55 Unit prices for internal linked funds

Form Contents
56 Index-linked business
57 Analysis of valuation interest rate
58 Distribution of surplus
59A With-profits payouts on maturity (normal retirement)
59B With-profits payouts on surrender
60 Long-term insurance capital requirement
Form 40 Fund value
Form 40 shows the income and outgo in respect of long-term insurance business. It
includes all actual items of income and outgo together with the increase or decrease in
the value of the assets backing unit-linked and index-linked contracts. Changes in the
value of the assets backing non-linked contracts are included only to the extent that the
company wishes to recognise them for the purpose of determining surplus.
It may be helpful to discuss briefly this recognition of capital gains under non-linked
contracts. This is of most relevance to with-profits business.
There are two different values of assets that appear in the supervisory Returns. There is
the market value of admissible assets, which is the basis for the figures that appear in
Form 2. There is also the fund value, which is a form of written-up book value. This
is used to control the amount of surplus recognised in the accounts and distributed each
year to fit in with the needs of a smoothed bonus system.
We shall illustrate the process by a simple numerical example. Imagine that at the start
of a year we have, in a mutual with-profits fund:
Value of liabilities = 200

Market value of assets = 250
Fund value = 200
The fund value has been kept just large enough to cover the liabilities, with 50 of capital
gains to date not yet recognised.
Over the course of the next year, the fund value and market value will be affected by the
normal revenue account items: premiums, expenses, investment income, claims and tax.
The market value will also be changed by any changes in capital values. Liabilities will
also change for various reasons, such as in-force business being closer to maturity, new
business coming on the books etc.

Let us imagine that the result of all this at the end of the year is as follows, before we
choose to recognise any further capital gains or losses in our fund value and before
declaration of with-profits bonuses.

Fund value = 205
Let us also assume that we want to declare bonuses with a value of 10 at the end of the
year. This has been determined by internal investigations that suggest that this is a
reasonable amount to declare this year given our long-term expectations for investment
returns etc.
To do this we can write the fund value up to 220 (say) by taking in previously
unrecognised capital gains. This creates a surplus of 10 (220 210), which we can
then distribute as bonus.
We end up with the final valuation position of:

Fund value = 220
This is, in a sense, all rather artificial. We decide on the basis of internal investigations
and a long-term view what smoothed bonus we are going to give, and then manipulate
the fund value to produce the right amount of surplus for us to distribute as bonus!
However, it does allow us, within the accounting framework, to marry a volatile value
of assets with a smoothed recognition of profit, in an explicit way. In good
investment years we set aside some capital gain that we do not immediately need to
declare our smoothed bonuses. In bad years we can call on this to declare our
bonuses even though, perhaps, we have made a loss on the market value of assets. You
may hear this process referred to as making transfers to and from the investment
reserve. Naturally enough, the fund value is not allowed to exceed the market value of
admissible assets.
For those of you wishing to tie this up with the supervisory Returns, the investment
reserve may be found on Form 14 at Line 51, under the heading Excess of the value of
net admissible assets.

In a proprietary with-profits fund, the situation would be slightly different. Assume

that again a total surplus distribution of 10 is thought to be appropriate, and that 9 will
go to policyholders and 1 to shareholders. The fund value would be written up in the
same way, but policyholder liabilities would be increased by 9 to 219. A transfer of 1
would be made from the assets to shareholders, reducing the market value to 244 and
the fund value to 219.
Appendix 9.4: Abstract of valuation report
The key requirement, in a prescribed format, is a description of the Pillar 1

Peak 1 actuarial valuation of the long-term liabilities of the company.
Chapter 11 defines the Pillars and Peaks. A Pillar 1 Peak 1 valuation is a regulatory
valuation that is performed by all life insurance companies. The description in the
valuation report must include the method and bases used in the valuation including a
description of the determination of the risk-adjusted yield and the method and
assumptions used in the valuation of options and guarantees.
Appendix 9.4A: Abstract of valuation report for realistic valuation
The main requirement, in a prescribed format, is a description of the realistic

actuarial valuation of the long-term with-profits liabilities of the company
required under Pillar 1 Peak 2.
A Pillar 1 Peak 2 valuation is a realistic valuation performed only by companies with a

relatively large amount of with-profits business (again, the details are in Chapter 11).
The description must include the method and bases used in the valuation. In the case of
the realistic valuation, this includes the investment return and expenses in respect of the
latest year in any asset share type calculations and assumptions used in the calculation
of the cost of options, guarantees and smoothing. A description of the nature of the
management actions assumed in the projection of assets and liabilities is also required.

Appendix 9.6: Certificate by directors and report of the auditors
A Directors Certificate and an Auditors Report are required. The Directors

Certificate must state, for example:
the insurer is able to meet its obligations and establish adequate mathematical
reserves in respect of new business written in the year
the mathematical reserves constitute proper provision for the liabilities
any with-profits funds have been managed in accordance with the Principles and
Practices of Financial Management (PPFM) (see Chapter 10 for more on
PPFMs)
the directors have paid due regard to the advice of the Actuarial Function Holder
and the With-Profits Actuary (see Section 3.4 for more on these roles).
If any of these statements cannot be truthfully made, this must be stated and the reason
given.
Appendix 9.7: Insurance statistics: Other EEA states
Forms 93 and 94 cover summaries of life business written in an EEA state other
than the UK.
3.3 Authorisation
Companies need to obtain permission from the relevant regulator in order to

carry out a regulated activity. Information on the requirements and process to
be followed for obtaining such permission (and a facility to generate an
authorisation application pack) can be found on the PRA/FCA websites. A
similar process has to be followed for the authorisation of individuals who carry
out specified roles, called controlled functions (see Section 3.5).

Long-term insurance business is a regulated activity. Under FSMA 2000

(Regulated Activities) Order 2001 Schedule 1 Part II, contracts of long-term
insurance are divided into the following main classes:
I. Life and annuity
II. Marriage and birth
III. Linked long-term
IV. Permanent health
V. Tontines
VI. Capital redemption
VII. Pension fund management
VIII. Collective insurance
IX. Social insurance.
Classes I and III are the most important ones for this Subject.
Insurers that write long-term insurance business may include general business
Classes 1 (Accident) and 2 (Sickness) as supplementary benefits to their main
long-term business classes. A company may not undertake insurance of a
particular class unless it is specifically authorised to do so. If it is authorised in
the UK, it may transact the same class in any other EU state and would be
subject to UK supervision. Similarly, a company authorised in another EU state
may transact business in the UK subject to supervision in its own home state.
3.4 Supervision Manual (SUP)
The Supervision Manual (part of Block 4) sets out the processes used to
supervise regulated firms. It incorporates the concept of risk-based supervision
(see also Section 2.1 above).
The Manual covers the tools that the regulators use to carry out their
supervision. These include information collected by the regulators, and reliance
on information provided by actuaries, auditors and other skilled people.
The regulators can collect information in a variety of ways, including meetings with
management and other representatives of a firm, on-site inspections and periodic
returns. The term skilled person is specifically defined by regulation.
The Manual also contains the detailed provisions of the approved persons
regime by which individuals who hold specified positions in regulated firms are
vetted to ensure they satisfy appropriate fit and proper criteria.

Both the Actuarial Function Holder and the With-Profits Actuary are approved persons
who must satisfy these fit and proper criteria. The Fit and Proper Test for Approved
Persons is one of the Block 1, High-level Standards in Section 2.2. It has three
components:
1. honesty, integrity and reputation
2. competence and capability
3. financial soundness.
3.5 Statutory actuarial roles
There is a statutory requirement for a life insurance company transacting long-

term business to have an Actuarial Function Holder, and for a company
transacting with-profits business to have also a With-Profits Actuary. In
addition, the auditors must use the services of a Reviewing Actuary (see below).
The roles and responsibilities of the Actuarial Function Holder and With-Profits
Actuary are set out in SUP 4. Both roles are controlled functions and the
holders are not allowed to fulfil other roles within a firm that would cause a
conflict of interest. The With-Profits Actuary cannot be a member of the Board of
Directors. However, subject to this condition, the Actuarial Function Holder and
With-Profits Actuary can be the same person.
There may be changes to statutory actuarial roles following the introduction of

Solvency II, but the details are not yet settled at the time of writing (April 2013).

Actuarial Function Holder
The main responsibilities of the Actuarial Function Holder are as follows.
To advise management on the risks being run by the firm that may affect
the long-term liabilities relating to policyholders, and on the capital
required to support the business on an ongoing basis.
To monitor these risks and inform the management of any concerns that
the firm may fail to meet its liabilities, including with regard to the terms
on which new business is written.
To advise the firms governing body on the methods and assumptions for
actuarial investigations, to perform the investigations and to report the
results to the firms governing body. The actuarial investigations include
those relating to solvency.
Having advised the firms governing body on methods and assumptions for the
actuarial investigations, the Actuarial Function Holder then performs the
investigations in accordance with methods and assumptions determined by the
governing body.
The Actuarial Function Holder also has a responsibility to monitor the adequacy of the
premium rates on which new business is being written and inform the management of
any material concerns.
This list is not intended to be exhaustive. Other examples of areas where a firm might
obtain advice from the Actuarial Function Holder include investment strategy and asset-
liability matching, individual capital assessment, pricing and assessing reinsurance and
other approaches a company might take to reduce risks.

With-Profits Actuary
The main responsibilities of the With-Profits Actuary are as follows.
To advise management on key aspects of the discretion exercised

affecting with-profits business and to produce a report to the firms
governing body covering this advice at least once each year.
To advise management whether the assumptions used to calculate the

With-Profits Insurance Capital Component (WPICC) are consistent with
the Principles and Practices of Financial Management (PPFM).
Companies with less than 500m of with-profits liabilities dont have to

calculate a WPICC and so this requirement wont apply to all With-Profits
Actuaries. The WPICC calculation is described in Chapter 11.
To produce a publicly available annual report for policyholders. This

report must confirm whether or not, in the opinion of the With-Profits
Actuary, the firm has properly taken policyholders interests into account
in exercising its discretion and whether it has treated its customers fairly.
Advising or reporting on the exercise of discretion should normally include:

bonus rates
investment policy
surrender value methodology (including MVRs)
new business plans and premium rates
allocation of expenses to with-profits business
investment fees to be charged to with-profits business
changes to the PPFM
communication with policyholders and potential policyholders on the above
issues.

Appropriate Actuary
A friendly society has to appoint an Appropriate Actuary in terms of the

requirements of SUP. The main responsibilities of the Appropriate Actuary are:
to carry out actuarial investigations in accordance with the rules in

IPRU-FSOC and applicable professional guidance
to report on those investigations
to prepare an abstract of the report for publication
to provide the certificate or statement required.
Reviewing Actuary
The directors of a life insurance company are responsible for certifying the
adequacy of the policy liabilities. In doing this they also have to certify that they
have received, and paid due regard to, actuarial advice provided by the Actuarial
Function Holder.
As part of their audit of the balance sheet, including the policy liabilities, the
auditors must obtain a report from the Reviewing Actuary who must be
independent of the company and the Actuarial Function Holder. This report does
not have to be made public so there is no public actuarial certification of the
policy liabilities under the new regime. The scope of what is covered in the
report has to be agreed with the auditor.
General points relating to statutory actuarial roles
In respect of the roles of Actuarial Function Holder and With-Profits Actuary a

firm is required:
To keep the actuary informed of its business plans and seek advice from
the actuary of the implications of these plans for policyholders.
To pay due regard to the advice of the actuary.
To provide the actuary with adequate resources and provide such data
and systems as may reasonably be required.

3.6 Professional guidance
APS L1: Duties and Responsibilities of Life Assurance Actuaries
This is a mandatory standard, applying to all members of the Institute and

Faculty of Actuaries who are appointed to any of the roles covered in the
previous section.
The key principles include:
Conditions for appointment in each role.
The need to ensure that sufficient information and resources are available
to enable the necessary investigations to be carried out.
The relationship between the Actuarial Function Holder and With-Profits

Actuary in regard to areas of discretion.
The need to ensure that the management is aware of the Actuarial

Function Holders interpretation of policyholders reasonable
expectations and obligations to treat customers fairly.
The need for the Actuarial Function Holder to inform management of the
implications of material changes in the companys business plans or
practices for fairness and the reasonable expectations of its
policyholders.
The need for the Actuarial Function Holder to satisfy him/herself that
systems of control are in place to ensure that policyholders are not misled
as to their expectations.
The need to ensure timely access to reports and papers relevant to the
actuarys areas of responsibility.
Circumstances under which the With-Profits Actuary must give advice to

the company on the future exercise of discretion affecting its with profits
business.
The relationships between the Reviewing Actuary and the auditor, and the
Actuarial Function Holder and the Reviewing Actuary (including that it is
inappropriate for an Actuarial Function Holder to rely on the checks or
opinions of the Reviewing Actuary).
Procedures relating to possible conflicts of interest, particularly if roles

are shared (Actuarial Function Holder and With-Profits Actuary).

APS L2: The Financial Services and Markets Act 2000

(Communications by Actuaries) Regulations 2003
This Actuarial Profession Standard gives guidance on whistle-blowing, ie the

circumstances under which a statutory obligation arises for an Actuarial
Function Holder, With-Profits Actuary or Appropriate Actuary (but not the
Reviewing Actuary) to communicate matters of which he or she becomes aware
to the regulators.
Matters that may need to be communicated to the regulators under APS L2 include:
contravention of legislation by an insurer
significant risk that an insurers assets may become insufficient to meet
liabilities
significant risk that the insurer did not or may not take into account policyholder
interests
inadequacies in the insurers relationship with the actuary (eg the provision of
information and resources).
APS L2 includes:
The need to verify first that the matter comes under the scope of the
relevant regulations and then to take other appropriate initial steps, such
as discussion with the firms compliance officer or other relevant senior
management in order to agree the facts of the situation.
The need to communicate matters with urgency, when the actuary

reasonably believes that a contravention may have occurred, that a matter
may be of material significance to the regulators, or that a significant risk
may be present. The conditions do not have to be definitely confirmed.
The need to communicate issues when they first come to the actuarys
attention, even if it has already been satisfactorily addressed by the firm.
The whistle-blowing obligation over-rides any legal duty of confidentiality

to the company.

4 The transfer of liabilities between insurance companies
4.1 Introduction
Transfers of long-term liabilities involve transferring all or some of the in-force long-term
business of one life insurance company to another life insurance company (possibly a new
one). These are commonly called Part VII transfers after the relevant section of FSMA.
(Under previous legislation they have been known as Schedule 2C transfers and
Section 49 transfers.) Transfers of business can be complex and costly to achieve, and
are not undertaken lightly.
Transfers of liabilities may arise in varied circumstances, for example:
When a mutual company demutualises, the usual process is to set up a new

proprietary company, into which the business of the mutual is then transferred.
The purchase of a closed company or fund by a consolidator company.
Although demutualisations and consolidator purchases are the glamorous end of

transfers, most transfers are of small funds, often closed, in restructuring or tidying-up
operations.
4.2 Requirements of transfers
The requirements relating to transfers of business are set out in Section 18 of SUP.
The first step is for the Board of the transferring company to propose a scheme and to
discuss the scheme with the PRA as soon as reasonably practical, to enable a practical
timetable to be agreed. The scheme must receive court approval before it goes ahead.
Under FSMA it is necessary to obtain the sanction of the High Court Court of
Session in Scotland before long-term insurance business can be transferred
from one life insurance company to another. The rules restrict the transfer to be
within EEA states.
The petition to the Court has to include a report on the scheme of transfer, in a
form approved by the PRA, from an independent expert nominated or approved
by the PRA.
For a transfer of long-term business, the independent expert must be an actuary familiar
with the role of the Actuarial Function Holder (and of the With-Profits Actuary if the
transfer involves with-profits business).

Before it gives its sanction to the transfer, the Court must be satisfied that the
companies concerned have:
adequately publicised the scheme
sent to all policyholders involved a short formal notice in a form approved

by the PRA (which will also consult with the FCA for this purpose). In
practice, this would involve sending to policyholders and, where relevant,
shareholders a statement:
setting out the terms of the scheme, and
containing a summary of the independent experts report that is
sufficient to indicate his or her opinion on the effect of the transfer
on the interests of the policyholders involved.
The Court is concerned only that the proposed scheme is acceptable to the parties
involved. The independent expert is not required to report on alternative schemes.
The Court must also be satisfied that the company to which the business is
being transferred is authorised to carry on that type of business and, after the
transfer, will be able to cover its regulatory capital requirements.
Regulatory capital requirements are covered in Chapter 11.
Any person, including employees of the companies concerned, can be heard by

the Court if they feel that the transfer would adversely affect them. The PRA and
FCA may also invoke a right to be heard by the Court.
The regulators are not formally required to approve a scheme. However, if the scheme
would go against the requirement to treat customers fairly (including PRE), the FCA may
intervene and make representations to the Court that would almost certainly result in the
scheme not being approved. The Court will show particular regard to the views of the
Secretary of State, as well as those of the independent expert.
Although it is usually not formally required by the Court, a ballot of members may be
needed to secure regulatory approval. A 75% vote in favour is seen as a good mandate.

5 Other legislation relevant to life insurance companies

The following were covered in Chapter 4 UK contract and trust law:
Unfair Terms in Consumer Contracts Regulations 1999
Question 9.1
Lets see what you can remember. Give three examples of an unfair contract
term.
Equality Act 2010 and EU Gender Directive
Financial Ombudsman Service.
Question 9.2
State four key responsibilities of the Financial Ombudsman Service.

This page has been left blank so that you can keep the chapter
summaries together for revision purposes.

Chapter 9 Summary
Financial Services and Markets Act 2000 and the regulators
From 1 December 2001, UK insurers have been subject to regulatory requirements

under the Financial Services and Markets Act 2000 (FSMA).
The Financial Services Act 2012 made substantial changes to FSMA. In particular, it
introduced two new regulatory bodies:
the Prudential Regulation Authority (the PRA)
the Financial Conduct Authority (the FCA).
The PRA has the following objectives in respect of insurance company supervision:
promoting the safety and soundness of the companies that it supervises
contributing to securing an appropriate degree of protection for those who are or
may become policyholders.
A key feature of the PRAs approach to supervision is risk-based supervision.
The FCAs key objective is to ensure that the relevant markets function well, under-
pinned by:
securing an appropriate degree of protection for consumers
promoting effective competition in the interests of consumers
protecting and enhancing the integrity of the UK financial system.
Regulatory Handbooks
The regulatory Handbooks contain all the PRAs and FCAs rules and guidance.
Sections of the Handbook include:

Prudential sourcebooks including INSPRU, GENPRU and IPRU-INS
Conduct of Business sourcebook (COBS)
Supervision Manual (SUP) covering both the tools that the regulators will use
to carry out their supervision and also the statutory actuarial roles of Actuarial
Function Holder and With-Profits Actuary.

Professional guidance
APS L1 applies to all members of the Institute and Faculty of Actuaries who are
appointed to the roles of: Actuarial Function Holder, With-Profits Actuary, Appropriate
Actuary and Reviewing Actuary.
APS L2 gives guidance on whistle-blowing, ie the circumstances under which a

statutory obligation arises for an Actuarial Function Holder, With-Profits Actuary or
Appropriate Actuary to communicate matters of which he or she becomes aware to the
regulators.
Transfers of liabilities
Transfers of long-term insurance business from one company to another require the
approval of the High Court (Court of Session in Scotland).
The petition to the Court must include a report on the scheme of transfer from an
independent expert.
Before it approves the transfer the Court must be satisfied that the companies concerned
have:
adequately publicised the scheme
sent to all policyholders involved a short formal notice in a form approved by
the PRA.
The Court must also be satisfied that the company to which the business is being
transferred is authorised to carry on that type of business and, after the transfer, will be
able to cover its solvency requirements.
Any person, including employees of the companies concerned, can be heard by the
Court if they feel that the transfer would adversely affect them.
The PRA and FCA may also invoke a right to be heard by the Court.
Suggestions for further reading:
The Penrose Report. A discussion meeting held by the Institute of Actuaries.

Abstract of the discussion. [Report of the Equitable Life Inquiry]
https://www.actuaries.org.uk/research-and-resources/documents/penrose-report-
discussion-meeting-held-institute-actuaries-abstract

Chapter 9 Solutions
Solution 9.1
Five examples of unfair contract terms were mentioned in Core Reading. These were
ones that:
allow the firm to change the terms of the contract without consulting, unless it
does so for a valid reason set out in the contract
charge a disproportionately large sum if the contract is cancelled
allow a firm to change the characteristic of its service without consulting, unless
it does so for a valid reason
give a firm the absolute right to interpret any term of the contract as it sees fit
mislead about the terms of the contract.
Any three of these will do.
Solution 9.2
Making rules of procedure (under the scheme) for reference of complaints to the
scheme and for their investigation, consideration and determination.
Making rules relating to the award of costs.
Making rules for the levying of case fees.
Reporting to the regulator on the discharge of its functions, and publishing that
report.





the course.

SA2-16: Professional standards and guidance Page 1
Chapter 16
Professional standards and guidance
Syllabus objective
investigations:
11. the principles underlying the requirements of the professional standards

and guidance relevant to actuaries practising in or advising UK life
(Professional guidance is covered in this chapter.)
0 Introduction
When carrying out work for a UK life insurance company an actuary (or actuarial
student) must comply with all relevant requirements under the Financial Services
and Markets Act (FSMA), together with any professional standards or guidance
relevant to the work being done and the professional body to which he or she
belongs.
Standards required of members of the Institute and Faculty of Actuaries (IFoA)

are detailed in the Actuaries Code, Technical Actuarial Standards (TASs) and
Actuarial Profession Standards.
Professional standards that are deemed to be technical in nature are produced

and maintained by an independent body, the Financial Reporting Council (FRC).
The FRC is independent of the IFoA. The IFoA retains responsibility for the setting
and maintenance of ethical standards.

Page 2 SA2-16: Professional standards and guidance
You should already be aware at least of the existence of these standards and guidance
and may already have read some. The relevant websites can be found by following the
Regulation link from the main menu at www.actuaries.org.uk. From here you can
access the Professional Standards Directory which includes all the guidance
maintained by the IFoA. From the Regulation link you can also access the FRC
website. Alternatively, you can find the FRC website directly at
http://www.frc.org.uk/Home.aspx.
The FRC and the IFoA have made a number of changes to their professional standards
and guidance in recent years. For example, as you work through the suggested reading
you may come across references to the old system of guidance notes. You may also see
references to the Board for Actuarial Standards (BAS), which used to be the part of the
FRC responsible for actuarial standards until the FRC took direct control and the BAS
was disbanded. Further changes may be made over time, eg to incorporate changes in
legislation.
The principles outlined in this Core Reading reflect the up-to-date versions as at
30 April 2013. You are not required to have knowledge of changes made after
this date for the purpose of Subject SA2. However, if your answer to an exam
question reflects knowledge of such changes, your answer will, in principle, be
acceptable.

1 Professional Standards Directory

The Professional Standards Directory on the IFoAs website enables members to
access the current FRC standards and the current version of the standards
issued by the IFoA: the Actuaries Code and Actuarial Profession Standards.
The Actuaries Code sets out five core principles which all members of the IFoA
are expected to observe in their professional lives, and which must be complied
with in both the spirit and the letter. The content of the Actuaries Code is
outside the scope of this Subject, but should be known by all members (students
and actuaries) of the IFoA.
The Actuaries Code contains the following five principles:

integrity
competence and care
impartiality
compliance
openness.
The Regulation area of the IFoAs website also includes Information and
Assistance Notes (IANs) and other non-mandatory resource material, which are
intended to provide helpful material on particular matters. Unlike the TASs, IANs
are not mandatory and, therefore, members do not have to follow them, being
free to obtain and follow alternative advice from other sources. However,
because they are part of professional guidance, a member may have to
demonstrate that he/she has considered them, if relevant. The IFoA has to
ensure that the content of an IAN does not conflict with any of the FRC
standards.
So far, the IFoA has released Information and Assistance Notes covering the following
topics:
The actuary and activities regulated under FSMA 2000
The actuary as an expert witness.

2 Technical Actuarial Standards

These principles-based Technical Actuarial Standards (TASs) are mandatory for
all members of the IFoA when undertaking work that is within the scope of that
TAS. The IFoA retains the responsibility for regulation of members and in
particular requires members, to whom the standards apply, to observe them.
The TASs of relevance to Subject SA2 are:

TAS D: Data
TAS R: Reporting
TAS M: Modelling
Insurance TAS
Transformations TAS.
Subject SA2 students are expected to be familiar with the underlying principles
of the relevant TASs, but will not be examined on the detail.
Generic TASs
TAS R, TAS D and TAS M are Generic TASs, which means that they apply to any
work which is commonly (or exclusively) performed by actuaries and which falls
within the scope of one or more of the Specific TASs (see below).
TAS R
The purpose of TAS R is to ensure that the reporting of actuarial work includes
sufficient information to enable users to judge the relevance and implications of
the reports contents, and that the information is presented in a clear and
comprehensible manner.
TAS R sets out a number of requirements that reports would be expected to contain
anyway. For example, TAS R requires each report to contain statements on its purpose,
intended users, sources of data and assumptions used.
However, TAS R is intended to improve past practice in a number of areas. For

example, where uncertainty exists the report must comment on the nature and extent of
the uncertainty. Also, it is not sufficient to state a net present value of cashflows, but in
addition, reports should indicate both the nature and timing of cashflows.

TAS R defines the following types of report:
aggregate report the set of all component reports relating to a piece of work
component report a document given to a user in permanent form (hard copy or

electronic) containing material information which relates to work within the
scope of TAS R.
So TAS R refers not only to big weighty reports of a hundred or more pages, but also to
draft reports, emails and presentations.
TAS D
The purpose of TAS D is to ensure that data used in preparation of reports is

subject to sufficient scrutiny and checking so that users can rely on the resulting
actuarial information, and that appropriate actions are taken where data is
inaccurate or incomplete.
TAS D also requires that the processes described above are sufficiently documented so
that a technically competent person with no previous knowledge of the exercise would
be able to understand the matters involved and assess the judgements made.
TAS M
The purpose of TAS M is to ensure that actuarial models used in the preparation
of reports sufficiently represent the issues on which decisions will be based, and
are fit for purpose both as theoretical concepts and as practical tools.
To be fit for purpose, the model should be a satisfactory representation of some aspect
of the world in the context of the purpose for which it is being used. The model should
be checked and no more complex than can be justified, and results should be capable of
being reproduced.
Further, TAS M requires that models be properly documented and that

significant limitations and their implications be reported.
Specific TASs
As well as these Generic TASs, the FRC has published a set of Specific TASs,
applying to work in particular areas. Of most relevance to this subject is the
Insurance TAS.

Insurance TAS
The Insurance TAS applies to all reserved work (ie where there is a regulatory or
legal obligation that this work be performed by a qualified actuary) concerning
insurance business, and any work concerning insurance business which is used
in reports.
The Insurance TAS applies to both long-term and general insurance.
The scope includes work relating to:

the production of financial statements
regulatory returns
embedded value reports
pricing
business reorganisations
the exercise of discretion in relation to premiums or benefits.
Its purpose is to ensure that management and governing bodies of insurers can
understand and rely on the information supplied by their actuaries, and
appreciate its limitations. It also requires that information provided to
policyholders is relevant, comprehensible and sufficient for their needs.
Principles include:
Determination and use of appropriate and relevant assumptions.
Assumptions should be derived from sufficient relevant information (or else as

much relevant information as is available). Shortcomings in one assumption
should not be compensated for by adjustments to another assumption.
Explanation of the approach taken to determine discount rates.
This should include the rationale for inclusion and derivation of any illiquidity
premium included in the discount rates.
Allowance for, and explanation of, future trends in assumptions.
Explanation and analysis of changes between methods and assumptions

used in related exercises.
Explanation of the relationship between prudent and neutral estimates.

In relation to discretion (which includes the management of with-profits

business, unit-linked charges and unit pricing):
Ensuring that any management actions modelled are consistent
with the fair treatment of policyholders.
Providing indication in reports of the effects of the proposed action
on the policyholders and on any estate.
Question 16.1
Suggest proposed discretionary actions that might need to be included in such reports.
It can be noted that the Insurance TAS is principles-based and intended to be

durable, containing few references to legislation and regulations.
Transformations TAS
Another TAS of relevance to life insurance actuaries is the Transformations TAS.

This gives more detail on principles that should be applied in actuarial work
relating to business reorganisations which affect policyholders, including Part
VII transfers, inherited estate attribution and changes to PPFM principles.
The Transformations TAS covers any actuarial work involving a transfer of assets or
liabilities from one insurer to another. It also covers any actuarial work carried out to
support decisions about modifications to policyholders entitlements.

3 Other professional standards and guidance

This section lists the other current professional standards and guidance that are
of most relevance to this subject. Subject SA2 students will not be examined on
the detail of these resources beyond what has been covered elsewhere in the
Core Reading.
Actuarial Profession Standards
The following Actuarial Profession Standards were described in Chapter 9:
APS L1 (Duties and responsibilities of life assurance actuaries)

relevant to all members appointed to one of the statutory roles.
The statutory actuarial roles are the Actuarial Function Holder, the With-Profits
Actuary, the Appropriate Actuary and the Reviewing Actuary. These were also
covered in Chapter 9.
APS L2 (The Financial Services and Markets Act 2000 (Communications

by Actuaries) Regulations 2003) guidance relating to the statutory
obligation to whistleblow.
Actuarial Function Holders and With-Profits Actuaries may need to

communicate certain matters to the regulators if they have concerns about an
insurer. This is commonly referred to as whistleblowing.
Matters that may need to be communicated to the regulators include:

contravention of legislation by an insurer
significant risk that an insurers assets may become insufficient to meet
liabilities
significant risk that the insurer did not or may not take into account
policyholder interests.
Non-mandatory resource material
As noted earlier, the IFoA also produces other non-mandatory resource material
which is intended to provide helpful guidance for its members.
These include Whistleblowing a guide for actuaries and Whistleblowing a

guide for employers of actuaries. These leaflets are intended to help all
actuaries (and their employers) understand their whistleblowing obligations,
both professionally and legally, and to alleviate concerns that they may have
about such responsibilities.

The IFoA has also put in place a confidential advice line that gives advice on when and
how best to raise concerns. Details of the advice line and the above guides can be found
at http://www.actuaries.org.uk/regulation/pages/whistleblowing.
Conflicts of interest a guide for actuaries. This leaflet builds on the

provisions of the Actuaries Code in relation to conflicts of interest and sets out
views on good practice regarding such conflicts and how they might be
managed.
The guide can be found at

http://www.actuaries.org.uk/regulation/pages/conflicts_of_interest.

This page has been left blank so that you can keep the chapter
summaries together for revision purposes.

Chapter 16 Summary
Professional Standards Directory
The Actuaries Code sets out five core principles which all members of the IFoA are
expected to observe in their professional lives.
The Professional Standards Directory also includes Information and Assistance Notes
(IANs) which are intended to provide helpful material on particular matters.
Technical Actuarial Standards
Technical Actuarial Standards are principles-based.
The TASs of relevance to Subject SA2 are:

TAS R: Reporting
TAS D: Data
TAS M: Modelling
Insurance TAS
Transformations TAS.
Other professional standards and guidance
The IFoA has issued the following Actuarial Profession Standards of relevance to
Subject SA2:
APS L1 Duties and responsibilities of life assurance actuaries
APS L2 The Financial Services and Markets Act 2000 (Communications by
Actuaries) Regulations 2003) guidance relating to the statutory obligation to
whistleblow
The IFoA has also issued the following non-mandatory guidance:

Whistleblowing a guide for actuaries
Whistleblowing a guide for employers of actuaries
Conflicts of interest a guide for actuaries.

Suggestions for further reading:
Technical Actuarial Standards: TAS D, TAS R, TAS M, Insurance TAS,

Transformation TAS
http://www.actuaries.org.uk/regulation/pages/technical-actuarial-standards-tass-online-
learning-materials
Other Actuarial Profession Standards and non-mandatory resource material as

listed in the Core Reading
http://www.actuaries.org.uk/regulation/pages/professional-standards-directory

Chapter 16 Solutions
Solution 16.1
The examples mentioned in the Insurance TAS are:

increasing surrender penalties if the value of assets falls sharply
postponing surrenders or switches due to illiquidity of assets
changes in PPFM
changes in bonus policy, investment policy or smoothing policy
changes in risk or expense charges
changes in charges to asset shares.





the course.

SA2-25: Surplus distribution (1) Page 13
Question 25.7
Even if UWP regular bonuses are a much higher percentage than conventional with-
profits regular reversionary bonuses, new business strain from early UWP bonuses will
still be much lower than for conventional business. Why?
Later in the policy term, the practice of giving a high regular bonus on UWP can negate
the effect of the low early cost of bonus, as far as the deferral of distribution is
concerned. There has tended to be much less scope for terminal bonus, and so closer to
maturity a greater proportion of total surplus may already have been distributed on
UWP than on a typical conventional with-profits contract.
The company will also benefit from a reduced new business strain as the cost of the
bonus in the early years is less than under the reversionary bonus system.
Question 25.8
What does the phrase cost of bonus mean in this context?
A key difference between UWP bonuses and conventional bonuses lies in the sources of
surplus that are distributed by a proprietary company. Under conventional with-profits
business, all surplus is divided in a set proportion between policyholders and
shareholders, usually 90/10.
However, for UWP business there are two main alternatives for distributing surpluses
from different sources. One possibility is for there to be no explicit charging structure
and for bonuses to reflect the policyholders share of all sources of surplus (typically
90%), ie as for conventional with-profits. Another possibility is for the policyholders to
receive all of the investment surplus through the bonus system and for shareholders to
receive all of the other sources of surplus through the use of an explicit charging
structure.
Since there are different possibilities for the distribution of surplus under UWP
business, it is important to be clear about the product design when discussing such
business.

Page 14 SA2-25: Surplus distribution (1)
4.4 Terminal bonuses
Under an approach that pays terminal, as well as reversionary, bonuses, the

policyholder has the prospect of higher potential benefits than if the terminal
bonus were replaced by a higher regular reversionary bonus. This is because
the declaration of higher reversionary bonuses increases guarantees, which in
turn requires the adoption of a more conservative investment strategy.
However, the use of terminal bonus means that he or she will not know what the
benefits will be until the insured event arises.
There will be a greater volatility in the proceeds than if all surplus were
distributed in reversionary form. In particular, the policyholder will be vulnerable
to falls in ordinary share and property prices when the insured event takes place,
unless a very smoothed approach to terminal bonuses is adopted.
As well as permitting greater investment freedom, a bonus strategy with a

greater weighting towards terminal rather than reversionary bonus will also allow
the company to hold lower reserves (due to lower guaranteed benefits) and
hence improve free assets.
The greater investment freedom allows more investment in assets with higher risk and
higher expected returns, such as equity shares and property. Selling terminal bonus to
advisers and clients therefore involves convincing them that these final expected
benefits are worth the uncertainty that terminal bonus brings. In the UK, the vast
majority of participating contracts have a mixture of terminal and regular bonuses,
although the mix does vary considerably from company to company.
4.5 New-style with-profits (post Sandler)
A new style of with-profits contract has emerged which has been developed to
minimise capital requirements and as a by-product of the Sandler type of
stakeholder products which are required to be transparent.

SA2-25: Surplus distribution (1) Page 15 A
Sandlers review of the UKs medium- and long-term retail savings market in 2002
proposed a radical reform of with-profits products in order to ensure that they met new
high standards of simplicity and transparency. The review recommended that all with-
profits funds be altered to reflect four main features:
a fund structure of 100/0 (ie policyholders receive all the investment surplus)
explicit management charging
a separate smoothing account, balanced to be neutral in the long run
full consumer disclosure, with the ability to impose an MVR to prevent
arbitrage.
This new style with-profits product features a smoothed investment fund and, in
a crucial difference from traditional with-profits structures, its unit price may
fall.
This last feature has led to some objections to the use of the with-profits label, saying
that they should be referred to as smoothed managed funds.
In general, the investment return produced by the fund will usually be wholly for
the benefit of policyholders but will be credited to policyholder accounts on a
smoothed basis with the aim of the smoothing being neutral over time.
In a proprietary company, shareholders would receive all of the other sources of surplus
and would do so via the charging structure.
The insurer may maintain a smoothing account and the method used to smooth
will generally be disclosed.
If capital support is needed for the smoothing method, this can be charged for
provided that policyholders are notified.
The product will normally be a unitised one and surplus may be distributed
solely through the unit price mechanism, ie no explicit bonuses. There should
also be less (or no) need for a market value reduction because the unit price can
fall. This style of product has an explicit charging structure and the only
guarantee likely to be offered, if any, is a mortality guarantee.
Question 25.8A
If the unit price can fall, why is there any need for an MVR?
Students are not required to have any knowledge of this product style other than
that described above. It is not covered in Core Reading in the UK-specific
products chapters.





the course.

SA2-27: Risk management and controls Page 3
1 Objectives of financial controls

The key objective of having appropriate controls and procedures is that they
should provide senior management with an adequate means of managing the
firm. As such, they should be designed and maintained to ensure that senior
management is able to make and implement integrated business planning and
risk management decisions on the basis of accurate information about the risks
that the firm faces and the financial resources it has.
Having controls in place to achieve this objective is something that most companies
would choose to do of their own volition for sound governance and management of the
business. However, certain systems and controls are requirements of Companies Act
reporting or required by the regulators, the Solvency II regime, the London Stock
Exchange (for listed companies) and actuarial professional guidance.
The regulators have a list of eleven core principles that are a general statement of the
fundamental obligations of insurers under the regulatory system. Principle 3
(Management and control) is that each insurer must take reasonable care to organise and
control its affairs responsibly and effectively, with adequate risk management systems.
Prudential risk management systems are the means by which a firm is able to:
identify the prudential risks that are inherent in its business plan, operating
environment and objectives, and determine its appetite or tolerance for these
risks
measure or assess its prudential risks
monitor its prudential risks
control or mitigate its prudential risks.
A firms prudential risks are those that can reduce the adequacy of its financial
resources, and as a result may adversely affect confidence in the financial system or
prejudice consumers.
In Sections 2 to 7 we consider the prudential risks addressed in INSPRU.
There is also a range of accounting and Companies Act guidance including the Turnbull
guidance on internal controls. The Turnbull guidance suggests means of applying the
part of the Combined Code on Corporate Governance (which applies to all listed
companies) that deals with internal controls.

Page 4 SA2-27: Risk management and controls
The Turnbull guidance says that in determining what constitutes a sound system of
controls, the Board of a company should consider factors such as:
the nature, size and likelihood of occurrence of the risks facing the company
the risks it regards as acceptable for the company to bear
the companys ability to mitigate the risks and the costs and benefits of operating
particular controls to manage risks.
Controlling risk is also a key part of enterprise risk management (ERM). ERM is
covered briefly in Subject CA1 and in much greater depth in Subject ST9.
The three lines of defence model can be used to implement enterprise risk
management, with strong communications between each line being vital:
First line of defence: business operations it is important to have a well

established control environment embedded into day-to-day operations.
So these are the procedures to control risk within each department, eg having all
work checked by a colleague.
Second line of defence: oversight functions (eg a standalone risk

function) these have responsibility for the production, implementation
and monitoring of risk management policies and procedures.
A company may have a Chief Risk Officer who is in charge of the risk function
and determines company-wide risk policy.
Third line of defence: independent assurance providers (eg internal and

external audit) this involves the evaluation and challenge of the
organisations risk management processes.
Audits can help to verify that the procedures in place are actually being followed
and are effective.
The following sections describe in more detail the risks that the firm may face
and the nature of controls and procedures that it may implement to manage
these risks.

These may include:
A statement of the firms profits or losses for each class of business that
it writes including an analysis of how these have arisen and variance
analysis from plan or budget.
The amount and detail of new business written and the amount of
business that has been lapsed or cancelled.
Emerging trends in persistency and expense levels.
Appropriate escalation procedures should be in place for any breaches of

defined limits.
6.2 Underwriting
Underwriting is an internal control appropriate for the management of some

insurance risks.
The general principles covered in Subject ST2 apply directly to a UK life

insurance company.
Question 27.7
List six ways in which underwriting can be used to manage risk.
The underwriter is attempting to ensure that a pool of lives insured is aligned to

the risk assessment criteria used by the actuary in pricing the product. The
underwriting philosophy of the life company will often be specific to that
company, and one company may employ different philosophies for different
products.
This might be the case where different products are aimed at different target markets
and/or sold through different distribution channels.
Each such philosophy, and how tightly it is maintained, will impact the
companys mortality or morbidity experience accordingly.
It is important to note that a change in underwriting practice can also impact the
mortality or morbidity experience of the pool of lives which is not underwritten.
For example, an increase in the volumes of underwritten (eg impaired life)
annuities would have a direct effect on the experience of non-underwritten
annuities.

Question 27.7A
Would the mortality experience for new non-underwritten annuities get better or worse
following the introduction of impaired life annuities?
Considerations relevant to the UK include:
For medical underwriting, most people in the UK will be registered with a

doctor who will have a comprehensive record of their past medical
history. Reports from these doctors are therefore a valuable source of
information about an applicant that allows the underwriters to assess
effectively any additional risk.
The relevant doctor is known as someones personal medical attendant

(PMA), usually the applicants general practitioner (GP). Although much UK
medical treatment is not actually performed by a patients GP, the GP should
nevertheless be informed of such treatment, and may well have referred the
patient for it in the first place.
There are also a limited number of confidential private services such as some
clinics for sexually transmitted diseases. These services theoretically undermine
the completeness of GPs records, but the general UK picture remains one of
fairly reliable and complete medical information.
Information is usually obtained by the doctor filling in a form known as a

personal medical attendants report (PMAR).
Question 27.8
Information from an applicants doctor is only one potential source of

information on the applicants state of health. State three others.
In the UK, supplementary questionnaires are also used for some proposals. For
example, supplementary lifestyle questionnaires have been requested from
young males, amongst others, with the particular aim of identifying high AIDS
risks.
Question 27.9
Information on a persons health is not the only type of information that will be
sought by underwriters. Suggest four other types of information that may be
sought.

Question 27.10
Once the required information has been gathered, the company will find that
some applicants are not acceptable on normal terms. State the three main ways
in which a company might deal with a proposal it is willing to accept, but only
on special terms.
Non-disclosure (eg of medical history or smoker status,) has historically

been a problem within the industry.
Insurance companies try to control non-disclosure in the following ways:
Tobacco related non-disclosure has been addressed by the use of

cotinine testing, which is obtained on all non-smoking applicants when a
medical examination is requested.
Application forms have become more comprehensive, with questions

worded in plain English to avoid misunderstanding and inadvertent
non-disclosure.
Client declarations on the application form are used to warn clearly of the
potential impact on insurance cover in the event of misrepresentation.
It has also become commonplace for insurers to conduct random

sampling of cases after acceptance, where medical reports are again
obtained.
An industry code of practice has been put in place by the ABI to ensure
commonality of approach to non-disclosure when it is discovered. This
provides guidance to ensure that any action is in moderation to the
perceived motives behind the non-disclosure; but the measures can
ultimately lead to a claim being declined.
Equality legislation, data protection and Unfair Contract Terms legislation

provide a framework within which the underwriting process must operate.
Recall from Chapter 4 that the Equality Act allows the company to charge higher
premiums for persons suffering from impairments provided the impairments are
relevant to the risks and provided the insurer can produce statistical evidence to
that effect.
Also from Chapter 4, EU companies are unable to use gender as a rating factor
with effect from December 2012.

Genetic testing is used to diagnose, identify and predict genetic

conditions. Few tests can predict with certainty when an illness might
begin, or how severe it might be. However, there have been concerns that
a minority of patients might be deterred from taking predictive genetic
tests if they believed that it could prevent them from obtaining insurance.
Therefore the UK life insurance industry currently has a voluntary
moratorium in place on the use of genetic information in underwriting.
This moratorium precludes the use of genetic information unless the

results yield a more favourable outcome for the applicant than would have
been the case if no genetic information had been provided. The exception
is for Huntingtons disease tests for large life insurance sums assured.
The moratorium (ie temporary ban) on the use of genetic test results by insurers
came into effect on 1 November 2001, for a duration of five years. In March
2005 the moratorium was extended and in April 2011 it was extended again until
2017. This ensures that, for the duration of the moratorium, consumers do not
have to disclose any past genetic test results, for cover up to specified limits (eg
500,000 for life insurance). Above these limits information on past results may
be requested for approved tests only, currently just Huntingtons.
There have been many articles written about the possible impact on life
insurance of advances in gene mapping. One article that should be easily
available is Human genetics the end of life insurance? by Jane Andrews,
which appeared in the June 2001 edition of The Actuary.
6.3 Reinsurance
As covered in Subject ST2, reinsurance can be used to manage insurance risk.

However, it generates its own additional risks:
Counterparty risk
The exposure of some companies to a reinsurer can be large. Exposure

could be measured as statutory or realistic reserves ceded or costs borne
to replace the cover.
Various forms of collateral, or defined actions given certain events, can

mitigate the risk itself.
For example, management could have in place a process to reduce (possibly to

zero) the amount of reinsurance ceded to any reinsurer whose credit rating falls
below a specified level.

Actuaries have always been expected to satisfy themselves that using a table
published by the CMI is appropriate for the particular purpose to which it is put.
The absence of recommended mortality projections in conjunction with the 00
Series tables emphasised the need for actuaries to consider the uncertainty
surrounding future mortality experience and to explain the financial
repercussions of this uncertainty to their employers and clients.
There was always a danger with having just one published projection, since actuaries
might be tempted to just accept it without giving much attention to other possibilities,
and clients might place undue weight on the single set of results produced.
The CMI has undertaken significant research into possible methods of projecting
mortality but this work has not led to adoption of a specific projection basis.
Instead, actuaries are advised to consider a range of scenarios. The CMI has
published a library of sample projections to assist actuaries in this regard.
The main two models that the CMI have been experimenting with are the Lee-Carter
and P-spline models, which are mentioned in Section 6.7.
Acknowledging the relative complexity of understanding and using stochastic

mortality projection approaches, in 2009 the CMI also developed and launched a
fairly simple spreadsheet model that actuaries could use to produce a range of
different projections based on the latest data on mortality improvements
(although it was left to the actuary to complete the parameterisation of the model
in order to generate a scenario for the chosen purpose).
The following sections look in more detail at these developments and related
considerations.
Regulations and professional guidance
Future mortality improvements are the subject of much debate and receive some
attention in regulations and professional guidance. For example:
INSPRU 1.2.60 says that the rates of mortality or morbidity should contain
prudent margins for adverse deviation, and that in setting rates a firm
should take account of possible future trends in mortality.
This guidance goes on to say that future trends in mortality should be taken into
account only where they increase the liability.
Question 27.12
The guidance referred to above cites four examples of causes of possible future
trends in mortality or morbidity experience. Suggest what these might be.

Also, INSPRU 1.2.17 says that where there is a considerable range of

possible outcomes, the regulator expects firms to use stochastic
techniques to evaluate these risks. In time longevity risk, where this
constitutes a significant risk for the firm, may fall into this category.
The Insurance TAS does not refer to mortality improvements explicitly,

but under a more general heading Claim rates it states: If assumptions
about claim rates are used in, or proposed for use in, an exercise
requiring the projection of claims over a number of years there shall be
separate assumptions for base claim rates and for subsequent changes to
those rates.
6.5 Principles of mortality projections
A large part of longevity risk is the simple uncertainty about future mortality
rates the longer one looks into the future, the less certain one can be.
This phenomenon is often referred to as the expanding funnel of doubt.
All forms of projection are fraught with difficulties.
There are several different approaches to determining future rates of mortality

improvement.
The approaches discussed here are:

expectation approaches
extrapolation approaches
explanatory approaches.
Expectation approaches involve expert opinion and subjective judgment to

specify a range of future scenarios.
So the mortality assumption could be set by asking a number of experts for their
opinion, eg by asking what they think future life expectancy might be.
An advantage to this approach is that it can implicitly include all relevant knowledge
(including qualitative factors). However, expectations are subjective and can be subject
to bias.
Extrapolation approaches are based on projecting historical trends in mortality

into the future. Such methods also require some element of subjective
judgement, for example in the choice of period over which such trends are to be
determined.

Looking at trends in smoking rates is a good example of this. Smoking rates (and
resulting mortality rates) fell during the 1970s and 80s, levelled off in the 1990s, but
started to fall again in the 2000s. Extrapolating this trend into the future is far from
straightforward and the introduction of a smoking ban in public places throughout the
UK makes projection highly subjective.
Explanatory, or process-based, projections attempt to model trends in mortality

rates from a bio-medical perspective. These projections are only effective to the
extent that the processes causing death are understood and can be
mathematically modelled.
Four major causes of death are:

circulatory diseases, eg heart disease, stroke
cancers
respiratory diseases
infectious diseases.
The absolute and relative rates of mortality due to these causes have changed markedly
over the past 90 years and an understanding of how these changes will continue into the
future could help with mortality projections. Since the mortality from each of these
causes has had a different pattern in the past, simply looking at rates overall will mask
these underlying patterns.
For example, the use of statins to reduce cholesterol has had a big impact on the
incidence of circulatory diseases recently, but wouldnt be expected to affect the other
causes of death.
In practice most mortality projections involve some aspects of each of the above
approaches. Each approach can be modelled within a deterministic or
stochastic framework.
6.6 Deterministic projections
The 92 Series mortality tables included a set of projection factors based on

experience over the recent past up to 1994. These factors were set out
formulaically and the same future rates of improvement were used for male and
female mortality tables.
In common with a number of other developed countries, mortality improvements

in the UK exhibit strong patterns by year of birth or cohort.

This is often called the cohort effect, whereby mortality improvement rates appear to
depend on a persons year of birth. For example, lives born between 1925 and 1945
have consistently experienced higher mortality improvements year by year than the
generations born either side of them.
Question 27.13
Why has this last fact been particularly significant for insurers?
The causes of the cohort effect are open to interpretation, but an important part
of this may be down to changes in smoking behaviours.
Another suggestion is that this generation has benefited most from the introduction of
the National Health Service.
In particular, the population of individuals born between 1911 and 1941 were
exhibiting much higher rates of mortality improvement than predicted by the
original 92 Series projections.
Figure 1, below (which isnt Core Reading), illustrates the cohort effect, using CMI
assured lives data covering the period 1947 to 2002. Age-dependent year-on-year
improvements in rates of mortality have been determined for each year during this
period and areas of the graph have been shaded to show the differences in improvement
rates.
The fact that areas exhibit a diagonal pattern going from bottom-left to top-right shows
that generations tend to benefit from similar improvements year by year, but that these
improvement rates are different for neighbouring generations.
You should be able to see that people who were 58 in 1990 (so born in 1932) have
generally had the best improvements.
Of the people still alive, those in the top-left of the graph, ie those who were 28 in 1995
(so born in 1967), have exhibited the lowest rate of improvement. However, this group
have also benefited from the mortality improvements of the earlier cohorts, so have
longer life expectancy than the group born in 1932.

Figure 1: Illustration of the cohort effect (using CMI assured lives data)
In recognition of the cohort effect, the CMI introduced mortality improvement

projections in 2002 based on year of birth (known as the interim cohort tables).
These mortality projections were derived from extrapolation of patterns in the
male lives assured data. There was not enough data to produce similar
projections from annuitant or pensioner experience, or for females.
This was the first time that the CMI had not published a single deterministic
projection of future mortality rates, but produced instead a selection of three, the
so-called short-, medium-, and long-cohort projections. These projections were
initially designed to be used in conjunction with the 92 Series projections.
The short-cohort projection allowed for the cohort effect to reduce to nil over
the period to 2010; that is, the projection rates were assumed to revert back to
the original 92 Series projections by 2010. The medium-cohort adjustment
applied until 2020 and the long-cohort until 2040. These dates were chosen
arbitrarily.
Publishing a range of different projections was part of a deliberate move away

from the false certainty of a single projection, and a step towards explicit
recognition of the uncertainty surrounding the path of future improvements.
This, in turn, led to the consideration of stochastic approaches see Section 6.7
below.
Companies that were using a deterministic approach at the time these cohort projections
were introduced tended to adopt the medium-cohort approach (partly because it was in
the middle) and before long it became a near universal standard for pricing annuities.

The interim cohort projections assumed a fall in the rate of mortality

improvement from the levels experienced up to their publication. However,
continuing high rates of mortality improvement meant that the short- and
medium- cohort projections began to imply a rapid tail-off in rates of
improvement that showed a very different pattern from the most recent CMI and
ONS data. It became common practice to use adjusted versions of these tables
to keep up with latest experience.
Scenarios similar to the three interim cohort projections described above were
regarded as very useful in presenting mortality risks to non-actuaries,
particularly boards of life insurance companies. Scenarios based on stochastic
approaches may be less easy to convey in this respect.
Theres a danger, though, with presenting the results of three projections in that clients
might be tempted to view the outside two results as best and worse case scenarios. Any
actuary presenting results must ensure their client appreciates that the results are
illustrative and that different mortality improvements could lead to results outside the
range presented.
In early 2009 the CMI noted that the interim cohort projections, or variants of
them, are still in near universal use, despite being based on experience data
only up to 1999 (see also comments in Section 6.8 below). It therefore developed
and launched a relatively simple, generic spreadsheet model that would be able
to produce a range of different projections based on the latest data in the short
term, combined with the actuarys expectation of the long term. Separate
projections are created for males and females.
This model is referred to as CMI_2009 and is described in Working Paper 41.
CMI_2009 produces a single deterministic projection of mortality rates for any given
set of inputs.
The CMI noted that the projections are highly sensitive to the choice of long term
improvement rate(s) and so the model is published without specific guidance on
this aspect. The CMI has however suggested a range of information sources
which could be used to assist with this.
The model allows the user to set a long-term rate of mortality improvement based on
expert opinion. The model then assumes that rates of mortality improvement will
follow the currently observed rates in the short term, but will blend into this specified
long-term rate through time.
Since initial publication of the model in 2009, the projections of initial rates of
improvement have been revised in line with latest ONS data for England and
Wales.

6.7 Stochastic approaches
The CMI commenced work on a stochastic model in October 2003 and an

intended modelling framework for stochastic mortality projection was covered in
its Working Paper 15 (July 2005). This added a probabilistic approach to the
previous deterministic projection methods.
The CMIs working papers and latest news are available on the professions website,
under the Research and resources tab.
Compared with the single deterministic projections, and the three interim cohort
projections that followed, a stochastic approach generates many different
scenarios. This means that any future possible scenario can be allowed for,
regardless of how small the probability of it happening may be.
Two methods of stochastic mortality projections have been tested by the CMI,
the Lee-Carter method and the P-spline method on either age-period or age-
cohort basis. Each has its own advantages and disadvantages. Knowledge of
these methods is not required for Subject SA2.
However, as your appetite is bound to have been whetted, we give some very brief
information on each method.
In its basic form, the Lee-Carter model is a bilinear model in the variables x (age) and
t (calendar time) of the following form:
log m ( x, t ) = a ( x ) + b( x )k (t ) + z ( x, t )
where:
m ( x, t ) is the force of mortality at age x in year t
the a ( x ) coefficients describe the average level of the log m ( x, t ) surface over
time
the b( x ) coefficients describe the pattern of deviations from the age profile as
the parameter k (t ) varies
the k (t ) parameter describes the change in overall mortality
z ( x, t ) is a random error term.
The basic model does not capture the cohort effect, although it can be expanded to do
so.

The P-spline method has the following features:

its a regression model fitted to past data
it can easily be fitted to an age-cohort surface to incorporate cohort effects
the model cant generate sample paths for use with stochastic modelling.
More details of these projection methods can be found in various of the CMIs Working
Papers.
In seeking justification of assumed future trends for the purpose of stochastic

modelling, it may be appropriate to start by understanding the drivers of
possible future change and consideration of events, relating to the major causes
of death that may lead to substantial future reductions. The stochastic
methodology proposed through the CMI does not seek to address these issues
or provide justifications for the scenarios produced. It feels that such
justifications are by their nature subjective and best left to individual actuaries to
consider as appropriate.
This makes life much harder than before for individual actuaries, since more emphasis
will be placed on explaining the particular view taken on future mortality
improvements.
The proposed methodologies aim to provide a sound mathematical foundation

which will aid users in developing their own views.
A number of consultancy firms have also developed and marketed their own
proprietary stochastic projection models which aim to improve understanding
and management of longevity risk.
However, the relative complexity of both the application and communication of

stochastic mortality projection methodologies may have been a barrier to their
widespread adoption.
6.8 Library of mortality projections
In November 2007 the CMI published a library of mortality projections (Working

Paper 30), allowing for a variety of projections to be obtained from a single
source and in a standard format for the first time. It brings together projections
previously produced by the CMI and the latest National Population Projections
from the Office for National Statistics (ONS). The former includes the 2002
interim cohort projections and example projections using both the P-spline and
Lee-Carter stochastic methodologies.

The library itself consists of a user guide together with a number of spreadsheets that
are broken down into the following eight volumes:
previously-published tables of projections
specimen adjusted interim Cohort Projections
specimen P-spline age-period projections
specimen P-spline age-cohort projections
specimen Lee-Carter projections
additional projections from version 1.1 of the library
additional projections from version 1.2 of the library
additional projections from version 1.3 of the library.
Each projection within the library gives one possible scenario for mortality rates
at each age up to the year 2130. However, none of the projections is
recommended for any particular situation, and the non-inclusion of a particular
projection does not imply that it is unsuitable. Provision of the library does not
take away the need for individual actuaries to use their own judgement and to
make recommendations best suited to the situation.
On publication of the library, it was noted that assumptions at very old ages are
hugely uncertain, as there is very limited data on which to assess current rates
of mortality, let alone interpret rates of improvement. A range of approaches can
be taken to deal with this area of extreme data shortage. A common approach is
to use a limiting age; the library user guide suggests alternatives that might be
more appropriate in any given situation.
Recent CMI tables have assumed a limiting age of 120 so that q120 = 1. However, some
projections show significant improvements in mortality even at high ages. The library
user guide considers the impact of increasing the limiting age, or applying the
improvement rates for age 119 to older ages.
All projections are presented in a similar format, for ease of use. It is the
intention that the library will continue to be updated by the CMI.
6.9 What experience should be projected?
In practice, most life insurance companies set mortality and longevity

assumptions based on their own experience.
This is often done by adjusting one of the CMI tables, normally the most relevant
table in the 00 series. The approach taken may make use of complex
statistical models which include postcode as a proxy to socio-economic factors.

There is nothing inherently wrong in using older tables. The key thing is to use a
mortality table that has an appropriate shape of mortality variations by age. The
importance of finding the best fit to expected experience will depend on the use
(eg pricing or supervisory valuation) and the consequences of accepting a broadly
approximate fit rather than a better fit.
For annuity business, future mortality improvement assumptions are of

fundamental importance, but an insurer is unlikely to have sufficient historical
data with which to identify trends fully. It may therefore base its assumptions on
an analysis of population data, using stochastic projection methods to derive a
range of potential future scenarios. The CMI projections model is widely used to
express future mortality improvement assumptions.
Changes in smoking habits and cardiovascular disease mortality have been

identified as important factors affecting mortality improvements. However, it is
not believed that changes in smoking incidence explain all patterns. Mortality
improvements for almost all causes arise due to the interaction of a number of
factors. Many of these factors are common to several causes and few of the
interactions are fully understood. Therefore, it is very difficult to model cause-
specific mortality rates in a robust way.
This is a good example of where work can be advanced through the interaction of
actuaries with other professions, in this case the medical profession.
A key issue is the extent to which improvement rates based on population or

assured lives mortality can be appropriate for modelling the mortality of
annuitants and pensioners, especially as the pace of improvement has been
consistently more rapid for the higher socio-economic groups such as
annuitants and pensioners (25 to 50 per cent higher in recent decades).
Also, in terms of the cohort effect, rapid improvements have occurred earlier for
higher socio-economic groups. This may be the result of earlier lifestyle
changes beneficial to health, such as reduction in smoking and improvement in
diet.
If population mortality is used as the basis for a stochastic projection

methodology, the magnitude and form of any adjustment to allow for these
improvements has to be at the discretion of each user and dependent on their
views of the particular market they are involved in.
Any of the projections in the CMIs library can, in theory, be used with any base table,
but when doing so the actuary must consider whether adjustments to the improvement
factors are necessary.

6.10 Sources of uncertainty
Various sources of uncertainty may influence the modelling of rates of mortality,

and their projection into the future. Simple statistical uncertainty is enough to
wipe out, or double, profit margins on, for example, annuities.
Question 27.14
Suggest ways to reduce the impact of statistical uncertainty on an insurers annuity

profits.
Uncertainty must be an explicit part of the management process for longevity

risk. This includes pricing, profit reporting, and statutory valuations.
Companies with small portfolios suffer much more from uncertainty than larger
ones, although even the largest is never immune.
Three particular sources of uncertainty that are associated specifically with the
use of statistical models are as follows it is not clear which of the three is the
most significant:
Model uncertainty
Often a choice of models presents itself. If an appropriate family of models has

been chosen, collecting more data may reduce model uncertainty.
Parameter uncertainty
Even if model uncertainty were absent, and the correct model were known,
there would be uncertainty about the choice of parameters suggested by any
finite set of observations. This is often capable of being measured by estimating
the distribution of the parameter estimates. Given the correct model,
collecting more data reduces parameter uncertainty.
Stochastic uncertainty
When a model is used for prediction, the predicted quantity may be inherently
stochastic. For example, suppose a model has been chosen to represent
mortality rates in a given population by age and calendar year. It has been
parameterised using historical data, and it is to be used to predict the number of
deaths next year. Even if the correct model and correct parameters were
known, the outcome would be uncertain.

6.11 Conclusion to mortality projections
There are no definitive answers when it comes to projecting future mortality.

Stochastic methodology should not be seen as a means of supplying definitive
answers to questions that have strong subjective elements. The CMIs view is
that all users of mortality projections should increasingly focus on the
uncertainty surrounding scenarios. Developing a stochastic methodology is one
way of making this uncertainty a central feature of the basis.
This uncertainty should also be a central feature of discussions with clients and boards.
6.12 Longevity hedging
Many life insurance companies face significant levels of longevity risk,

particularly within immediate annuity portfolios ie at older ages. Longevity
swaps are a tool which can be used by such companies to hedge this risk,
without also hedging investment risks at the same time.
For example, Aviva hedged 475 million of annuity business using a longevity swap in
2009.
The purpose of the swap, from the insurance companys perspective, is to

remove the uncertainty around the cost of providing immediate annuities by
fixing this cost.
The swap has two counterparties:

counterparty A (the insurance company)
counterparty B (a reinsurer or bank).
The swap market may be attractive to banks as the profits they earn should have low
correlation with the financial markets.
The swap may be structured as reinsurance, or it may be structured in derivative

format with standardised legal wording.
Counterparty A pays a fixed series of payments agreed at the outset of the swap
(the fixed leg or reinsurance premiums).
The fixed payments will reflect counterparty Bs best estimate of the annuity costs plus
a risk premium.
The payments are fixed, in that they are known at outset. However, these payments
usually reduce over time as they are likely to be related to the expected number of
survivors in the annuity book.

SA2-27: Risk management and controls Page 32A
Notice that the reinsurance and derivatives markets use different terminology. The
payments made by Counterparty A under the fixed leg in the derivatives market are
simply called reinsurance premiums in the reinsurance market.
Counterparty B pays a floating series of payments linked to the actual annuity

amounts paid (the floating leg or reinsurance claims).
In practice, only the difference between the fixed and floating payments changes hands.
As a result of the transaction, the insurance company has fixed its future
outgoings but has increased its counterparty risk, ie it is exposed to the risk that
counterparty B does not honour its obligations. Equally, counterparty B is
exposed to the risk that the insurance company defaults on its payments.
Therefore, an important part of the swap is the collateral mechanism.
Collateral takes into account the value of the swap at any given date, ie the
present value of the floating leg less the present value of the fixed leg. If this is
positive then counterparty A is at risk and would require this amount of
collateral. If it is negative then counterparty B is at risk and would require this
absolute amount of collateral.
In order to calculate the value of the swap the counterparties need to agree the
discount rate (typically this is based on a swap curve) and also, in order to value
the floating leg, they need to agree a mechanism for determining the assumed
life expectancy (ie the forward rate of mortality).
The collateral is calculated on a regular basis.
When the floating payments are based upon the actual annuity payments then
the insurance company has indemnified itself against its longevity risk. An
alternative structure involves basing the payments upon a generic population
mortality index, in which case the insurance company retains an element of
basis risk.
If payments are based on a generic mortality index then the insurer is exposed to the
risk that the floating payments do not follow the insurers own experience. This is
called basis risk





the course.

SA2-29: With-profits surrender values Page 1
Chapter 29
With-profits surrender values
Syllabus objective
(g) Describe the management of UK with-profits business, including:

the determination of discontinuance and alteration terms.
(Surrender values are covered in this chapter.)
0 Introduction
In this chapter we consider surrender values for with-profits business.
The general methodologies and considerations for surrender values as outlined

in Subject ST2 are relevant to with-profits as well as without-profits business.
This chapter covers additional issues that are specific to with-profits business or
to the UK environment. Candidates are strongly advised to review the
Subject ST2 Notes, as these will supplement the comments made below.
The Core Reading in this chapter refers to asset share and earned asset share. The
ActEd text uses the phrase asset share throughout. The two terms can be used
interchangeably for exam purposes.

Page 2 SA2-29: With-profits surrender values
1 Principles
The principles to be considered in setting surrender values have already been
considered in Subject ST2.
Question 29.1
What are they?
In addition to the principles outlined in Subject ST2, PPFMs include explicit

statements about a companys practice regarding surrender values relative to
asset shares. It is very important to ensure that the actual method used is
consistent with the PPFM and the WPA will confirm compliance with the PPFM
on an annual basis.
For example, the PPFM may state a target range for surrender values as a percentage of
the unsmoothed asset share. However, this target range may have a lower upper limit
than the target range applied to maturities.
1.1 Profit and retained surplus
The determination of surrender values for with- and without-profits policies is very
different. This difference occurs primarily in the approach taken to profit.
Without-profits business exists to generate profits for the life company, so the surrender
terms should allow the company to retain profit accrued to date and (perhaps) the profit
that would accrue were the contract to continue.

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SA2: CMP Upgrade 2013/14 Page 1

This CMP Upgrade contains:

all changes to the Syllabus objectives

significant changes to Core Reading

The Actuarial Education Company IFE: 2014 Examinations

1 Changes to the Syllabus objectives

(b) Describe the major products of interest to UK life insurance companies,

IFE: 2014 Examinations The Actuarial Education Company

2. The supervision of the UK business of life insurance companies under

3. The principles underlying the Solvency II regulatory regime.

4. The transfer of liabilities from one life insurance company to another.

6. An analysis of surplus on a supervisory basis reasons for carrying out

7. Profit and value reporting under the Companies Act legislation, EU

8. An analysis of the change in the embedded value of a proprietary UK life

9. The Conduct of Business rules with regard to Treating Customers Fairly,

The Actuarial Education Company IFE: 2014 Examinations

10. The management and controls to be exercised by a life insurance

11. The principles underlying the requirements of the professional standards

IFE: 2014 Examinations The Actuarial Education Company

2 Changes to the Core Reading and ActEd Course Notes

The first paragraph of ActEd text has been amended to read:

other recommended references on the Life practice area of the Institute

Demystifying the risk margin: theory, practice and regulation

Dynamic management actions

Clark, D; Kent, J; Morgan, E

The web address for the TASs (Chapter 16) is now:

The Actuarial Education Company IFE: 2014 Examinations

Insurance accounting: a new era?

The following paper has been added to the reading list:

Chapters 25 and 26 Surplus distribution

Equity between with-profits policyholders and shareholders

The first bullet point has been amended to read:

The regulators www.bankofengland.co.uk/pra and www.fca.org.uk/

The last bullet point has been amended to read:

The IFRS Foundation and the IASB www.ifrs.org

IFE: 2014 Examinations The Actuarial Education Company

The second paragraph of ActEd text has been amended to read:

The second paragraph of Core Reading has been amended to read:

Terminal illness, which does not pay out on diagnosis of a specified

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The last two paragraphs of Core Reading have been deleted.

This section has been deleted.

The summary of deposit administration contracts has been deleted.

IFE: 2014 Examinations The Actuarial Education Company

A new summary for microinsurance has been added:

Microinsurance is targeted at low income groups, particularly in the developing world.

Microinsurance offers protection to those who cannot afford traditional insurance.

The first paragraph of Core Reading has been amended to read:

The Actuarial Education Company IFE: 2014 Examinations

Notwithstanding the bursting of the technology bubble in stock market terms in

The final two paragraphs have been amended to read:

IFE: 2014 Examinations The Actuarial Education Company

Independent Financial Advisers (IFAs) and Whole of Market Advisers (WMAs)

The penultimate paragraph has been shortened so that it now reads:

The penultimate paragraph of Core Reading has been amended to read:

The last paragraph of Core Reading has been amended to read:

The Actuarial Education Company IFE: 2014 Examinations

The first paragraph of Core Reading has been amended to read:

The third paragraph of Core Reading has been amended to read:

The first two paragraphs have been amended to read:

The Unfair Terms in Consumer Contracts Regulations 1999 give some

IFE: 2014 Examinations The Actuarial Education Company

The first paragraph of Core Reading has been amended to read: