Ch19: Models (2)

Question 1

The NPV profit criterion depends on several assumptions

Answer 1

1. there is a perfectly free and efficient capital market
2. when two risky investments are compared, each is discounted at a risk discount rate appropriate to its riskiness

Question 2

Disadvantages of NPV

Answer 2

• subject to the law of diminishing returns
• it says nothing about competition

Question 3

Useful measures with NPV

Answer 3

• relative to commission
• % of PV of premium income (which gives an indication of market share)

Question 4

When is NPV more reliable than IRR?

Answer 4

• if there is more than one change in sign in the stream of profits in the profit signature, the IRR will not normally be unique
• NPV can be related to useful indicators of the policy’s worth to the company, in terms of sales effort or market share
• IRR might not exist if makes profit from outset

Question 5

Disadvantages of DPP

Answer 5

• often disagrees with NPV as ignores all cashflows after the discounted payback period

Question 6

Marketability might lead to a reconsideration of

Answer 6

• the design of the product
• the distribution channel to be used
• the company’s profit requirement
• whether to proceed with marketing the product

Question 7

Disadvantages of writing capital-intensive business

Answer 7

• all other things equal, lower rate of return
• could lead directly to a problem with supervisory solvency
• could weaken company’s resilience to fall in value of assets
• reduce company’s apparent financial strength
• represents an opportunity cost
• could lead to unexpected problem with supervisory solvency if company sells much more business than anticipated

Question 8

EV definition

Answer 8

The value of the future profit stream from the company’s existing business together with the value of any net assets separately attributable to shareholders

Question 9

Two main ways in which the values of the assets and liabilities can be determined:

Answer 9

• supervisory values
• economic values

Question 10

What is dynamic solvency testing and why is it used?

Answer 10

• static solvency test will not enable the actuary to assess the company’s ability to withstand future changes in both the external economic environment and the particular experience of the company
• dynamic solvency test involves the projection of the company’s revenue account and balance sheet forward for a sufficient number of years so that the full effect of any potential risks may become apparent.

Question 11

Uses of capital

Answer 11

• write new business
• adopt a less restrictive investment policy
• smooth surplus distribution
• reduce the need for reinsurance
• smooth dividend payments to shareholders
• allow the company to seize any profitable business opportunities as they present themselves