Range of weight for Section A: 20-30 percent
The portfolio theory portion of this section discusses the relationship between the risk and return for different combinations of risky and risk-free investments and discusses the effect of diversification on this relationship. Candidates are introduced to the manner in which investors might select a particular portfolio, from those available, that best suits their individual preferences for risk and return. In the portion of this section on equilibrium in capital markets, various equilibrium models are presented, including the Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT). The concept of market efficiency is presented to help candidates understand the factors that move market prices towards and away from the theoretical prices presented in these models.
Relevant concepts should be treated from an insurance perspective.
Concepts of risk should cover Rothschild-Stiglitz four characterizations of risk.
Include value functions and adjusted probabilities in addition to utility.
| LEARNING OBJECTIVES | KNOWLEDGE STATEMENTS |
|---|---|
| 9A.1 Explain key concepts of risk: | a. Utility functions, utility |
| scores, and utility | |
| - Appetite | maximization |
| - Tolerance | b. Risk aversion |
| - Aversion | c. Mean-variance criterion |
| - Measurement | d. Capital allocation line |
| - Portfolio construction | e. Complete portfolio |
| - Strategies for monitoring | f. Reward to volatility ratio |
| (Sharpe ratio) | |
| g. Passive versus active | |
| strategies: costs of active | |
| strategy and free-rider | |
| benefit | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - BKM, Chapter 6 | |
| 9A.2 Calculate the expected | a. Expected return and standard |
| value, variance, and covariance | deviation for portfolios of |
| of returns of asset portfolios | risky and risk-free assets |
| in a multi-dimensional setting. | |
| b. Optimal risky portfolio | |
| c. Optimal complete portfolio | |
| Range of weight: 0-5 percent | |
| 9A.3 Describe the Markowitz | a. Minimum variance frontier |
| Portfolio Selection Model. | |
| b. Efficient frontier of risky | |
| assets | |
| c. Optimal capital allocation | |
| line | |
| d. Separation property | |
| e. Asset allocation versus | |
| security selection | |
| Range of weight: 0-5 percent | |
| 9A.4 Explain and demonstrate | a. Systematic risk |
| effects of various | |
| diversification strategies. | b. Risk pooling |
| c. Risk sharing | |
| d. Insurance principle | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - BKM, Chapter 7 | |
| 9A.5 Explain and use the single | a. Markowitz model |
| factor models and | |
| compare/contrast the process of | b. Single factor model |
| portfolio construction with the | |
| full covariance (Markowitz) | c. Single index model |
| model. | |
| d. Systematic risk | |
| e. Alpha, Beta estimating and | |
| forecasting | |
| f. Covariance and correlation | |
| estimates for single index | |
| model | |
| g. Risk premiums due to market | |
| and non-market factors | |
| h. Parameter estimation risk | |
| i. Macroeconomic factors | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - BKM, Chapter 8 | |
| 9A.6 Explain the assumptions and | a. CAPM assumptions |
| construction of CAPM and use | |
| CAPM to calculate expected | b. Market price of risk |
| returns for risky securities. | |
| c. Capital market line | |
| d. Security market line | |
| Range of weight: 3-7 percent | |
| 9A.7 Compare/contrast CAPM and | a. CAPM |
| single index model and explain | |
| the assumptions that are | b. Single index model |
| modified under various | |
| extensions of CAPM. | c. Expected versus actual |
| returns | |
| d. Market portfolio versus | |
| market index | |
| e. Extensions of CAPM | |
| - Zero Beta CAPM | |
| - CAPM with non-traded | |
| assets and labor income | |
| - ICAPM | |
| - CAPM with liquidity | |
| adjustments | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - BKM, Chapter 9 | |
| 9A.8 Use APT to determine the | a. Arbitrage and the Law of One |
| expected return for a security | Price |
| and compare/contrast with CAPM | |
| and factor models. | b. APT and its comparison to |
| CAPM | |
| c. Factor betas | |
| d. Factor portfolios and factor | |
| risk premiums | |
| e. Fama and French’s 3 Factor | |
| Model | |
| f. Alternative factors in | |
| multifactor models | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - BKM, Chapter 10 | |
| 9A.9 Explain market efficiency | a. Efficient market hypothesis |
| and its implications for | |
| portfolio management, and | b. Random walk |
| describe the various tests and | |
| studies of market efficiency. | c. Technical analysis |
| d. Fundamental analysis | |
| e. Passive investment strategy | |
| f. Portfolio management | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - BKM, Chapter 11 | |
| 9A.10 Explain the influence of | a. Information processing errors |
| behavioral finance in | |
| understanding certain aspects | b. Behavioral biases |
| of market efficiency. | |
| c. Limits to arbitrage | |
| d. Violations of Law of One | |
| Price | |
| e. Behavioral critique | |
| f. Technical analysis | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - BKM, Chapter 12 |
Range of weight for Section B: 10-20 percent
This section exposes the candidate to factors that influence the price sensitivity of fixed income securities and presents various ways in which a portfolio manager might manage the interest rate and cash flow risk in a portfolio of these instruments. The same concepts are also applied to the interest rate risk associated with a firm’s liabilities and the interest rate risk associated with a firm’s total market value, inclusive of their franchise value.
| LEARNING OBJECTIVES | KNOWLEDGE STATEMENTS |
|---|---|
| 9B.1 Explain the different Term | a. Expectations hypothesis |
| Structure Theories | |
| b. Liquidity preference theory | |
| c. Forward rates versus expected | |
| short rates and spot rates | |
| Range of weight: 0-5 percent | |
| 9B.2 Determine U.S. Treasury zero | a. Determining zero rates from |
| rates at different maturities. | coupon bonds using both |
| annual and semi-annual | |
| compounding | |
| b. Determining forward rates | |
| from spot rates (zero | |
| rates) | |
| c. Spot rates | |
| d. Short rates | |
| e. Forward Contracts | |
| f. Treasury Inflation Protected | |
| Securities (TIPS) | |
| Range of weight: 3-7 percent | |
| READINGS | |
| - BKM, Chapters 14, 15 and 16 | |
| 9B.3 Utilize various strategies | a. Duration (Macaulay, modified, |
| to manage interest rate risk | and effective) |
| and cash flow risk in a bond | |
| portfolio. | b. Convexity |
| c. The effect of interest | |
| changes on bond prices | |
| d. Immunization | |
| e. Cash flow matching and | |
| dedication | |
| f. Rebalancing | |
| g. Use of interest rate swaps, | |
| mortgage-backed securities, | |
| and other derivative | |
| securities to alter the | |
| interest rate risk for a | |
| bond portfolio | |
| h. Currency swaps | |
| Range of weight: 3-7 percent | |
| READINGS | |
| - BKM, Chapters 16 and 23 | |
| (Sections 23.3 and 23.4) | |
| 9B.4 Quantify franchise value, | a. Total economic value |
| evaluate the impact of interest | |
| rate sensitivity, and | b. Franchise value—magnitude |
| demonstrate how interest rate | and exposure to interest |
| sensitivity of the franchise | rate risk (duration) |
| value can be managed. | |
| c. Pricing strategy | |
| d. Advantages of managing the | |
| interest rate sensitivity | |
| of | |
| the firm’s total economic value | |
| through pricing strategy | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - Panning |
Range of weight for Section C: 25-35 percent
This section addresses financial risks as well as risks related to the insurance industry from the financial economics perspective. The concepts and techniques presented in this section are important components in the field of enterprise risk management.
| LEARNING OBJECTIVES | KNOWLEDGE STATEMENTS |
|---|---|
| 9C.1 Estimate the credit risk due | a. Default risk |
| to default and default | b. Bond safety determinants |
| correlation associated with | |
| fixed income securities. | c. Expected loss from default |
| d. Yield spread | |
| Range of weight: 0-5 percent | |
| 9C.2 Describe the credit risk in | a. Counterparty default risk |
| derivatives transactions and | |
| various mechanisms to manage | b. Collateralization |
| the risk. | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - BKM, Chapter 14 | |
| 9C.3 Describe the reasons for the | a. Credit default swaps (CDS) |
| development of credit | b. Types of Active Bond |
| derivatives market, the | Portfolio management swaps |
| valuation of credit derivative | |
| contracts, and the complexity | c. Collateralized debt |
| of trading credit risks. | obligations (CDOs) and |
| related structured | |
| financial instruments | |
| d. The role credit derivative | |
| contracts played in the | |
| 2008 financial crisis | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - BKM, Chapters 14 and 16 | |
| - Coval, Jurek, and Stafford | |
| 9C.4 Discuss the development and | a. Effect of securitization on |
| the complexity of financial | sources of funds for |
| engineering products such as | mortgage holders and on |
| mortgage- backed securities and | interest rate risk retained |
| other forms of securitization. | by the mortgage originators |
| b. Mortgage pass-throughs and | |
| the effect of mortgage | |
| prepayment on cash flows to | |
| investors | |
| c. Collateralized mortgage | |
| obligations (CMOs) and the | |
| effect of prepayments on | |
| cash flows to investors in | |
| particular tranches | |
| d. Market liquidity and premium | |
| spreads | |
| e. Lessons from the recent | |
| subprime crisis | |
| Range of weight: 0-5 percent | |
| 9C.5 Describe the market for | a. Products on the market: |
| securitizing catastrophe risk | |
| in the insurance industry and | - Risk-linked securities |
| explain the reasons for its | |
| growth. | - CAT bonds |
| - Sidecars | |
| - Cat-E-puts | |
| - Catastrophe risk swaps | |
| - Industry loss warranties | |
| b. Factors influencing interest | |
| in insurance securitization | |
| in relation to traditional | |
| reinsurance | |
| c. Factors impeding the growth | |
| of the market: | |
| - Regulatory | |
| - Accounting | |
| - Tax | |
| - Rating issues | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - BKM, Chapter 16 (Section | |
| 16.2) | |
| - Coval, Jurek, and Stafford | |
| - Cummins CAT Bond | |
| 9C.6 Describe various risk | a. Capital structure and risk |
| measures and the need for | taking incentives |
| practicing sound financial risk | |
| management. | b. Regulation and rating agency |
| c. Value at risk (VaR) | |
| d. Risk-based capital | |
| e. Expected policyholder deficit | |
| (EPD) | |
| f. Capital associated with a | |
| constant EPD ratio | |
| g. Risk-adjusted return on | |
| capital (RAROC), including | |
| alternative measures of | |
| income and alternative | |
| measures of risk-adjusted | |
| capital | |
| h. Economic value added (EVA) | |
| i. Percentile layer of capital | |
| j. Lessons from past failures | |
| due to poor financial risk | |
| management | |
| Range of weight: 3-7 percent | |
| READINGS | |
| - Bodoff | |
| - Butsic | |
| - Cummins Capital | |
| - Goldfarb | |
| 9C.7 Describe the concept of | a. Financial and insurance risks |
| economic capital (or risk | |
| capital) in the insurance | b. Economic capital or risk |
| industry and various methods of | capital |
| allocating the risk capital to | |
| business units or lines of | c. Risk aggregation |
| business. | |
| d. Strengths and weaknesses of | |
| the various allocation | |
| methods using risk measures | |
| such as: | |
| - Percentile (VaR) | |
| - Conditional tail | |
| expectation (CTE) | |
| - EPD Ratio | |
| - Merton-Perold method | |
| - Insolvency Put/EPD ratio | |
| risk measure | |
| - Myers-Read method | |
| - Co-Measures | |
| - Co-CTE | |
| - Percentile Layer of | |
| Capital | |
| Range of weight: 3-7 percent | |
| 9C.8 Apply the RAROC framework to | a. Economic profit as income |
| risk management in the | measure |
| insurance industry. | |
| b. Cost of capital | |
| c. RAROC | |
| d. Additional risk margin in | |
| price | |
| e. Multi-period capital | |
| commitment | |
| Range of weight: 0-5 percent | |
| 9C.9 Assess the performance of | a. Economic profit as income |
| business units and set prices | measure |
| for insurance policies on a | |
| risk-adjusted basis. | b. Cost of capital |
| c. RAROC | |
| d. Additional risk margin in | |
| price | |
| e. Multi-period capital | |
| commitment | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - Bodoff | |
| - Cummins Capital | |
| - Goldfarb |
Range of weight for Section D: 25-35 percent
This section explores the relationship between insurance concepts (such as underwriting profits, premium-to-surplus ratios, and investment income) and financial concepts (such as interest rates, inflation rates, cost of capital, and risk premiums). The readings build on a background of finance as related to the insurance business, and deal with specific techniques used by actuaries to develop an appropriate profit loading in insurance prices.
Because insurance claims are fortuitous, the expected profit loaded in rates may not be realized. Some models discuss insured events that are predictable in time and amount while other models consider when insured events are uncertain, particularly where capacity is limited and/or sufficient diversification of exposure is impossible.
| LEARNING OBJECTIVES | KNOWLEDGE STATEMENTS |
|---|---|
| 9D.1 Evaluate the internal rate | a. Inter-relationship between |
| of return framework. | the product market and |
| financial market | |
| b. IRR Model calculations | |
| c. Decision rule of the IRR | |
| model | |
| d. Distinction between equity | |
| flows and all other cash | |
| flows | |
| e. Impact of surplus allocation | |
| and timing on equity flows | |
| f. Methods of allocating surplus | |
| and impact on IRR | |
| g. Potential pitfalls in IRR | |
| analysis | |
| Range of weight: 3-7 percent | |
| READINGS | |
| - Feldblum Financial | |
| 9D.2 Evaluate the components of | a. Relationship between |
| total return to stockholders | profitability measures from |
| and how leverage can be used to | investors’ perspective, |
| maximize shareholder value. | society's perspective, and |
| regulators’ perspective | |
| b. Insurance leverage and | |
| reserve capital | |
| c. Influence of leverage on | |
| stockholders’ equity | |
| d. Optimal capital structure | |
| e. Dynamic relationship among | |
| formula variables | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - Ferrari | |
| 9D.3 Assess insurance | a. Policyholder versus investor |
| profitability. | perspectives |
| b. Return on equity versus | |
| return on sales | |
| c. Methods to determine | |
| benchmark rate of return | |
| Range of weight: 0-5 percent | |
| READINGS | |
| - McClenahan | |
| 9D.4 Describe the underwriting | a. Evolution of the profit |
| profit provision. | provision |
| b. Policyholder versus | |
| stockholder return | |
| c. Types of underwriting profit | |
| Range of weight: 0-5 percent | |
| 9D.5 Calculate and compare the | a. Calendar Year Investment |
| provision for underwriting | Offset procedure |
| profit in property and casualty | |
| insurance rates | b. Present Value Offset |
| procedure | |
| c. Calendar Year Return on | |
| Equity and Growth Model | |
| d. Present Value of Income over | |
| Present Value of Equity | |
| method | |
| e. Present Value Return on Cash | |
| Flow method | |
| f. Risk-Adjusted Discounted Cash | |
| Flow method | |
| g. Internal Rate of Return on | |
| Equity Flows method | |
| Range of weight: 3-7 percent | |
| READINGS | |
| - Robbin IRR | |
| - Robbin UW | |
| 9D.6 Use Riskiness Leverage | a. Relationship of capital needs |
| models to determine risk loads. | and risk loads |
| b. Forms of riskiness leverage | |
| models | |
| c. Representation of various | |
| risk attitudes with | |
| riskiness leverage models | |
| d. Properties of riskiness | |
| leverage models | |
| e. Evaluation of reinsurance | |
| purchases with riskiness | |
| leverage models from the | |
| cedant perspective | |
| Range of weight: 3-7 percent | |
| READINGS | |
| - Kreps Ratios | |
| 9D.7 Calculate and compare the | a. Order dependency |
| risk loads for property | |
| catastrophe insurance. | b. Marginal Surplus method |
| c. Marginal Variance method | |
| d. Sub-additive and | |
| super-additive properties | |
| e. Renewal additivity | |
| f. Shapley Value method | |
| g. Covariance Share method | |
| Range of weight: 3-7 percent | |
| READINGS | |
| - Mango |
posted 2022-02-18 | tags: NOC