CAS Exam 9 Spring 2013, Question 18

Study guide: Exam 9

An actuary has made the following assumptions for the purpose of pricing an auto policy for ABC Insurance Company:

Premium is collected in full on the effective date of the policy.
Fixed expenses equal to $50 are incurred and paid on the effective date of the policy.
Variable expenses equal to 15% of premium are incurred and paid on the effective date of the policy.
Expected future loss payments to be paid at the end of each year:
- $400 in year 1
- $200 in year 2
- $150 in year 3
The surplus requirement is set to 90% of loss reserves at the beginning of each year.
Taxes on investment income and underwriting profit are paid at the end of each year at a rate of 35%.
The risk-free interest rate is 3%, and the pre-tax return on the investment portfolio is 5.5%.
The market risk premium is 5%.
ABC is a publicly traded mono-line auto insurance carrier. The expected rate of return on ABC's stock is 7%.
ABC invests its assets in portfolio XYZ, which yields an expected rate of return of 5.5%.

Using the risk adjusted discounted cash flow model, determine the underwriting profit provision for the policy.

Part a (2.5 points)

No current syllabus covers this question; it is kept for the record.