CAS Exam 9 Spring 2014, Question 14
Study guide: Exam 9
A company writes two lines of business, A and B. The claim payment patterns are as follows:
| End of Year | A | B |
|---|---|---|
| 1 | 60% | 80% |
| 2 | 30% | 20% |
| 3 | 10% |
Assume the following:
- Risk-free interest rate is 5%.
- Cost of capital is 15% for each line.
- Undiscounted loss ratio is 70% for each line.
- Expense ratio is 25% for each line.
- Premium is $43 million for each line.
- Each line has been assigned $25 million of risk capital at the beginning of year 1.
- Expenses are paid at the end of year 1, and capital is released as claims are paid.
Determine which line of business the company should grow using the risk-adjusted return on capital (RAROC) framework.
Part a (2 points)
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