CAS Exam 9 Spring 2019, Question 16
Study guide: Exam 9
An insurance company is evaluating an opportunity to acquire a new line of business. Given the following information for the new line of business:
| Item | Value |
|---|---|
| Loss (millions) | $55 |
| Fixed Expense (millions) | $15 |
| Variable Expense Ratio | 20% |
| Investment Income on Surplus (millions), received at Time 1 | $3 |
| Risk-Free Rate | 5% |
| Average Market Return | 9% |
| Beta Coefficient for Losses | -0.25 |
| Income Tax Rate, taxes are paid at Time 1 | 21% |
Underwriting Cash Flow Patterns:
| Time in Years | Premium Payment Pattern | Loss Payment Pattern | Expense Payment Pattern |
|---|---|---|---|
| 0 | 0.60 | 0.30 | |
| 1 | 0.40 | 0.40 | 0.70 |
| 2 | 0.60 |
Part a (2.5 points)
Calculate the profit provision using the Risk-Adjusted Discounted Cash Flow method, discounting all cash flows to Time 1.
Part b (0.5 points)
The company will only move forward with the acquisition if the profit provision calculated in part a. above is positive. Identify and briefly describe whether this is appropriate.
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