June 2021 Volume 27 No. 2

Exams IRL: Exam 9

by Dan Watt, FCAS

The purpose of the “Exams IRL (in real life)” series is to share how content from CAS exams are used in the workplace today. In essence, the series aims to supply a little motivation by answering the questions “Why am I learning this stuff?” and “When am I ever going to use any of it?” If you have not already done so, please take a moment to read our prior articles (see Exams IRL Archive below).

For this issue, we’re focusing on Exam 9–Financial Risk and Rate of Return. In your journey through this material, you will gain an understanding of finance, investment and financial risk management topics. A deeper understanding of how risk is managed by utilizing the markets is vital for an actuary. We are, after all, predicting the future, which naturally includes subjectivity, assumptions and, therefore, risk.

As an actuary, you will interact regularly with business partners investing the capital and reserves for the company. Exam 9 will provide knowledge on portfolio management and equilibrium in capital markets, including the capital asset pricing model (CAPM). Having this background knowledge aids you when interacting with portfolio managers and other investment partners. It will help you see the big picture on how the risk of selling insurance policies is managed using diversification and how investment income has the ability to offset costs, allowing more competitive premiums for some lines of business. Seeing how the market directly affects your work as an actuary is incredibly important.
Exam 9 will also delve deeper into concepts related to enterprise risk management (ERM). “Enterprise” refers to the company as whole (i.e., managing risk for the total company). This part of the material digs deeper into the impacts of derivatives, introducing other instruments, such as collateralized debt obligations (CDOs) and mortgage-backed securities. You’ll also learn about how various investments are used to offset the impacts of catastrophes, such as CAT bonds.

My favorite part of the ERM material is digging into the causes of the subprime mortgage crisis. Now, watching the film The Big Short is fun and helpful, but Exam 9 allows you to get into the guts of what happened. It’s super interesting stuff! You will be intrigued and appalled simultaneously.

The ERM section of the material also teaches various measures used when analyzing risk. For example, value at risk (VaR), expected policyholder deficit (EPD), conditional tail expectation (CTE) and risk-adjusted return on capital (RAROC). These metrics are used along with selected thresholds to help inform decisions on how risky a particular line of business or product and the like is, thus informing risk management. This is particularly pertinent to actuaries when working with an economic capital model, which is vital for planning and investment strategy.

Lines of business differ in their riskiness. As such, it would be unfair for all lines to “pitch in equally,” so to speak, the dollars necessary as a risk buffer for the enterprise. In simple terms, the riskier lines should cover more of the risk capital than less risky lines. Exam 9 teaches the different ways this capital allocation is quantified. How should we compare the riskiness of the different lines? What is fair? These risk capital requirements flow into ratemaking decisions and premium costs. Therefore, this process has a direct impact on the profitability of a line and is handled very carefully. It is vital that actuaries understand capital allocation.

Finally, Exam 9 discusses how an appropriate profit loading is selected for insurance pricing. Again, we are predicting the future and, as such, the risk associated with the unknown needs to be taken into consideration. Much of this risk can be reduced by diversification, but fully reducing risk is impossible. Learning about rates of return, risk loads and contingency provisions will help you select proper profit loads when doing indications, which is also a vital skill for an actuary.

As with all of the actuarial exams, Exam 9 is tough, but the concepts provided are the core to P&C actuarial work. While studying for the exam, my recommendation is to do so with the mindset that every topic you dig into will be useful during the span of your career. The methods learned will be used. The assumptions memorized will become second nature. Exam 9 will make you a more effective partner at the table. Soak up the material! It is an incredibly helpful exam!


Exams IRL Archive

MAS I: https://www.casact.org/newsletter/article/exams-real-life-mas-i
MAS II: https://www.casact.org/newsletter/article/exams-real-life-mas-ii
Exam 5: https://www.casact.org/newsletter/article/exams-real-life-exam-5
Exam 6: https://www.casact.org/newsletter/article/exams-real-life-exam-6
Exam 7: https://www.casact.org/newsletter/article/exams-irl-exam-7
Exam 8: https://www.casact.org/newsletter/article/exams-irl-exam-8-advanced-ratemaking

 

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