INSTITUTE AND FACULTY OF ACTUARIES

EXAMINATION

12 September 2022 (am)

Subject CM1 – Actuarial Mathematics

Core Principles
Paper A
Time allowed: Three hours and twenty minutes

In addition to this paper you should have available the 2002 edition of
the Formulae and Tables and your own electronic calculator.

If you encounter any issues during the examination please contact the Assessment Team on
T. 0044 (0) 1865 268 873.

CM1A S2022 © Institute and Faculty of Actuaries

1 Calculate, showing all working, 3.5 q56.25 , assuming a constant force of mortality
between integer ages.

Basis:
Mortality ELT15 (females)
[4]

2 A non-tax-paying investor wishes to invest a lump sum for a period of 5 years. The
investor is considering depositing the lump sum with a bank. Interest will be credited
to the initial lump sum at a variable market rate. Interest will only be added when the
cash is withdrawn.

The investor has set up a generalised cashflow model for this investment.

Describe the cashflows with reference to the certainty and uncertainty of size and
timing of payments from the investor’s point of view. [4]

3 An individual aged 20 exact wishes to purchase a commercial property at age 45,

which is currently priced at $1,000,000. They plan to save a fixed amount, X, monthly
in advance for the first 10 years, then 2X monthly in advance for the remainder of the
term.

The investment return is expected to be 2.5% p.a. effective, and property price
inflation is expected to be 0.5% effective per half year.

Calculate X, using annuity functions. You must show all working. [5]

4 (i) Describe, in words, the meaning of the following: A 2 [2]

45 50:20

Two lives, x and y, are independent with respect to mortality. Life x is subject to a
constant force of mortality of 0.025, and life y is subject to a constant force of
mortality of 0.02.

(ii) Calculate the probability that life y dies more than 3 years after life x. When
performing your calculation, you should set out an appropriate integral
function and show all your working. [5]
[Total 7]

CM1A S2022–2
5 A decreasing 2-year term assurance pays a benefit at the end of the year of death.

The sum assured is £90,000 in the first year and £50,000 in the second year. No
benefit is payable on survival to the end of the second year.

(i) Determine the mean and variance of the present value of the benefit for this
contract issued to a life aged 62 exact. [6]

Basis:
Mortality AM92 ultimate
Interest 6.5% p.a. effective

(ii) Explain, without performing any further calculations, how the mean calculated
in part (i) would change if:

(a) the age at which the life had taken out the policy had been older than
62.

(b) select rather than ultimate mortality had been used.

[Note: You should consider (a) and (b) separately.] [2]

[Total 8]

6 The following information about the term structure of the interest rates is given:

Term Spot rate

(in years) (% p.a.)
1 2.3
2 2.8
3 X
4 3.5
5 4.5

A 1-year zero-coupon bond will be issued at time 3 and has a theoretical price of $95
per $100.

(i) Calculate, showing all working and assuming no arbitrage:

(a) X, the 3-year spot rate.

(b) the 2-year discrete forward rate starting at time 2.

[3]

A 5-year bond is issued paying annual coupons at 9% p.a. and is redeemable at 110%
of the par value.

(ii) Show that the annual gross effective redemption yield on this bond is
approximately 4.29%. [3]

(iii) Comment on the numerical value of the annual gross effective redemption
yield in part (ii). [3]
[Total 9]

CM1A S2022–3
 D
When pricing fixed interest bonds, the capital gains test compares i   to 1  t1   ,
p
7
R

where

p is the frequency of the coupon payment,

t1 is the income tax rate,
D is the annual coupon rate,
R is the redemption rate, and
i is the annual effective rate of return.

D
Show that if i    1  t1   then there is a capital gain at redemption.
p
(i) [4]
R

Two situations where a capital gains test needs to be performed are:

1. for an investor who pays capital gains tax.

2. where the redemption date of the bond is variable.

(ii) Explain, for these two situations, why the capital gains test is necessary. [6]
[Total 10]

8 A life insurance company issues 20-year term assurance policies to lives aged 45
exact. The sum assured of £300,000 is payable at the end of the year of death. Level
premiums are payable annually in advance for the term of the policy ceasing on the
death of the policyholder if earlier. The insurance company uses the following
assumptions:

Mortality AM92 (select)

Interest 4% p.a. effective

Expenses
Initial £250 incurred at the outset of the policy
Renewal £50 incurred at the start of the second and each subsequent policy year
Claim £75 incurred when the benefit is paid out

Commission
Initial 25% of the annual premium
Renewal 1.5% of each annual premium excluding the first

(i) Write down the gross future loss random variable at outset for the policy in
terms of Kx, the curtate future lifetime of a life aged x exact. [4]

The company sets the premium such that the expected present value of the gross
future loss random variable is equal to 4% of the expected present value of premium
income.

(ii) Calculate the gross premium, showing all working. [7]

[Total 11]

CM1A S2022–4
9 A unit-linked policy has the following profit vector:

Year In-force profit

1 –22
2 –25
3 –39
4 55
5 70

(i) Calculate, showing all working, the reserves required to zeroise the expected
negative future cashflows at the end of years 2 and 3, assuming the non-unit
fund accumulates at 3% p.a. effective and that qx = 0.02 for all ages. [3]

(ii) Determine the net present value of the profits, assuming a risk discount rate of
8% p.a.:

(a) before zeroisation.

(b) after zeroisation.

[6]

(iii) Comment on the results you obtained in part (ii). [2]

[Total 11]

CM1A S2022–5
10 On 1 January 2006, a life insurance company issued a portfolio of identical 25-year
endowment assurances with sums assured of £200,000 to lives then aged 40 exact.
Premiums of £3,885 are payable annually in advance and cease at the end of the
policy term or on earlier death. The sum assured is payable at maturity or at the end of
the year of death if earlier. At the start of 2021, there were 520 policies in force.

(i) Calculate, showing all working, the gross premium reserve per policy on
1 January 2021, using the prospective method. [4]

Reserving basis
Interest 4% p.a. effective
Mortality AM92 ultimate
Surrenders Ignore
Renewal expense £25 incurred at the beginning of each policy year
Claim expense £100 incurred at the same time as the benefit
payment is payable
Renewal commission 1% of the annual premium

The actual experience of the insurance company in respect of this portfolio of policies
during 2021 was:

 actual investment return on assets backing the reserves was 4.3%.

 2 deaths.
 10 surrenders, each receiving a surrender payment of £113,000 at the end of the
year.
 actual renewal expenses attributed to the entire portfolio were £55,000.
 total actual expenses incurred on handling the death claims were £200.
 actual renewal commission payments were 1% of the annual gross premium.

The gross premium reserve per policy on 1 January 2022 is £113,238, calculated
prospectively on the reserving basis above.

(ii) Calculate, showing all working, the total profit earned from this portfolio of
endowment assurances during 2021. [8]

(iii) Comment on the sources of profit, comparing the actual experience with the
reserving basis. [3]
[Total 15]

CM1A S2022–6
11 A loan of £300,000 was taken out on 1 January 2015. The loan is repaid by an annuity
payable quarterly in arrears for 12 years. The amount of the quarterly instalment
increases by £400 after every 4 years.

The instalments were calculated based on a nominal rate of interest of 6% p.a.

convertible quarterly.

(i) Assuming the equivalence principle applies, state an equation of value which
can be used to calculate the initial quarterly instalment, R. [3]

(ii) Using your answer to part (i), calculate R, showing all working. [4]

(iii) Calculate, showing all working, the amount of capital repaid in the first
quarterly instalment made on 31 March 2015. [2]

(iv) Calculate, using an appropriate annuity function, the amount of loan

outstanding immediately after the quarterly instalment due on
30 September 2022 has been made. You must show all working. [4]

On 1 October 2022, the borrower asked to change the loan contract such that the
quarterly payments would be level for the remainder of the term. The lender agreed,
provided that the interest rate was increased to 7.5% p.a. effective and that the
original term of the loan is unchanged.

(v) Calculate, using an appropriate annuity function, the new quarterly level
instalment. You must show all your working. [3]
[Total 16]

END OF PAPER

CM1A S2022–7