September 2012 Q4iii)

Hi,

I can’t see this having been asked before on the forums:

I understand how the inflation factors have been calculated, but I don’t understand how m1 and m2 have been calculated, and why 2009 hasn’t been adjusted for 2 months of inflation in the solution.

When attempting the question, I multiplied the 2007 SI by 1.05^(26/12), the 2008 SI by 1.05^(14/12) and the 2009 SI by 1.05^(2/12), which is clearly incorrect but I’m not sure why.

Any help gratefully received.

 

For 2007
I think the assumption you've made is somewhere along the lines of there being 25.1m sum insured as at 1st November 2007 and attempted to inflate that by the 13 months it is exposed to a 5% inflation (i.e. up to 31st December 2009).

The examiner's report only inflates the 25.1m sum insured from the middle of the exposure period (i.e. 1st May 2008), so only 20 months [1.05^(20/12) = 1.08471].

This might be the assumption I had made too. However, the examiner's report does note (see assumptions) include the following comment: "or other sensible assumption, provided calculations are consistent)." So, if you stated that all SI is written at the beginning of the policy year, and SI is at the beginning of the year for inflation purposed, then carried those forward you may well be okay (or at least not lose many marks). I think this would similarly apply to your logic for other years.

M1 Trend Factor
They give this as one possible option (which they use in the rest of their solution).
It is just the inflation factor applicable for the midpoint of the policy year (6 months in). This approach is consistent with their "SI is at midpoint of year for inflation purposes" assumption.
Again, this is why they've only applied 20 months of inflation to 2007.

M2 Trend Factor
This second option is a little more calculation intensive. I'd suggest avoiding unless it's really necessary for the exam question.
But, since you asked...M2 is the (mean) average of all inflation factors across the policy year (e.g. for 2009, the average of 1.00816, 1.00407 & ten 1.000's)
I guess assumption 2 might look slightly different here...I don't know how I'd word it.

That was quite a long-winded answer to your question, but anyway...

I'm not an examiner, so I don't know precisely how things are marked, but so long as you clearly state the assumptions you've made, I don't think you'll lose many marks. As a general rule of thumb though, I always had a preference of assuming I was applying any adjustments from the midpoint of the exposure period. It feels more 'sensible' (in examiner's report terms) to think of SI being written evenly across each year, particularly for this LOB, than all at the same time.

Good luck!