This paper was written by the Derivatives Working Party, a permanent working party of the Life Research Committee of the Institute and Faculty of Actuaries. Our aim is to consider how life assurers may use, or may wish to use, derivatives, and if their use is unduly constrained, e.g. by regulation. This paper focuses on credit derivatives. We provide an overview of the credit derivatives market, and the strong growth in this market over recent years. We then focus on the two main traded credit derivative instruments — Credit Default Swaps (CDSs) and Collateralised Debt Obligations (CDOs). We explain how these instruments work and are priced, and clarify some of the more complex topics involved, such as the settlement of CDSs, basis risk and the relevance of implied correlation in pricing CDOs. We then consider how life insurers could make use of credit derivatives, for example to provide more efficient investment management in taking exposure to credit risk, or to hedge credit exposures, and consider the regulatory implications of so doing. Finally, in the Appendix, we discuss the credit spread puzzle, and the existence or otherwise of a liquidity premium in corporate bond spreads, with implications for the valuation of illiquid liabilities.

Projections of future mortality typically used for funding pension scheme liabilities assume that future year-on-year decreases in mortality rates will slow rapidly, and that there is very limited potential for further decreases at the oldest ages. This paper considers the consistency of such projections with current trends in life expectancy. Particular focus is paid to whether future mortality should be subject to a minimum level of improvement to reflect general advances in medicine. Care is taken to exclude the additional increases in longevity arising from a concentration of positive health factors amongst the generation who are currently experiencing the ‘cohort effect’.

If historic trends continue into the future, then period life expectancy from age 65 in England & Wales will increase at 26 days p.a. for women and 41 days p.a. for men, with additional increases arising from the ‘cohort effect’. This is a faster rate of period increase in life expectancy than embedded in the interim cohort projections. One way to ensure that actuarial projections keep pace with the population trend is to subject projections to a minimum level of (geometric) improvement of at least 11/4% p.a. for men and 3/4% p.a. for women, at all older ages and in all future years.

Consideration is given to the possible impact of differences between the socio-economic profile of England & Wales and the membership of the pension schemes to whom the projections will be applied ultimately. This paper also highlights that the application of a single minimum value, independent of time and age, simplifies a more complex underlying pattern, but that minimum improvements of 11/4% p.a. for males and 3/4% p.a. for females represent an average of historic improvements in mortality seen in England & Wales.

The paper includes a survey of the history of the low levels of mortality seen currently. The survey includes some discussion on the potential for future improvements and considers topical issues, such as the potential impact of obesity on life expectancy projections (and, in turn, the minimum value applied to improvements).

The financial impact of subjecting projections of mortality improvement to a minimum value is quantified.

This Presidential Address considers what needs to be done to enable the United Kingdom actuarial profession to flourish in a more competitive environment. It addresses the need for continued modernisation of the actuarial skill-set, and the need to pay greater attention to the way we communicate our findings. The Address briefly reviews some of the recent changes to the regulation of life assurance in the U.K. before considering the role and structure of the professional body in the post-Morris era. It ends with some thoughts on developments in education and CPD.

This Presidential Address is delivered towards the end of the 150th anniversary year of the Faculty of Actuaries, and is timed to coincide with the International Actuarial Association and Groupe Consultatif holding meetings in Edinburgh. It deals with the growing globalisation of the Profession, reviews the key developments arising out of the Morris Review and the implications of current changes. It then moves on to examine communication and the role the Profession can play with the media. A comparison between actuarial practice in life and pensions follows, with suggestions for a closer alignment between pension expectation and pension reality. Comment is made about the prospects for healthy life expectancy. Finally, the relationship between the Faculty and the Institute of Actuaries is debated, and a consultation with Faculty members is launched.

This paper overviews a practical approach to the assessment of operational risk in life insurance companies. It considers how actuaries, working in conjunction with risk management professionals and senior management, can develop a framework to assess the capital requirements relating to operational risk, taking into account the capital requirements of other risks and their interaction.

This paper recognises that we do not live in an ideal world, and that a lot of the data which one might want for operational risk assessment are not, and in some cases never will be, available. Consequently, the approach outlined in this paper takes into account the fact that management and assessment of operational risk is at an early stage of development in the life industry. In addition, it outlines some of the areas where development is necessary or desirable in the coming years.

There is a section on the operational risks against which it is appropriate to hold capital. As this is a new area for insurance companies, and given the governance requirements for Individual Capital Assessments, it is important to explain the results effectively to senior management. Therefore, a brief review of techniques for reporting the results of the assessment is provided.

The paper concludes with some thoughts on how operational risk management can be embedded more in the business, and then considers what future work will help develop the framework. To echo the thoughts of the authors of the general insurance paper on this topic (Tripp et al., 2004), we hope that the paper will sow seeds for the development of best practice in dealing with operational risk, and will raise the awareness and increase the interest of actuaries in this emerging topic.

This paper represents the views of the individuals in the working party, and not necessarily the views of their employers or the Actuarial Profession.

Patterns and trends in late-life mortality are of growing financial importance. The growth in pension liabilities, both public and private, are of crucial interest to governments, insurers and companies with defined benefit pension schemes. This paper explores the patterns in international mortality data, and draws important lessons for actuaries in the United Kingdom.

Under the new regulatory regime, it is a requirement that the trustees and the sponsors of pension schemes negotiate scheme funding according to a defined process. For some schemes these negotiations have already started; for many they are due to start shortly. What is clear is that the outcome of the first funding negotiation is critical, as it will set the benchmark for the future.

This Sessional Meeting covers pension scheme funding negotiation, with an emphasis on:

— the ways in which actuaries, trustees and sponsors can, or should, take account of the credit quality of the sponsor;

— the lessons on negotiation drawn from other areas of finance; and

— the role of the regulator.

The meeting takes the form of presentations by three speakers, taking stock of the current situation, and the discussion follows.

The European Commission's project to develop a Europe-wide risk-based solvency supervision framework is well advanced, with the draft Directive due to be put before the European Parliament in June 2007. The consultation exercise which has helped to shape the proposals has been wide ranging, and will continue for some time to come. Actuarial input into the proposals has been extensive. As well as the activity of individual actuaries, the Groupe Consultatif has a large team of volunteers spread across a number of working parties, and the United Kingdom Actuarial Profession has two U.K. working parties set up, respectively, by the General Insurance and the Life Boards.

While many aspects of the proposed framework have been well debated across Europe and the overall shape of the likely final outcome is reasonably well understood, a number of significant issues still remain. It is important that actuaries are aware of what might be in store, and what could be done now to help to prepare for the new regime.

On the eve of the start of the third round of Europe-wide test calculations (Quantitative Impact Study 3, or QIS3 for short), therefore, it is appropriate to hold a Panel Discussion to explore some of the key issues and possible implications. A Briefing Note follows this introduction.

The meeting takes the form of presentations by the three panel members, and the discussion follows.

The abstract of the discussion held by the Institute of Actuaries on 30 October 2006 is printed in British Actuarial Journal, 13, I, 61-80.

Capital and cost of capital form a bridge between the insurance firm and the financial markets. The term capital is used in various ways. In current parlance, economic capital is frequently used to mean capital calculated using a risk-based measure which is independent of the regulatory requirements. In this paper we discuss the concept of target capital, where the firm takes account of three different approaches to risk appetite: regulatory capital plus a buffer; rating agency views; and the views of shareholders, where they make commitments to customers and wish to protect franchise value. We describe how, when blending these views, the firm needs to understand the trade-offs between too high and too low amounts of capital, with reference to the double taxation burden, insurance gearing (leverage of premiums to capital ratio), and the impact of the firm's credit rating on maximising franchise value. We then discuss the main drivers of the cost of capital, which we define as the required total return on the market value of the firm, as determined by reference to the opportunity cost of alternative investments of equivalent risk. We explain that, because the stock market value of the firm is not the same as the capital held inside the firm, the cost of capital derived from external studies cannot be directly applied to internal measures of target return such as return on equity (ROE); it is necessary to translate between the two measures. We separate the risk of the firm between the investment risk and the insurance risk. We describe the frictional costs of investing in an insurance firm, and explain the role of parameter and model risk arising from the uncertainty of the future claim costs of the firm. We describe the findings of two studies of the actual historical stock market returns of United States P&C companies. One of them suggests that applying the Fama-French model produces higher and more accurate cost of capital estimates than the capital asset pricing model (CAPM) method. This is explained by linking the price to book ratio to the costs of financial distress, which are particularly important for general insurance firms, given the influence of insurance strength ratings from the rating agencies. Finally, we attempt to estimate the risk load required in premiums to compensate investors for the elements of cost of capital which we have described, in a way that combines the financial economic approaches to insurance target returns with the traditional actuarial approaches to assessing the risks in the insurance business.

This paper looks at the risks faced by financial institutions, and how they can be modelled and managed. I compare the way in which each of the risks affects different types of financial institution and look for similarities (and differences) across industries. Finally, I consider what makes a good risk management system.

The General Insurance Premium Rating Issues Working Party (GRIP) was established by the General Insurance Board of the Faculty and Institute of Actuaries in 2005 to review actuarial involvement in premium rating issues, pricing being one of the key areas in which actuaries work.

GRIP published a full report in January 2007, which is available at www.actuaries.org.uk/grip. This short paper summarises the recommendations of that full report. Further background, discussion and the rationale for these recommendations are set out in more detail in the full report.

In the following discussion, whenever reference is made to ‘the paper’, this is the paper Anderson et al. (2007), which is the full paper produced by the General Insurance Premium Rating Working Party (GRIP), and which is being discussed here. The full reference on how to access the paper is given at the end of the Summary Paper, which appears immediately before this discussion.