COURSE 8: Fall 2004 - 1 - GO TO NEXT PAGE
Finance and Enterprise Risk Management; Core Segment
Morning Session
**BEGINNING OF EXAMINATION**
FINANCE AND ENTERPRISE RISK MANAGEMENT; CORE SEGMENT
MORNING SESSION
Questions 1-3 pertain to the Case Study.
Each question should be answered independently.
1. (7 points) Zoolander Life is very concerned about being able to secure reinsurance for its
term life insurance business line after January 1, 2005. Richard Scarlet, the reinsurance
intermediary, has been unable to secure a replacement for Rose Re’s YRT reinsurance
program at a reasonable price.
As an alternative, Richard Scarlet has proposed accepting a 100% funds withheld
coinsurance contract which is available from Cranberry Reinsurance Solutions. Under
that arrangement, the reinsurance allowance is set at 10% of ceded premiums, and the
risk charge is 1% of the outstanding surplus account for the prior year.
A simplified income statement for the term life insurance business line follows:
Zoolander Life
Projected 2005
Term Life Business Line
Before Reinsurance
Premiums
Gross 33,000,000
Ceded 0
Net Premiums 33,000,000
Investment Income
Gross 1,650,000
Ceded 0
Net Investment Income 1,650,000
Reinsurance Allowance 0
Total Revenue 34,650,000
Claims & Surrenders
Gross 19,000,000
Ceded 0
Net Claims & Surrenders 19,000,000
Reserve Increase
Gross 11,000,000
Ceded 0
Net Reserve Increase 11,000,000
Total Benefits 30,000,000
Expenses & Commissions 3,500,000
Gain from Operations 1,150,000
COURSE 8: Fall 2004 - 2 - GO TO NEXT PAGE
Finance and Enterprise Risk Management; Core Segment
Morning Session
(a) For Zoolander Life, show:
i. the change in the income statement for 2005 under a 100% funds
withheld coinsurance arrangement
ii. the outstanding surplus account as of December 31, 2005.
(b) Explain, from Zoolander’s perspective, the benefits of their existing YRT
reinsurance as compared to the benefits of Cranberry’s proposed arrangement.
(c) Recommend if Zoolander should purchase the reinsurance from Cranberry Re or
should retain the risk. Defend your answer.
COURSE 8: Fall 2004 - 3 - GO TO NEXT PAGE
Finance and Enterprise Risk Management; Core Segment
Morning Session
Questions 1-3 pertain to the Case Study.
Each question should be answered independently.
2. (11 points) Bonnie Hawke, Zoolander Life’s 2nd Vice President of Capital Planning,
proposes to allocate capital by line of business using the GAAP required surplus
methodology. You are given the following information.
Zoolander Life Proposed Capital Allocation
Line of Business 2003 Projected
2004
Annuity 100.0 103.0
Disability 150.0 160.0
Life Insurance 200.0 240.0
Variable 215.0 225.0
Corporate 367.6 390.0
Total 1,032.6 1,118.0
(a) Explain why a company might choose to allocate capital by line of business.
(b) Evaluate the appropriateness of the proposed allocation method chosen by Bonnie
Hawke as compared to other capital allocation methods.
(c) Using Bonnie Hawke’s proposed allocation, determine whether each line of
business is projected to create or destroy economic value in 2004 and whether
each line of business is projected to generate free cash flow. Show your work.
(d) Explain the implications of the results in (c) above.
COURSE 8: Fall 2004 - 4 - GO TO NEXT PAGE
Finance and Enterprise Risk Management; Core Segment
Morning Session
Questions 1-3 pertain to the Case Study.
Each question should be answered independently.
