Scenario Background

Cascadia is a small country undergoing big changes. A decade ago, Cascadia enacted legislation to modernize its workforce. Among other things, the legislation established the Cascadia Department of Education Foundation (CDEF), a fund to support higher education costs for eligible Cascadian youth.

About the Cascadian school system

Most Cascadians send their children to public primary and secondary schools, which run from grade 1 to grade 10. Currently, all Cascadian colleges are publicly funded, and all charge the same tuition.

About the CDEF

The CDEF is separate from all other government funds. An independent body is tasked to manage the fund according to the risk guidelines given in the legislation. To fund the CDEF, a special payroll tax is assessed annually against each employed person. The amount of the tax was fixed at 1,050 Cascadian dollars (CAS) when the fund was established; legislative action is required to change the payroll tax assessment amount. The fund is available to pay up to four years of college1 tuition on behalf of eligible college students. The fund is very popular and recent legislation extended its lifetime to provide payments for any eligible student entering college within the next 30 years.

CDEF funding is available to students who graduate from a Cascadian public high school and enroll full-time and immediately at a Cascadian college. Students must maintain a 65% grade average to receive funding for each subsequent year. Funding covers the full cost of tuition and is available for four consecutive college years.

An Investment Statement consisting of

Statement of Investment Objectives

Policies

Return Expectations

Risk Management

was established to document the key investment objectives, policies, standards and procedures approved by the Board of Directors of the CDEF Investment Board for the assets of the CDEF, in accordance with the CDEF Investment Board Act and CDEF Investment Board Regulations. The Investment Statement is intended to govern the day-to-day management of the CDEF, including decision authorities, risk management policies and standards, performance measurement standards and reporting protocols.

1 In Cascadia, the word "college" is the generic term for any post-secondary undergraduate education.

The investment policy has not changed since the CDEF was established and recommends the following target asset mix:

Asset Class

Target Mix (%)

Portfolio Allocation

Treasuries

15

0% - 30%

Bonds

75

40% - 90%

Equities

10

0% - 30%

The CDEF Investment Board Act had the following objectives:

Assist the CDEF in meeting its obligations to beneficiaries and their contributors.

Manage the assets in the best interest of the CDEF beneficiaries and their contributors.

Invest assets to achieve a maximum rate of return without undue risk of loss.

Ensures the CDEF meets its financial obligations on any given business day.

Recent changes

Following a contentious election, the newly elected government has enacted a program to determine the true financial health of the Cascadian government. This has prompted a fresh review of all governments and quasi-government agencies, including the CDEF. A team of auditors, lawyers, actuaries and forensic business analysts ("ALAF") were tasked with reporting findings on best and worst practices.

Summary of ALAF's findings related to the CDEF

1) The Board of Directors of the CDEF Investment Board comprises six family members: husband, wife, brother-in-law and three cousins. The husband and wife, Percy and Marjorie, have extensive experience in the financial sector in Cascadia. The brother-in-law, Pablo, is a self-made financial planner with brokerage license in mutual funds and life insurance. Two cousins, Annie and Baz, are now successful as owners of Build Large Inc., the largest construction company in Cascadia in gross revenue. The third cousin, Jamie, is an actuary who is the Chief Financial Officer ("CFO") of Build Large Inc., the family construction company.

2) Jamie is the Chief Actuary of CDEF, a position assumed on a contractual basis. ALAF noted that Jamie has been a fully qualified general insurance actuary for less than 2 years but has been fulfilling actuarial contracts for the CDEF over the last 5 years as Chief Actuary of CDEF.

3) The day-to-day operations are overseen by a team of seven employees, including two administrative assistants, one IT technician and four analysts. The analysts and the IT technician play together in the local recreational hockey league. They grew up with the children of Percy and Marjorie.

4) The CDEF is required to follow the Cascadia government recruitment process, but ALAF found no formal public job posting, employment contracts, job descriptions, nor employee profiles for any of the seven back-office employees.

5) The IT analyst initiated an internet-based submission form to improve the efficiency of the application process. The online process consists of emailing the completed application form to a Gmail email address, including some proof of Cascadian residency and cc to the high school office of admission.

6) None of the seven back office employees have a CDEF email address. Instead they use their personal email addresses for work-related correspondence.

7) The IT security system is completely dependent on a free online no-fee antivirus software. Employees occasionally rely on the nearby global coffee chain shop for their internet wireless service.

8) The Board of Directors frequently schedule week-long, all expenses paid, team-building meetings in luxury vacation resorts and sometimes on luxury cruises.

9) The Board of Directors claims all housing expenses including four cars that the family owns as business expenses. In Cascadia, housing and car expenses are paid as business expenses for government employees who live more than 100 km (60 miles) away from their working location and need to temporarily rent housing closer to their reporting office. The Board members all live within 10 km (6 miles) of the CDEF office.

10) The annual audit process is overseen by an international audit firm. The audit process involves email-based correspondence and questionnaires which have remained the same over the past 5 years. The auditors have not conducted any process or document reviews on site.

11) The current portfolio composition is as follows:

a. 20% of the portfolio is invested in the Build Large Inc. construction company.

b. 15% of the portfolio is invested in the National Oil Company ("NOC") of the neighboring country Vashnie. NOC is the largest global oil and gas company with a consistent return of more than 25% over the last 10 years.

c. 15% of the portfolio is invested in Cabbage Incorporated ("CI") a cutting-edge biopharmaceutical company located outside of Cascadia. CI is developing a technology to harvest electricity from plants and root vegetables. Their reputation came from a specialized gene-therapy treatment for cancer which combined Nano- technology and DNA-based medicine. In addition to CI's local government, CDEF is the sole foreign investor in CI.

d. The remaining portfolio of CDEF is invested in traditional assets such as equity, fixed income and cash in the following proportion: 25% equity, 15% bond and 10% cash.

The Board claims that the investment policy strategy was too restrictive and that it is there for uninitiated investors only. Furthermore, performance generated for CDEF is a true testimony to that vision and approach. In fact, the CDEF balance has doubled under their watch. Last year alone the fund returned 30%.

12) Other than a stack of paper with hand-written trading instructions, major transactions are often confirmed via email correspondence. In fact, the CI investment decision was confirmed in an email to the Board that includes some pictures with their CI counterparts at a luxury resort.

13) There has not been any monitoring of the investments other than a monthly call with the major stakeholders (fund dealers, other investment managers and opportunity finders). The calls last at most 10 minutes and the discussions always end with next meeting schedule at a sport club or next opportunity finding trip.

14) The Board was also considering as part of their next investment an acquisition of an IT service company based outside of Cascadia. A discussion has been initiated in valuations and pricing to pay for the acquisition. There is no paperwork of any prior discussions other than a thank you email from the president and owner of the IT service company.

Your Role

You are an actuary working for Fixham Harbor Consulting. Fixham was originally retained by ALAF to assist in the review of several government agencies, and now the Cascadian Minister of Finance has asked Fixham to offer recommendations regarding the financial and operational health of CDEF.

Deliverables Guidance

As an actuary in a consulting firm, most of your memos are internal and typically directed to your project lead at Fixham. These are fewer formal memos for an audience you work with often. You may assume a higher level of technical familiarity from this audience.

One memo is directed to the client, the government of Cascadia. The tone and formality of this memo should accommodate the needs of a less technical audience that you do not work with often. In particular, this memo should be written with a focus on structure, format and appropriate content. Be sure to use language that is clear and concise when communicating with the client.

Overall Length of Document

TASK 1

Fixham Harbor Consulting has been asked to review the findings and assess the risk exposure of the CDEF. To start your project, you are to identify and group findings into various major risk categories.

Develop a risk management tool by creating a high-level risk categorization and definition ("RCD") organized as follows:

Major Risk Category

Risk Subcategory

Definition

Financial

Strategic

Insurance

Operational

Include ten to fifteen risks.

Recommend and justify one key risk per category. Suggest possible risk mitigating techniques for each key risk, with justification and support on how your mitigation techniques help prevent or remediate the various risks as highlighted in the findings.

Provide your RCD tool and recommendations in a memo to your project lead. Consider only risks that are relevant to the management of CDEF. Listing of non-relevant risks is highly discouraged.

Write a memo to the project lead

TASK 2

One of the lawyers on the ALAF emailed to ask you to comment on the role of the CFO/Actuary of Build Large Inc. as a board member and the actuary of the CDEF. In your comments, address the following assuming that the Cascadian Society of Actuaries follows the governing rules of the SOA:

Broadly, what would be the role of the Actuary in this scenario? Does the credential of the CFO/Actuary allow Jamie to issue statements on CDEF?

What precept(s) of the Code of Professional Conduct might Jamie have violated, if any?

Discuss any obligations you may have, as another actuary, regarding Jamie's action (s) and roles, and make recommendations to address the situation.

Create a email response in the appropriate section of the Microsoft Word template.

TASK 3

Fixham has been asked to examine the CDEF investment strategy and portfolio composition. As part of that larger effort, you have specifically been asked to construct a bond-only portfolio option. You are provided with the cash flow generated based on the current students' population which represents the future payments from the CDEF for the foreseeable future. Using the yield curve provided, please perform the following:

Calculate the reserve for the CDEF.

Determine the single equivalent rate that would produce the same reserve.

Calculate the modified duration of the reserves.

Recommend an investment strategy which matches the CDEF obligation based on your answer above; given that in Cascadia there are 3 types of bonds portfolio:

o Short Duration: 9.8

o Medium Duration: 13.9

o Long Duration 18.2

Summarize and present your work in a memo to your project lead including contrasting the current investment strategy with your recommended strategy.

Write a memo to the project lead

TASK 4

During a meeting with ALAF and the Minister of Finance, the scenario you provided in Task 3 was discussed. The Minister of Finance is in favor of recommending a bond-only portfolio. However, an auditor of the ALAF stated that duration matching techniques only increase the contribution amount per employed person, and thus investing in equity is preferred. The auditor strongly opposes the proposed duration technique and instead advocates for using the key-rate duration technique, effective duration, or convexity.

Following the meeting, the Minister of Finance requested that you provide the following:

An overview of the different duration techniques and explain how the use of the techniques the auditor mentioned differ from the duration techniques you used in your analysis in Task 3.

An analysis of adding the following investment options to the bond-only portfolio, and make a recommendation as to which, if any, of the investments are appropriate:

o real estate investment

o infrastructure investment

o investment in Build Large Inc.

You do not need to perform any calculations. Consider the duration matching environment as you discuss these options.

Write an email to the Minister of Finance of Cascadia

TASK 5

Your team's in-depth analysis is complete. Now a recommendation is to be put forth regarding the corporate governance, key risks, asset mix and investment policy for the CDEF education fund. Draft a formal memo to the Minister of Finance with your recommendation, including an executive summary. Your recommendation should highlight your analysis and conclusions from Tasks 1 through 4, but you should not repeat every detail. Keep in mind that this memo is to the client, not your fellow consultants.

Write a memo to the Minister of Finance of Cascadia