33. Investment Flashcards
What are the principles of investment?
a. In order to minimise risk, company must select investments appropriate to nature, term and currency of liabilities.
b. Investments must be selected to maximise overall return on assets, where overall return includes investment income and capital gains; and,
c. the extent to which appropriate investments referred ti above may be departed from will depend on extent of company’s free assets.
What is the liability outgo?
Benefits + Expenses - Premiums
How can nature of liabilities be divided?
- Guaranteed in money terms
- Guaranteed in terms of an index
- Investment-linked
- Discretionary
Break liability outgo of regular premium w/profits policy
Benefits:
* Guaranteed in money terms
* Surrender value and future bonuses are discretionary
Expenses:
* Guaranteed in terms of index e.g. inflation
Premiums:
* Guaranteed in money terms
Break liability outgo of single premium inflation-linked annuity
Benefits:
* Guaranteed in terms of index
Expenses:
* Guaranteed in terms of index
Premium:
* Guaranteed in money terms
Break liability outgo of unit linked savings product with minimum death benefits
Benefits:
*Investment linked
* Guarnteed in money terms arising from excess of minimum sum assured over unit fund, should correspond to death bemefit over next month (or until next deduction from units is made to pay for mortality cover), so should be small
Expenses:
* Guaranteed in terms of index
Premium:
* Guaranteed in money terms
Why would company invest overseas?
- May have liabilities in overseas currency
- Suitable assets may not be available in country or be of better value in a different country
- May have enough free assets to mismatch and maximise returns
What is the difference between mismatching and resilience
Risk from mismatching:
* Income from assets over time falls short of liability outgo due to having to buy assets at lower than expected yields or having to sell assets at depressed market values to meet L.
* Cashflow projection model would be used to assess risk.
Resilience:
* Risk that company won’t be able to meet supervisory reserving requirements if market investment conditions changed suddenly.
* Would perform resilience testing- analyse statutory solvency position under different assumptions
Whathappens if proceeds exceed outgo?
How would assets be selected to match liabilities guaranteed in money terms?
- Invest in assts with proceeds matching liability outgo
- Impossible to find perfect match, best match okay
- There is a reinvestment risk if asset proceeds exceed outgo
- Immuinisation can be used to address this risk
How would assets be selected to match liabilities guaranteed in terms of index?
- Invest in assets based on same index or most similar asset
How would assets be selected to match invement-linked liabilities?
- Investment in underlying investment
How would assets be selected to match discretionary liabilities?
- High return/ high risk assets, subject to not exceeding ph risk appetite and…
… degree of risk allowable given extent of free assets available
What are the factors that will affect the investment approach for discretionary benefits?
- Bonus philosophy of company
- Level of free assets
- Published or expected investment strategy of company
- Company’s views on investment performance of assets
What is an appropriate choice of assets for regular with-profits?
- Guaranteed liability- suitable bonds with same duration
- Discretonary liability- high return assets e.g. equities
- I.e. invest amount = to realistic policy reserve in bonds and excess of asset share over amount in equities
What is an appropriate choice of assets for single premium inflation-linked annuity?
- Inflation-linked govt bond with term = life expectectance of annuitant(s).
- If bond NA, invest in fixed-interest bonds and inflation-resilient investment e.g. equities
- Weights of two will simulate inflation-linked bond.
What is an appropriate choice of assets for unit linked with min death benefit?
- Unit-related liability invested in underlying assets.
- Non-unit liability in inflation linked bonds.
- Invest amount corr to mortality outgo in short term fixed-interest bonds / cash
Why is mismatching not common for investment-linked liabilities?
- Significant risk of loss even if it can be absorbed by free assets.
- Company will have to hold higher reserves for mismatching risk»_space;
» … increasing capitsl required to write new business»_space;
» … increasing cost of capital»_space;>
» … increases cost of product through higher charges - Regulation
How can model be used to determine an investment strategy?
- Build model investment portfolio based on proposed investment strategy
- Allocate proportion of free assets to support assets backing the reserves
- Project A+L forward based on assumptions of expected future experience and deviations from assumptions
- For assets, stochastic investment models will be used to project future investment returns and changes in capital values.
- Inflation rate models used to project future expenses for liabilitues
- Projected A+L valued at end of each projection year on company’s supervisory basis.
- Interested in excess of A/L and if it’s suffcient to comfortably cover level of solvency capital.
- This will depend on:
- regulatory requirements
- nature of business
- competitors
- Using stochastic investment model and simulation techniques, can produce statistical distribution of amounts available each year to cover solvency capital.
- Probability of future insolvency estimated.
- Calculate some measure of aggregate profitability.
- Repeat steps 3-11 for different investment strategies until target probability of insolvency reached.
- Pick strategy with highest profitability for same probability of ruin
Weaknesses of using model office to determine investment strategy?
- Model risk
- Owners of free assets may not want all their assets at risk in an investment strategy. However, this doesn’t mean certain assets should be excluded from the model. One approach is to set constraints, like accepting a 1% probability that 50% of free assets might disappear. The entire asset portfolio can still be modeled, allowing for interpretation of results and potentially providing more useful insights.
- Must take care that minimum solvency requirement isn’t constant.
What are the 3 variables that can be varied in investment strategy model?
- Riskiness of investment strategy
- Level of free assets
- Probability of insolvency
Factors affecting asset mix
- Nature, term and currency of L
- PRE
- Free assets
- Risk tolerance
- Business objectives (incl competitive position)
