33. Investment

Question 1

What are the principles of investment?

Answer 1

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.

Question 2

What is the liability outgo?

Answer 2

Benefits + Expenses - Premiums

Question 3

How can nature of liabilities be divided?

Answer 3

• Guaranteed in money terms
• Guaranteed in terms of an index
• Investment-linked
• Discretionary

Question 4

Break liability outgo of regular premium w/profits policy

Answer 4

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

Question 5

Break liability outgo of single premium inflation-linked annuity

Answer 5

Benefits:
* Guaranteed in terms of index

Expenses:
* Guaranteed in terms of index

Premium:
* Guaranteed in money terms

Question 6

Break liability outgo of unit linked savings product with minimum death benefits

Answer 6

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

Question 7

Why would company invest overseas?

Answer 7

1. May have liabilities in overseas currency
2. Suitable assets may not be available in country or be of better value in a different country
3. May have enough free assets to mismatch and maximise returns

Question 8

What is the difference between mismatching and resilience

Answer 8

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

Question 9

Whathappens if proceeds exceed outgo?

How would assets be selected to match liabilities guaranteed in money terms?

Answer 9

• 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

Question 10

How would assets be selected to match liabilities guaranteed in terms of index?

Answer 10

• Invest in assets based on same index or most similar asset

Question 11

How would assets be selected to match invement-linked liabilities?

Answer 11

• Investment in underlying investment

Question 12

How would assets be selected to match discretionary liabilities?

Answer 12

• High return/ high risk assets, subject to not exceeding ph risk appetite and…
  … degree of risk allowable given extent of free assets available

Question 13

What are the factors that will affect the investment approach for discretionary benefits?

Answer 13

• Bonus philosophy of company
• Level of free assets
• Published or expected investment strategy of company
• Company’s views on investment performance of assets

Question 14

What is an appropriate choice of assets for regular with-profits?

Answer 14

• 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

Question 15

What is an appropriate choice of assets for single premium inflation-linked annuity?

Answer 15

• 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.

Question 16

What is an appropriate choice of assets for unit linked with min death benefit?

Answer 16

• 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

Question 17

Why is mismatching not common for investment-linked liabilities?

Answer 17

• Significant risk of loss even if it can be absorbed by free assets.
• Company will have to hold higher reserves for mismatching risk&raquo_space;
  » … increasing capitsl required to write new business&raquo_space;
  » … increasing cost of capital&raquo_space;>
  » … increases cost of product through higher charges
• Regulation

Question 18

How can model be used to determine an investment strategy?

Answer 18

1. Build model investment portfolio based on proposed investment strategy
2. Allocate proportion of free assets to support assets backing the reserves
3. Project A+L forward based on assumptions of expected future experience and deviations from assumptions
4. For assets, stochastic investment models will be used to project future investment returns and changes in capital values.
5. Inflation rate models used to project future expenses for liabilitues
6. Projected A+L valued at end of each projection year on company’s supervisory basis.
7. Interested in excess of A/L and if it’s suffcient to comfortably cover level of solvency capital.
8. This will depend on:
   
   • regulatory requirements
   • nature of business
   • competitors
9. Using stochastic investment model and simulation techniques, can produce statistical distribution of amounts available each year to cover solvency capital.
10. Probability of future insolvency estimated.
11. Calculate some measure of aggregate profitability.
12. Repeat steps 3-11 for different investment strategies until target probability of insolvency reached.
13. Pick strategy with highest profitability for same probability of ruin

Question 19

Weaknesses of using model office to determine investment strategy?

Answer 19

• 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.

Question 20

What are the 3 variables that can be varied in investment strategy model?

Answer 20

• Riskiness of investment strategy
• Level of free assets
• Probability of insolvency

Question 21

Factors affecting asset mix

Answer 21

• Nature, term and currency of L
• PRE
• Free assets
• Risk tolerance
• Business objectives (incl competitive position)