CA1 Flashcards
Corporate structures
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Mutual societies
- no dividends
- finance cannot readily be raised
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Proprietaries
- easy access to capital markets
- greater economics of scale
- more dynamic mangement
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Private companies
- smilar restrictions to raising capital as mutuals
- Close involvement of owners is a management advantage
Mitigating risk
- Avoiding
- Accepting and minimizing
- Sharing
- Transferring
Information asymmetry
- Anti-selection
- Moral hazard
Key roles of the state
- Provide benefits (e.g. retirement / medical care / unemployment)
- Educate or require education (about importance of providing for the future)
- Regulate to encourage or compel (benefit provision by or on behalf of population, e.g. by tax breaks)
- Regulate bodies providing benefits to ensure security for promises made
Funding level of a defined benefit scheme
Value of assets / Value of liabilities
Types of pension schemes
- Defined benefit scheme
- Defined contribution scheme
- Defined ambition scheme
- Risks are share between the different parties involved
Types of pension scheme members
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Actives
- Still earning future benefits
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Deferrred member
- stopped earning future benefits but have existing benefit entitlement
- Current pensioneers
Provider of pensions
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Occupations schemes
- offered by employers to their employees
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Personal pension plans or arrangements
- purchased from an insurance company by an individual
Regulatory regimes
- Unregulated markets
- Voluntary odes of conduct
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Self-regulation
- No government intervention
- Implemented by people with greatest knowledge
- Respond rapidly to chcanges in market needs
- Closeness of regulator to industry
- regulator may accept industry’s point of view and not consumer
- inhibit entrants to the market
- Statutory regulation
Forms of regulation
- Prescriptive
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Freedom of action
- rules on publicity
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Outcome-based
- Freedom of action, but prescribe outcome that will be tolerated
Maintaining confidence
- Capital adequacy
- Competence and integrity
- Require professional qualifications
- Prevent an individual working in a particular industry if they are not deemed a “fit and proper” person
- Compensation scheme
- Other protection for investors
- Ensure that the market is transparent, orderly and provides proper protection to investors
- Stock exchange requirements
- Fulfill specificed obligations for the disclosure of financial and other information
Dealing with information asymmetry
- Disclosure and education
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Remove conflict of interest
- restrict to publily available information
- Chinese walls
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Negotiation / Price controls
- Maximum commission rates
- fee basis instead of commission
- max premium rates / management charges
- Remove unfair features of insurance contracts
Reasons for need of regulation
- Confidence
- Information asymmetry
Aims of regulation
- Correct perceived market inefficiencies
- Protect consumers of financial products
- Maintain confidence in the financial system
- Help reduce financial crime
Actuarial controll cycle (ACC)
Underwriting
a process used by the (life) insurer to decide the level of risk posed by a potential policyholder. As a result of underwriting, the policyholder may be charged a higher than standard premium, given a lower than standard benefit, or even declined insurance.
With-profit: Factors when setting level of bonus
- Smooth benefits (keep back profits in good years to help in bad years)
- Policyholder expactations (e.g. based on past bonus distributions)
- Competitors (looking at what competitors are doing)
- Regulatory limits (adhering to regulatory limits on payout)
Pure endowment and endowment assurance: Customer needs
- Means of transferring wealth from parents to children (guarantee that substantial wealth transfer will be made, even in the case of death)
- Sometimes used as a means of repaying the capital on a loan
- Saving money for retirement
Whole life assurance: Customer needs
- Provide for funeral expenses
- Meeting liability to tax on the death (e.g. inheritance tax or death duties)
- Generally providing long-term protection to dependents
Term assurance: Customer needs
- Providing protection against financial loss for the assured’s dependants
- Decreasing term assurance to repay balance outstanding under a loan
- Where the policyholder is a corporate body or partnership, provide p_rotection against the financial loss that might arise on the death of a key person_ within the organisation
Convertible or renewable term assurance: Customer needs
- Combine attractions of a term assurance (cheap death cover) with the certainty of being able either to convert to a a permanent form of contract, or to renew the original contract without health evidence being provided
Income drawdown: Customer needs
- Should the member die before having to secure an annuity, the member’s heirs can inherit the balcance of the funds
Income drawdown: Risks
- If only the income earned on the fund is taken, income could be volatile
- If too high a level of income is taken the capital could reduce to zero before the member dies
- Charges taken in relation to administering the arrangement may be high
- Remaining fund on the member’s death may be insufficient to provide adequate benefits for a dependant
- May be tax charge on the residual fund on the member’s death
Rating factor
A factor used to determine the premium rate for a policy, which is measurable in an objective way and relates to the likelihood and/or severity of the risk. It must, therefore, be a risk factor or a proxy for a risk factor of risk factors.
Financial loss insurance covers
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Pecuniary loss
- Protects insurance against bad debts or other failure of a third party
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Fidelity guarantee insurance
- Covers the insured against financial losses by dishonest actions by its employees
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Business interruption cover
- Indemnifies the insured against losses made as a result of not being able to conduct business
Liability insurance covers
- Employers’ liability
- Motor third party liability
- Public liability
- Product liability
- Professional indemnity (cover to indemnify against negligence in the provision of a service)
Property damage insurance covers
- Household and commercial buildings property
- Moveable property
- Motor property
- Marine property (hull and cargo)
- Aircraft
Commercial considerations associated with a contract design
- Profitability
- Marketability
- Competitiveness
- Statutory / Regulatory requirements
General insurance fixed benefits covers
- Personal accident insurance
- Health insurance (e.g. hospital cash)
- Unemployment insurance
Level and form of benefits
Level: Amount
Form:
- Regular / One-off
- Monetary or non-monetary (goods or services)
Motor insurance is commonly written on three bases
- third party only
- third party, fire and theft
- fully comprehensive
Level and form of benefits relating to a term assurance contract
- Amount of the sum assured
- Whether the benefit is decreaseing of level
- additional rider benefits (e.g. critical illness)
- waiver of premium benefit (e.g. in case of sickness, accident, unemployment)
- whether or not the premiums can be reviewed
- A renewal option at the end of the term, with or without further underwriting
What should be a primary consideration in deciding what level of discretionary benefits to offer?
PRE (Policyholders’ Reasonable Expectations)
Variables impacting profitability of an insuarnce contract
- Claims experience
- Claims frequency
- Claims severity
- Claims inflation
- options and guarantees
- Expenses and expense inflation
- Investment returns
- Withdrawal experience
- New business sales volumes and mix
Aspects of a contract design that improve marketability
- Innovative design features such as options and guarantees
- Simplicity - easy to understand
- Transparency - good disclosure of information to the customer
- Low charges
Capital Project definition
Any project where there is initial expenditure and then, once the project comes in to operation, a stream of revenues less running costs.
Capital Project Appraisal: Initial Appraisal
- Strategic issues
- Resources
- Synergies
- Other projects (compatibility)
- Key risks (sufficient upside potential)
- Political Constraints (within and without the organisation)
Capital Project Appraisal Techniques
- net present value (NPV)
- internal rate of return (IRR)
- payback period
- discounted payback period
Issue of IRR
Can have multiple solution –> Take lowest positive solution
Issues with NPV
- Highly dependent on risk discount rate
- Says nothing about the length of the project or the time until profits are made
- Cannot be used to compare projects since it is an absolute amount that will depend on the size of the project
Issues with payback period
- Ignores the time value of money
- ignores cash flows beyond the date that payback is achieved
- ignores the scale / size of the project
Capital Project: Difference between
- Sensitivity analysis
- Scenario testing
- Sensitivity analysis: investigates how the profitability of the project changes in response to a change in a single assumption in isolation
- Scenario testing: varies several assumptions simultaneously and in a mutually consistent fashion
Capital Project: Discount rate for projects with a higher than normal degree of systemic risk
- Look at other companies that habitually engage in such projects
- Problem: those companies may have more experience in these projects
Capital Project: Risk Identification
- Make a high-level preliminary risk analysis
- Hold brainstorming session of project experts and senior internal and external people
- Carry out desktop analysis to supplement the results from the brainstorming session, by identifying further risks and mitigation options
- Carefully set out all identified risks in a risk register, with cross-references to other risks where there is interdependency
Capital Project: Analysis of risks
- Frequency of occurrence
- Consequences if risk occurs
- Correlation between risks
- Controllability of the risks
Capital Project: Risk Matrix - type of risks
- Political
- Natural
- Economic
- Financial
- Crime
- Project
- Business
Money Markets definition
Covers
- Bank deposits
- Short-term securities
Money market instruments
- Treasury bills
- Local authority bill
- Bills of exchange
- Certificate of deposit (CDs)
- Commercial paper
- Term deposits
- Call deposits
Types of deposits
- Call deposits: Depositor has instant access to withdraw the capital
- Notice deposits: Depositor has to give a period of notice before withdrawal
- Term deposit: No access to the capital before maturity
- Certificate of deposit (CD): Short-term security issued by banks and building societies showing that a stated sum of money has been deposited for a specified time for a specified rate of interest. (usually 28 days to 6 months)
CD is tradable!
Theories to explain deviations in the yield curve compared to the expectation
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Liquidity preference theory
- Investors require a greater return for assets committed for a longer period of time.
- less downward sloping yield curve (or more upward sloping)
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Inflation risk premium theory
- Under the inflation risk premium theory the yield curve will tend to slope upwards because investors need a higher yield to compensate them for holding longer-dated stocks which are more vulnerable to inflation than shorter-dated stocks
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Market segmentation theory
- Market segmentation theory says that yields at each term to redemption are determined by supply and demand from investors with liabilities of that term.
Gross redemption yield
The return that you would expect to get on a bond if you hold it until redemption. Note that this assumes that you could reinvest the coupons at the same rate, and it ignores expenses, tax and default risk.
Price of a semi-annual coupon bond
SYSTEM T
- Security (risk)
- Yield (real or nominal)
- Spread (diversification, volatility)
- Term
- Expenses
- Marketability
- Tax
Running yield definition
- Bond: coupon/price
- Equity: dividend/price
- property: rent/price
Corporate bond
- income cover
- capital cover
- income cover: number of times the operating profit (before interest payable and tax) covers the interest on the particular loan in question (including equal and prior ranking loans)
- capital cover: number of times the assets of the company (excludinng intangibles and after notionally paying current liabilities) cover the amount of the loan (including prior ranking loans)
Real rate of return calculated from nominal rate of return and inflation rate
