CH 30 (WM) Flashcards
The regulatory framework may limit what a company may do in terms of investment. List the type of restrictions that may apply. [4.75]
- Type of assets that a company may invest in.✓✓
- Amount of any particular type of asset that can be taken into account for the purpose of demonstration solvency.✓✓
- Restrictions on the amount that could be invested in a particular asset type.✓✓
- Requirement to hold a minimum proportion in a particular asset type✓✓ , eg government bonds.✓
- The extent to which mismatching is allowed.✓✓
- Requirement to hold a mismatching reserve.✓✓
- Restrictions on overseas investments.✓✓
- Custodianship of assets/Max exposure to a single counterparty✓✓
- Method of VAL✓✓
State the principles of investment. [2]
A company should select investments that are appropriate to the nature, term and currency of the liabilities.✓✓
The investments should also be selected so as to maximize the overall return on the assets, where overall return includes both investment income and capital gains;✓✓ and
The extent to which (a) may be departed from in order to meet (b) will depend, inter alia, on the extent of the company’s free assets and the company’s appetite for risk.✓✓
These principles could also be expressed as:
The company should invest so as to maximize the overall return on the assets, subject to the risk being taken on being within the financial resources available to do so.✓✓
What are the components of the liability outgo? [1.75]
The liability outgo consists of:
Benefit payments + Expense outgo – Premium income [1]
The expected liability outgo in any year or month✓, depends on the monetary value of each of the constituents✓ and the probability of it being received or paid out.✓
Describe the four categories of liabilities and give an example of each. [4]
Guaranteed in monetary terms✓ – this consists of benefit payments where the amount is specified in the insurance contract in monetary terms✓, eg fixed SA on PA policy.✓✓
Guaranteed i.t.o. an index of prices, earnings or similar✓✓ – this consists of benefits whose amount is directly linked to such an index,✓ eg expenses✓.
Indemnity✓ – this indicate policies such as PMI✓ where the amount paid i.r.o. the PH is dependent on the costs incurred in receiving treatment covered by the policy.✓✓
Investment-linked✓ – this consists of benefits where the amount is determined directly by the value of the investments u/l the contracts✓✓, eg UL contract.✓
Describe the investment strategy w.r.t.
(a) liabilities “guaranteed in monetary terms”.
(b) liabilities “guaranteed i.t.o. an index of prices, earnings or similar”. [5.5]
(a) A company will ideally want to invest so as to ensure that it can meet the guar’s.✓✓ This means investing in assets that produce a flow of assets proceeds to match the liab outgo.✓✓ This will involve taking into account also the term of the liab outgo✓✓, and hence the prob of the pmts being made, so as to indicate the term of the corresponding assets.✓✓
Except for certain types of company, it will probably be impossible in practice to find assets whose proceeds exactly match the expected liab outgo.✓✓
In particular, the term of available fixed-interest securities are often much shorter than the corresponding liab’s.✓✓ A best match is all that can normally be hoped for.✓ Immunisation might be used to reduce mismatching issues.✓✓
(b) A suitable match would be securities that are linked to the same index in which the guarantee is denominated, if available.✓✓ Ideally chosen to match also the expected term of the liability outgo.✓✓ In their absence, a substitute would be assets expected to provide a real return✓✓, eg equities and property✓.
Describe the investment strategy w.r.t. “Indemnity liabilities”. [4.5]
The insurer will monitor the likely costs arising from the various treatments covered by the medical insurance contracts.✓✓
Normally PMI (and similar products) are short-tail business with little scope for significant investment return.✓✓ This is because it is hoped that, at least approximately, the premium income from all policies should be sufficient to cover the claims outgo, as well as the insurer’s expenses.✓✓ Therefore the reserves under PMI policies will be very small✓✓, and so investment income on them is negligible.✓
However, assets will still be required, so normally a mixture of cash and sec’s such as ST fixed interest bonds would be suitable.✓✓
However, an insurer will occasionally need to establish reserves where it is aware of future treatment that could persist over some future years.✓✓
The amounts payable will be unknown at the time of setting these provisions✓ and any current costs will escalate in line with medical inflation prior to final settlement.✓✓
Hence the assets recommended in these circumstances should be those that are expected to provide a real return over the relatively short period until the case goes off the books.✓✓
Describe the investment strategy w.r.t. “Investment-Linked liabilities”. [2.75]
The benefits are guaranteed in the sense that their value can be determined at any time in accordance with a definite formula✓✓ based on the value of a specified fund of assets (or investment index).✓✓
Clearly the company could avoid any investment matching problems by investing in the same assets as used to determine the benefits.✓✓
The most common example of this liability is a UL product.✓
In some markets the insurer might be required to invest so as to match the underlying assets exactly.✓✓ Even if not legally obligatory, it is normal practice to do so, and there would have to be a very strong reason not to do so.✓✓
Explain the investment strategy w.r.t free assets. [4]
The existence of free assets in an insurance company means that it can depart from the matching strategies so as to improve the overall return on its assets.✓✓
These excess returns will benefit its PH’s through lower premium rates, and its s/h’s (if any) through higher dividends.✓✓
It is almost always the case that assets with the highest expected return also have the highest variance of that return.✓✓
If the assets supporting guaranteed benefits were invested in the assets with the highest expected return, the probability that the asset proceeds will become inadequate may be too high for comfort, i.e. the risk of insolvency is too great.✓✓ This assumes that only enough assets are held, so that their expected proceeds will cover the benefits.✓✓
If there are free assets, they can be used as a cushion to reduce the probability of insolvency to an acceptable level.✓✓ Clearly this use of the free assets is most appropriate i.r.o. the assets backing the guaranteed benefits.✓
Also one could argue that it is reasonable use of the free assets to mismatch inv-linked liabilities if by doing so the company can achieve a higher return.✓✓ Note though that if this is done any excess returns so achieved, will not accrue to the UL PH’s, but to the owners of the business.✓✓
What are the conditions for an immunised position? [1.5]
PV of the LIAB OUTGO = PV of the ASSETS PROCEEDS ✓✓
DMT of the LIAB OUTGO = DMT of the ASSETS PROCEEDS ✓✓
The spread about the mean term of the value of the ASSETS PROCEEDS > the spread of the value of the LIAB OUTGO.✓✓
Describe the steps of the model office approach for determining an optimal investment strategy. [4]
Allocate a certain amount of free assets to support the assets underlying the reserves.✓✓
Perform ALM model projections of the company’s future assets and compare these total assets against the reserves.✓✓
Check that the excess of these assets over the liabilities exceeds any statutory SCR✓✓ (or possibly, exceeds some comfy multiple of that requirement✓) for the entire projection period✓ for most (eg 99%)✓ of the model runs.✓
Calculate some measure of aggregate profitability.✓✓
Repeat these last three steps✓ assuming different (more or less risky) ✓ investment strategies until the target profitability/insolvency is achieved.✓✓
Identify which of the possible strategies, having equal insolvency risk, produces the highest profitability.✓✓
What will the results of the ALM investigation be used for? [1.75]
- The level of riskiness of investment strategy that can be supported.✓✓
- The level of free assets required to support any strategy✓✓, or
- The resulting probability of insolvency.✓✓
Noting the interdependence between the three aspects.✓
a) How will a fund manager’s performance be assessed?
b) What are the challenges when monitoring the performance of an external fund manager?[2.75]
a)
* Compare results against the original targets set for overall return.✓✓
* Compare results against the performance of other fund managers with similar investment mandates.✓✓
* Analyse the riskiness of the strategy undertaken.✓✓
* Where possible, the assessment should be over several such periods to eliminate the effects of luck.✓✓
b)
* Less control✓
* More difficult to access performance data✓✓
State the circumstances under which an insurer will hold highly liquid assets. [1]
- Short-term liabilities ✓
- Uncertain timing of liabilities ✓
- Volatile claims experience ✓
- If the book is in a state of run-down ✓
Describe the different ways that a health insurer can value its assets. [3.25]
The method of VAL of assets will depend on the purpose of the exercise and the market’s perception of fair value.✓✓
For PMI business, which has typically only ST liabilities✓✓ , there would be little alternative but to value the backing assets (normally cash or similar to cash)✓ at their market price.✓
For LT liabilities, there are two possibilities✓:
* DCF method✓, incl. eventual disposal✓, on a basis consistent with the VAL of the liabilities.✓
* MV approach✓ as an objective and readily understood methodology.✓✓ This has become the norm in many territories.✓
Explain the importance of policyholders’ expectations as far as investment returns are concerned, for health and care insurance. [2]
Q&A 6.1
Policyholders’ expectations are, in this context, unlikely to be very important. [1⁄2]
For the majority of health insurance products, investment returns play a minor role in the benefits provided, so policyholders will not normally expect investment gains. [1⁄2]
Exceptions to this may include unit-linked or with-profits health insurance products, eg pre-funded long-term care insurance. [1⁄2]
However, expectations may not be met if the insurer relies on investment returns to such a degree that underperformance leads to premium increases on reviewable products. [1⁄2]
In any case, it is important to ensure that customers are treated fairly. [1⁄2] [Maximum 2]
