Ch33: Investments

Question 1

We can consider asset types according to the following characteristics

Answer 1

• return
• security
• marketability
• expenses
• term
• currency

Question 2

The principles of investment

Answer 2

a) in order to minimise risk, a company should select investments that are appropriate to the nature, term and currency of the liabilities
b) the investments should be chosen so as to maximise the overall return on assets, where overall return includes both investment income and capital gains
c) the extent to which the appropriate investments may be departed from in order to maximise the overall return will depend on the extent of the company’s free assets

Question 3

Benefit payments can be subdivided into 4 types

Answer 3

• guaranteed in money terms
• guaranteed in terms of an index of prices or similar
• discretionary
• investment-linked

Question 4

Problems and limitations of immunisation

Answer 4

1. it immunises against profits as well as losses
2. it can be difficult to immunise against real liabilities
3. theory only works with small interest rate fluctuations
4. theory assumes that when interest rates change, the same change occurs at all terms
5. you would need to reanalyse the situation every day and change investments accordingly
6. assets of the required term may not exist
7. the timing of asset proceeds may not be known and that of liabilities can only be estimated

Question 5

The decision on assets for the discretionary benefits and whether this will affect the investment approach for the guaranteed benefits will depend on a number of factors:

Answer 5

• the bonus philosophy of the company
• the level of free assets
• the risk appetite of the company
• the published investment strategy of the company
• the views of the company at any time as to the relative performance of the asset classes concerned

Question 6

asset liability model approach to setting investment strategy

Answer 6

• allocate certain amount of free assets to support assets underlying the reserve
• perform asset/liability projections of the company’s future assets and compare to against reserves
• check that excess of these assets over liabilities exceeds and minimum capital requirement for the entire projection period for most of the runs
• calculate some measure of aggregate profitability
• repeat the last three steps assuming different investment strategy until the target probability of insolvency is achieved
• identify what possible strategies, having equal insolvency risk, product the highest profitability

Question 7

Issues with asset-liability modelling method

Answer 7

• model risk
• only considers a portion of free assets
• need to be very careful if minimum capital requirement is not constant