Chapter 15

Question 1

What is capital management?

Answer 1

system used to plan for, obtain and control an insurer’s long-term funds.
for insureres its used to manage risk and generate profits. in

Question 2

Insurers typically use capital budgeting to balance the need to hold capital to manage risk with the need to invest capital to increase profitability. What is capital budgeting?

Answer 2

analysis of decisions about the investment of long-term funds.
Allows insurers to evaluate
- allocation of general account funds to specific assets or projects
- allocation of product line capital to specific blocks of business, customer groups, geoprahic markets, new products
- allocation of corporate capital to new product lines, existing prodcut lines, or purchasing NB.

Question 3

profits for a new product are generally measured in terms of either the NET cash flow or the earnings that the new product is expected to generate. define net cash flow.

Answer 3

products total cash inflow generated from premiums, investment and other sources minus the total cash outflows generated by such items as commissions, expenses and benefit payment.
*focuses only on CASH

Question 4

profits for a new product are generally measured in terms of either the NET cash flow or the earnings that the new product is expected to generate. define earnings.

Answer 4

product are the amount that the product adds to the insurance company’s capital in a given period.
* reflect on cash, and noncash adjustments that the figure into a products contribution to capital.

Question 5

What is the initial investment for a new product?

Answer 5

the amount of capital that an insurer must invest to establish the product.

Question 6

Insurers typically must use several tools for evaluating product profitability. What are some common measures used to evaluate product profitability?

Answer 6

1) Net present Value (NPV)
2) internal rate of return (IRR)
3) profit margin

Question 7

Define the net present value (NPV)

Answer 7

an investment project calculated by subtracting the project’s intiial investment from the present value of the project’s earning.

Question 8

whats the equation for NPV?

Answer 8

= (PV of earnings) - (initial investment)

• it yields a monetary amount representing the present value of the profit that a capital investment project is expected to earn.
• If NPV is +ve insurer should consider pursuing the product.

Question 9

What is an internal rate of return (IRR)?

Answer 9

defined as the interest rate, i, at which the products net cash flow must be discounted, using present value techniques, in order to exactly repay the insurers intitial investment in the product.
* its the nterest rate aty chih the products’ present value of earning is equal to its initial invesment and the NPV is 0.

Question 10

An insurer can use the company’s hurdle rate as its required IRR. What sthe hurdle rate?

Answer 10

minimum percentage rate of return on capital that an insuere must ear to cover its cost of capital.

Question 11

What is cost of capital?

Answer 11

the overall percentage cost the insurer pays for the funds it employes.
*

Question 12

What is a simple decision rule?

Answer 12

is to require that the projected IRR for the product be euqal to or greater than the insurer’s required IRR for the product.
Accept if projected IRR > required IRR
Reject if projected IRR < required IRR.

Question 13

What is profit marging?

Answer 13

the ratio of profits to sales revenue.

- profit equal to the products net cash flow, adjusted for investment earnings and reserves.

Question 14

what is profit margin and when is it used?

Answer 14

for multiple-premium life insurance or annuities it represemt the value profits divided by the present value of premiums

profit margin = (PV of profit)/(PV of premiums)

Question 15

profitability ratios consist of two measures. What are they?

Answer 15

1) measure of gain from operations.

2) measure of resources employed or invested to generate the gain.

Question 16

How do insureres determe if their prupose is to obtain an an overall measure of profitability or identify the sources of profits?

Answer 16

1) to determine sources of profits, insurance analysts, typically look in detail at two primary sources of cash flows: investment income and premium income.

Question 17

What is return on capital?

Answer 17

represents the percen tage return an insurere has earned on its capital. its calculated by dividing a given measure of earnings by some measure of total capital employed.

Question 18

What is the return on capital equation?

Answer 18

= (Net income) / Beginning capital.

• results show how efficiently the company has used its capital to earn a return .

Question 19

What is return on investment assets and its ratio?

Answer 19

return on invested assets (ROLA) ratio- indicated how efficiently a company is using its investmetn portfolio to earn returns.

Question 20

What is the return on invested assets ratio ( ROLA)

Answer 20

ROIA = (net income)/ (average invested assets)

Question 21

What is the investment yield?

Answer 21

determines the rate of return, or yield, on an insurer’s investment portfolio.
Its calculated by dividing the insurer’s investmetn portfolio income by the company’s average invested assets for the period.

Question 22

Whats the investment yield ratio?

Answer 22

= (investment portfolio income)/ (average invested assets)

Question 23

What is the net profit margin?

Answer 23

shows how much after-tax profit is generated by each dollar of total revenue.

Question 24

whats the net profit margin equation?

Answer 24

= net income/ total revenues.

Question 25

define the term embedded value (EV) for a life insurance company?

Answer 25

is euqal to the present value (PV) of expected future distributable profits pertaining to in-force covered business, after sufficient allowance is made for the aggregate risks represented by this business.

Question 26

What are the 3 basic components of EV?

Answer 26

1) uncommitted capital
2) required capital
2) value of business in force.

Question 27

What is uncommitted capital?

free surplus

Answer 27

market value of any capital and surplus, over and above the required capital, allocated to the in-force covered business.
* could be immediately distributed to shareholders.

Question 28

What is required capital?

Answer 28

the amount of capital an insuree must hold to back the liabilities for in-force covered business and for which distribution to shareholders is restricted.
- adjusted for the cost of holding required capital.

Question 29

What is the value of business in force (VBIF)?

Answer 29

the present value (PV) of future sharegolder cash flows from the in-force business, discoutned at the appropriate discount rate.
- associated cash valyes: premiums, investment income, fees, benefits and expenses.

Question 30

What is the EV equation?

Answer 30

= (uncommitted capital) + ((required capital)-(cost of holding required capital)) + (value of business in force)

Question 31

What is the purpose of tracking changes in the EV value?

Answer 31

to assure the company is adding value at a rate in excess fo the hurdle rate.

• it provides standardied info on the value of a company to analyst and broader invement community
• pinpoints what operations of the company are creating value
• provides info on risk exposure through the use of sensitivity, stress, and scenario tests.
• insurer must be able to identify the reasons for changes in EV over time.

Question 32

What are some drawbacks of EV calculations?

Answer 32

1) very sensitive to the choice of assumptions used.
2) complicated to explain to nonactuarial audiance.
3) potentially inconsitent with capital market pricing paradisms.

Question 33

How can companies counter EV limitations?

Answer 33

1) use discount rate based on the risk profile of each product line.
- rates might be too optimistic
2) companies need to fidn a way to acknowledge the impact of other sources of value by meausing performance in terms of appraisal value and market value. > but both difficult to measure.

Question 34

define appraisal value and market value.

Answer 34

appraisal:L embedded valye (EV) of a compny plus the value of the company’s future sales
Market: is the appraisal value of a compay plus its brand value

Question 35

Why is it difficult to measure a company’s growth?

Answer 35

growth rate is not consistent.

its fluctuates and thus predictions are impossible.

Question 36

why is it difficult to measure customer perception?

Answer 36

most investment have psychological and emotional components..
- measuring “feeling” is difficult.