Chapter 19: Investment principles and ALM Flashcards
2 type of returns that shareholders of an insurer is interested in
- an insurance (or underwriting) result, and
- an investment result
Primary objectives of investment
To maximise return subject to meeting contractual obligations:
- meeting claims and expenses as they fall due
- maintaining statutory solvency and any internal company solvency constraints.
The risk of not earning a return is within the scope of the insurer’s risk tolerance.
The risk appetite of the insurer will depend on (4)
Its
- liabilities
- assets currently held
- external influences
- insurer-specific constraints
7 Liability characteristics that need to be considered
- nature - real or fixed liabilities?
- currency
- term
- level of uncertainty (timing and amount)
of existing liabilities - estimated future liabilities arising from the portfolio of business planned
- location of liabilities
- whether the liabilities are discounted.
“The nature of existing liabilities”
Are they fixed or “real” in monetary terms.
The majority of general insurance liabilities will be real in nature.
“Currency of existing liabilities”
Many domestic, personal and commercial insurers may have portfolios predominantly denominated in their local currency.
However, international insurers and reinsurers have portfolios that contain a range of currencies.
“Term of existing liabilities”
Most general insurers’ portfolios are likely to contain a significant proportion of short-term liabilities (1-3 years), with a smaller proportion of medium-term (4-10 years) and long-term liabilities (10+ years)
6 Considerations with respect to the assets
- size of the assets, in relation to the current liabilities
- expected long-term return from various asset classes
- expected volatility within the various asset classes
- existing asset portfolio
- non-investible funds
- economic outlook
Free reserves
The excess of the value of an insurer’s assets over its technical reserves and current liabilities.
Monies not available for investment include (3)
monies held by:
- agents (eg brokers holding premiums for two months before passing them on)
- policyholders (eg premium payments by instalment, or end-of-year adjustment premiums due to exposure adjustments or experience rating)
- reinsurers (ie delays in making recoveries)
7 External influences on investments
- tax treatment of different investment and the tax position of the general insurer
- statutory, legal, ethical or voluntary restrictions on how the insurer may invest
- statutory valuation requirements
- solvency requirements
- rating agency constraints on capital required to maintain the insurer’s desired rating, and therefore a better image and better terms for raising future capital
- competition - strategy followed by other funds
- regulatory constraints eg. Lloyds, PRA or FCA
-investment / economic conditions
- claims inflation
the risk of catastrophes
seasonal effects
any non-investible funds
shareholders’ expectations
2 Insurer-specific investment considerations
- Risk appetite
- Company-specific investment objectives
3 Possible insurer situations wrt cashflow
- insurer expects that premiums and investment income will continue to exceed claim payments for the indefinite future
- insurer is in run-off and expects to have to rely on the maturity and realisation of assets
- insurer has suffered a major insurance event and needs to obtain short-term liquidity in order to settle claims
2 fundamental choices when modelling future liability outgo
- whether to include premium income and outgo relating to business that will be written after the accounting date, which will depend on whether the exercise is to assess ongoing profitability, solvency an investment policy
- only the liability outgo relating to the existing liabilities (for business already written), which will depend on whether the exercise is to determine assets suitable for matching to existing liabilities.
The aim is to project, on a BEST ESTIMATE basis, the overall liability outgo in each future time period.
Overall liability outgo can be calculated as (5)
liability outgo = total gross claim payments - reinsurance and other recoveries \+ expenses - outstanding premiums received \+ tax and dividend payments
Claim payment projection must include (4)
- all future payments in respect of unsettled reported claims
- IBNR and reopened claims
- claims that will emerge from unexpired risks
- claims that will emerge from new business
4 important considerations in an investment income projection
- income from investment
- any capital proceeds, eg the redemption payments on any maturing bonds, during the period of consideration
- the expenses of investment
- the future volatility of capital values and investment income
possible solvency requirements might be related to (4)
These requirements can also be self imposed by an insurer
- the length of tail
- the likelihood of catastrophes and accumulations
- the spread of risk groups within the portfolio, ie how well diversified the insurer is by the classes written
- the insurer’s experience in writing the class and therefore how predictable the liability outgo is.
The purposes of a new business projection might be to assess (3)
The purposes of a new business projection might be to assess
- the future solvency of the office under different volumes of new business
- the future solvency under different scenarios for asset distributions, or
- the likely levels of profitability