Chapter 27: Developing an investment strategy

Question 1

2 Principles of investment

Answer 1

A provider should select investments that are appropriate to the
- nature
- term
- currency
- uncertainty
of the liabilities

and the providers appetite for risk

Secondly, the investments should be selected so as to maximise the overall expected return on the assets, where overall return includes both income and growth of the asset values.

Question 2

Define the net liability outgo for a provider

Answer 2

Benefits + Expenses - Premium/Contribution income

Question 3

4 Types of benefits

Answer 3

• guaranteed in money terms
• guaranteed in terms of a price / earnings index
• discretionary
• investment-linked

Question 4

A good asset match for liabilities guaranteed in money terms

Answer 4

Conventional bonds
But an exact match is normally impossible since the timing of the bond proceeds is unlikely to correspond with the liability outgo.
Equally the bond may not be long enough in duration.

Question 5

A good asset match for liabilities guaranteed in terms of an index.

Answer 5

Index-linked bonds.
But these may not exist, or they may not be linked to the exact index as the liabilities.

Alternatively, we might suggest equities or property.

Question 6

A good asset match for discretionary liabilities.

Answer 6

Equities or property to maximise returns.

However the choice will also be affected by the level of policyholder expectations and free assets.

Question 7

Why is it important to take into account the free assets of the provider

Answer 7

Free assets act as a cushion against volatile returns and the risk of insolvency.
Significant free assets may enable the provider to mismatch in pursuit of higher returns.

However, the amount of free assets required to mismatch guaranteed liabilities is often too great for a provider to consider, given the other competing uses (financing new business growth).

Question 8

A good asset match for investment-linked liabilities

Answer 8

Invest in the same assets as used to determine the benefits.
In many countries, mismatching of investment-linked liabilities is not allowed.
However, if it is, it is the provider who accrues the extra losses / profits, not the beneficiaries.

Question 9

8 Examples of restrictions imposed by supervisory authorities

Answer 9

restrictions on:

• the TYPES OF ASSETS invested in
• AMOUNT OF ASSETS held
• EXPOSURE TO A SINGLE COUNTERPARTY

requirements to

• MATCH assets and liabilities by CURRENCY
• hold a certain proportion of assets in a particular class
• hold a MISMATCHING RESERVE
• in relation to the CUSTODIANSHIP of assets

limits on the extent to which mismatching is allowed