Chapter 28 Investment

Question 1

State the 3 main principles of investment for a life insurance company (5) and how can these investment principles be summarised (2)?

Answer 1

Principles of investment

1. To minimise risk, insurer should select investments that are appropriate to nature, term and currency of liabilities
2. Investments should be selected to maximise overall return on assets, including botn investment income and capital gains
3. Extent to which ‘appropriate’ investments referred to above may be departed from to maximise overall return will depend, amongst other things, on
   extent of company’s free assets
   company’s risk appetite
   Alternatively, principles of investment may be stated as

company should invest so as to maximise overall return on assets,
subject to risk taken on being within available financial resources

Question 2

cash

Answer 2

By cash, we normally mean

money held on overnight accounts earning spot rates of interest

Question 3

What is perfect liability matching? (1)

Why is asset liabiliity matching generally undesireable, and under what circumstances may it be desireable? (2)

Answer 3

Perfect asset liability matching is when

assets are chosen whose proceeds are identical to outgo of money being paid out on liabilities, as they occur => would be no investment risk

Desireability/undesireability of asset liability matching

perfect matching usually undesireable as it removes chance of investment profit
may be desireable if company has very low free assets such that, without matching, probability of ruin would be unacceptably high

There is a distinction between

cashflow mismatching
risk over time asset proceeds income less than outgo needed to meet liabilities due to such things as
having to buy assets in future at lower than expected yields
having to sell assets at depressed market values.
result of assets liability mismatch by nature, term or currency and its effect unfolds over time as actual cashflows take place (requires cashflow projection to assess mismatch.
short term asset shocks risk
relates to whether company would continue to be able to meet its supervisory reserving requirements if market investment conditions were to change suddenly.
e.g. change in fixed interest yields or a fall in capital values of equity and property.
identify risk, analyse statutory solvency position under different assumptions of current investment conditions.
This is known as resilience testing.

Question 4

cashflow mistmatching

Answer 4

cashflow mismatching
risk over time asset proceeds income less than outgo needed to meet liabilities due to such things as
having to buy assets in future at lower than expected yields
having to sell assets at depressed market values.
result of assets liability mismatch by nature, term or currency and its effect unfolds over time as actual cashflows take place (requires cashflow projection to assess mismatch.