Chapter 30 - Investment

Question 1

What are the principles of investment

Answer 1

1. A company should select investments that are appropriate to the nature, term, and currency of the liabilities
   2.The Investments should also be selected so as to maximise the overall return on the assets, where the overall return includes both investment income and capital gains
2. The extent to which 1. may departed from in order to meet 2. will depend, inter alia, on the extent of the company’s free assets and the company’s appetite for risk

These can also be expressed as:
- The company should invest so as to maximise the overall return on the assets, subject to the risk being taken on being within the financial resources available to it

Question 2

What are the nature of benefit payments

Answer 2

• Guaranteed in monetary terms - the amount payable is specified in the insurance contract terms
• Guaranteed in terms of an index of prices - this consists of benefits whose amount is directly linked to an index
• Indemnity - this indicates policies such as PMI where the amount paid in respect of the policyholder is dependent on the costs incurred when receiving treatment covered by the policy
• Investment-linked - this consists of benefits where the amount is determined directly by the value of the investments underlying the contracts

Question 3

What are the regulatory framework that limits what a company can do in terms of investment

Answer 3

MET MECCA

• a requirement to MATCH assets and liabilities by currency
• restrictions on the maximum EXPOSURE to a single counterparty
• restrictions on the TYPES of assets the provider can invest in
• a requirement to hold a MISMATCHING reserve
• a limit to the EXTENT to which mismatching is allowed
• CUSTODIANSHIP of assets
• a requirement to hold a CERTAIN proportion of total assets in a particular class
• restrictions on the AMOUNT of any one asset used to demonstrate solvency may be restricted

Question 4

What is the aim of immunisation

Answer 4

To protect the investor from changes in future interest rates

Question 5

What are the 3 scenarios that will lead to a position of immunisation

Answer 5

• The PV liability outgo = PV Asset proceeds
• DMT Liability outgo = DMT Asset proceeds
• Spread liability outgo < Spread Asset proceeds

Question 6

Why might a company want to invest overseas

Answer 6

• If some liabilities were denominated in the currency of that market
• To increase diversification - or invest in assets not available locally
• deliberate mismatching in search of gains
  – it would only be possible if the company could allocate some free assets to cover the potential downside

Question 7

Model-office approach to investment strategy

Answer 7

APE CRI

• Allocate some free assets to support reserves
• Perform asset-liability projections of the company’s future assets and compare total assets against reserves
• Ensure excess of assets over liabilities exceeds statutory solvency capital requirement for entire projection period
• Calculate some measure of aggregate profitability
• Repeat steps 2-4 with different investment strategies until target probability of insolvency is achieved
• Identify the investment strategy with highest profitability among those with equal insolvency risk.

Question 8

Weaknesses of Model-office approach

Answer 8

• The ALM process will only be valid to the extent that the model, and inherent parameterisation are valid
• Issue of considering only a portion of free assets – although owners of free assets might justifiably not want all of those assets to be put at risk in supporting an unmatched investment strategy, that does not imply the model should necessarily exclude certain assets
• We will need to be very careful if the statutory SCR is not constant – in many countries it is a function of reserves, inter alia, the reserves
• In this case an approach that is less vulnerable to error would be to include the SCR in the asset-liability model to ensure that it is modelled correctly

Question 9

What are the 3 elements that can be varied when determining the appropriate investment strategy

Answer 9

1. The riskiness of the investment strategy
2. The level of free assets
3. The probability of insolvency

Question 10

The effect of investment strategy on liquidity

Answer 10

• The company may need to keep a supply of ready funds, to allow for the volatility of its day-to-day cashflows, particularly if modelling reveals that outcomes are sensitive to experience

Question 11

The effect of investment strategy on product design and pricing

Answer 11

• The return on investments to support the liability outgo for any product will enable the actuary to price and design more competitively
• The company’s ability to invest more widely than competitors due to possibly higher free assets, may result in a higher overall investment return
• This may enable the company to quote lower prices or to include further features at the same price