Chapter 30 Investment

Question 1

Asset-liability matching requirements

Answer 1

• Nature, term and currency of the liabilities
• Effects of the nature of liabilities
• free assets
• regulatory framework

Question 2

Nature, term and currency of the liabilities

Answer 2

-

Question 3

Term

Answer 3

• also known as discounted mean term
• the DMT of liabilities is important in considering an investment strategy
• when a liability is matched with an asset of the same DMT the insurer will be protected from interest rate fluctuations.

Question 4

Currency

Answer 4

-liabilities denominated in a certain currency should be matched with assets in the same currency, so as to reduce any currency risk.

Question 5

Limitations of immunisation

Answer 5

• immunises profits as well as losses
• assets of appropriate nature may not exist
• it may be difficult to immunise against real liabilities
• theory works only with small interest rate fluctuations
• theory assumes when interest rate change, the same change happens at all terms
• you would need to reanalyse the situation everyday.

Question 6

Regulatory framework within a country may limit what a company can do in terms of investment. Following controls may be implemented:

Answer 6

• restrictions on the types of assets in which an insurer can invest.
• restrictions on the amount of any particular type of asset that can be taken into account for the purpose of demonstrating solvency
• restrictions on the maximum exposure to a single counterparty
• a requirement to hold a certain proportion of total assets in a particular class for eg government stock.
• a requirement to match assets and liabilities by currency
• a requirement to hold a mismatching reserve, this will increase the liabilities of the insurer.
• a limit on the extent to which mismatching is allowed at all
• custodianship of assets
• Other controls:
• regulatory environment can also affect the choice of assets through their relationship with the investment assumptions used to value liabilities.
• a certain asset selection may allow a company writing long-term health insurance products to use a higher yield assumption and thereby increase its assets but decrease value of its liabilities.
• method required to value the assets.

Question 7

What is resilience testing

Answer 7

• Changes in fixed interest yields or a fall in the capital values of equities and property could lead to insolvency.
• To identify the risk the company would have to analyse its supervisory solvency position under different assumptions of current investment conditions.
• this is referred to as resilience testing.

Question 8

Using a model office to determine an investment strategy

Answer 8

• using a model of business in force, a model investment portfolio can be built up based on the company’s proposed investment strategy and incorporating appropriate proportion of free assets.
• the liabilities and assets will then be projected forward on assumptions that represent expected future experience, although the company will want also to consider the effect of variations from these.
• for assets, stochastic investment models can be incorporated in order to project future investment income and changes in capital values, Inflation rate models can also be used to project future expenses on the liability side.
• there should be consistency between parameters/assumptions.
• projected value of assets & liabilities can be valued at the end of each year of projection on the company’s supervisory basis.
• the item of interest will be excess value of assets over liabilities. Insurer needs to be comfortable with this especially from a regulatory requirement.
• a stocastic investment model and simulation techniques will produce a statistical distribution of amounts available at each year to cover level of SCR. Probablity of future insolvency can be estimated. Each simulation will represent a particular investment strategy.

Question 9

The insurer will perform AL modelling to test the proposed investment strategies, which could be used to investigate (3):

Answer 9

• riskiness of the investment strategy
• level of the free assets
• probability of insolvency

Question 10

Other uses of the model office

Answer 10

• simulations could be also used to determine the level of free assets that the company needs in order to support a particular investment strategy & keep probability of insolvency below an acceptably low figure.
• for a proprietary company effect of investment strategy on earnings of shareholders can be assessed.
• it can determine a strategy that maximises shareholder income whilst keeping risk of insolvency relativel low bearing in mind level of free assets.

Question 11

Liquidity

Answer 11

• if an insurer is writing business that can produce claims levels that fluctuate widely or if it is in run-off it will be wise to maintain access to ready liquid funds.
• even with reinsurance protection the insurer will be left with the obligation to pay gross claims far in advanceof making recoveries from reinsurers.

Question 12

Asset valuation

Answer 12

• method of valuation of assets will depend on the purpose of the exercise and the market’s perception of fair value.
• For PMI business which has nly-short-term liabilities assets should be valued at market price.
• for long-term liabilities there are two possibilities.
  1. discount the likely returns on consistent basis as valuation of liabilities.
  1. Use market values as an objective and readily-understood methodology.

Question 13

Treating customers fairly

Answer 13

• it is unlikely that customers of conventional health and care insurance products have any expectation of investment gains through their insurance.
• If insurer experiences underperformance in investment portfolio this may necessitate an increase in premiums, this however would raise questions on TCF.