Chapter 30 - investments

Question 1

DMT

Answer 1

weighted sum of the terms of the payments weighted by the present value of the payment at that term

Question 2

Conditions for immunisation

Answer 2

1. present values of the liability outgo and the asset proceeds are equal
2. the DMTs of the liability outgo and the asset proceeds are equal
3. the spread about the mean term of the value of the asset proceeds is greater than the spread of the value of the liability outgo

Question 3

Problems with immunisation

Answer 3

• it immunises against profits as well as losses
• can be difficult to immunise against real liabilities
• only works with small interest rate fluctuations
• theory assumes that when interest rates change, the same change occurs at all terms
• would need to reanalyse the situation every day and change investments accordingly
• assets of required term may not exist
• the timing of asset proceeds might not be known and that of liabilities can only ne estimated

Question 4

Regulatory restrictions on investments

Answer 4

TECH SCAM

• restrictions on the type 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
• a requirement to match assets and liabilities by currency
• a requirement to hold a mismatching reserve
• a limit on the extent to which mismatching is allowed at all
• custodianship of assets
• restrictions on the valuation method that may be used

Question 5

Model office approach

Answer 5

1) allocate a certain amount of free assets to support the assets underlying the reserves
2) perform asset-liability model projections of the company’s future assets and compare these total assets against the reserves
3) check that excess of assets over liabilities exceeds SCR for the entire projection period for most of the model runs
4) calculate some measure of aggregate profitability
5) repeat these last three steps using different investment strategies until the target probability of insolvency is achieved
6) identify which possible strategies, having equal insolvency risk, produces the highest profitability

Question 6

Potential weaknesses of model office approach

Answer 6

• modelling risk
• the issue of only considering a portion of free assets. model should not necessarily exclude certain assets
• be careful if SCR is not constant

Question 7

How to make an investment strategy riskier

Answer 7

1. For assets backing some liabilities
   - reduce the amount of matching by nature
   - reduce the amount of matching by term
   - reduce the amount of matching by currency
2. increase duration of assets assuming there are no associated liabilities
3. in both cases:
   - move from government bonds to corporate bonds
   - move to lower credit rated bonds
   - from equities, move from an established company to a newer company or from an established sector to a new sector