CHP 9 Flashcards
1.1. Cashflow matching
Providers of benefits deliver this by investing in assets. A key decision is to match assets and liabilities or not. The optimal matched position must be determined.
This is difficult given the uncertain nature of asset and liability cashflows. Use methods based on financial economics and corporate finance theory.
If assets and liabilities are not matched, additional capital (free assets) must be held to cover the event of assets < liabilities. Determining the level of capital to be held is not easy.
1.2. Cashflow process
Both the timing and amount may be unknown.
Insurance companies first receive positive cashflows and then pay out claims later, the positive CF can be invested to generate returns.
Where the timing of the cashflow is uncertain, assign a probability to the amount and the existence of the cashflow.
2.2. annuity cashflows
Provides a series of regular premiums in return for a single premium. The conditions under which the annuity payments will be made must be clearly specified.
Also consider the provider’s expenses. The number of pmts are uncertain, level could be uncertain (linked to an index).
2.3. Term assurance cash flows
Provides a lump sum on death if this occurs within the term.
Usually purchased by a recurring premium, generally but not necessarily of a constant amount.
Premiums normally cease on death, premiums could be paid for a shorter period than the term or could be single prem.
The provider will receive an unknown number of regular cashflows of known amount. The negative cashflow is not certain (if it will happen, sometimes the sum assured increases in line with an index).
2.4. Endowment assurance cashflows
The cashflows are similar to that of term assurance except that there is certainty about paying out the benefit.
Due to the certainty of payment of the benefit, the premium for this is higher than term assurance and the provider will need to invest the premiums to be able to sell the assets and pay out the benefit from that.
2.5. An interest-only loan cfs
Loan repayable by a series of interest payments followed by a return of the initial loan amount.
In the simplest case, the cashflows are the reverse of a fixed interest security.
In practice the interest rate need not be fixed in advance and thus the regular cashflows may be unknown.
The loan may be repaid early, thus the number of cashflows may also be uncertain.
2.6. A repayment loan (or mortgage) cfs
Repayable by a series of amounts that includes interest and capital repayment. If the interest rate is fixed, the payments will be level, paid at known, regular intervals.
Cashflows are similar to that of an annuity but the number of payments are fixed and not dependent on survival.
Could repay early, payments may be made to vary with time. These changes can be smooth or discrete.
Interest and capital portions vary over the term of the loan, this is relevant if the tax treatment of these are different.
2.7. Motor insurance cfs
Typically provides cover over the period of one year in return for a regular premium. Here the insurance company will accept the risks involved with the policyholder’s motoring.
The amounts and timing of the premiums are known but the amount and timing of the claims are not known.
Mostly the claim is paid soon after the event but it could be that the claim is only paid long after the cover period has lapsed (wait for recovery, court decisions etc.).
