Investments Flashcards
ESG concerns
Economic, Social, Governance
An ESG model
Economic Scenario Generator
Liability outgo calculation
Benefit outgo
+ Expense outgo
- Premium income
Goal of investment
Maximization of overall return on assets (income and capital gains) subject to an acceptable level of risk and meeting its liabilities as they fall due.
How should assets be selected for investment?
To match liabilities by CUNT
Currency
Uncertainty (timing and amount)
Nature (guaranteed, investment linked, discretionary)
Term (discounted mean term / duration)
DMT
Discounted Mean Term
A.K.A duration
The weighted sum of the terms of the payments, where the weight attributed to each term is the present value of the payment at that term
Why might a company want to invest overseas?
1) If some of its liabilities are denominated in the currency of that market
2) To increase diversification
3) To invest in assets not available locally
4) Because another country’s assets seem to offer particularly good value compared with the home market
List the possible variations in nature of liabilities
1) Guaranteed in money terms
2) Guaranteed in terms of some non-investment index
3) Discretionary
4) Investment-linked
Give examples of the types of liabilities by nature
1) Guaranteed in money terms
- without-profits contracts
- accrued vested benefits under with-profits contracts
- premium income
2) Guaranteed in terms of some non-investment index
- CPI-linked
- expenses
3) Discretionary
- future with-profits bonuses
- surrender values
4) Investment-linked
- unit-linked contracts
- investment index-linked contracts
Disadvantages of Immunisation Theory
1) Immunises both profits and losses
2) Ccan be difficult to immunise against real liabilities
3) Assets of required term may not exist
4) Timing of asset proceeds might not be known and that of liabilities only estimated
5) Theory only works for small fluctuations in interest rate
6) Theory assumes a flat yield curve - when rate changes, the same change occurs at all terms
7) One would need to re-analyse the situation constantly and change assets accordingly to remain immunised
How does deviation from a matched investment position benefit policyholders?
1) Higher expected returns
2) Higher expected bonuses
3) Lower expected premiums
How does deviation from a matched investment position benefit shareholders?
1) Higher expected returns
2) Higher expected dividends
Blue chip companies
Secure, established companies in mainstream sectors
Overall strategy of investing for a life company
Invest away from a matched position, to the maximum extent possible consistent with the desired level of risk, in order to maximise returns for shareholders ajd with-profits policyholders
List the uses of Asset-Liability modelling
1) Test the proposed investment strategy
2) Investigate the level of riskiness of investment strategy that can be supported
3) Investigate the level of free assets required to support any strategy and keep P(insolvency) acceptably low
4) Investigate the resulting probability of insolvency
List the generic implications of tje rax treatment of investments
1) Tax reduces returns
2) Tax regimes may favour investment in particular assets
3) Tax regimes may favour income over capital gains (or vice versa)
Risk from cashflow mismatching
Over time, the income from the asset proceeds falls short of the outgo needed to meet the liabilities, as a result of mismatching by CUNT.
The effects of this only arise over time as actual cashflows occur, but can be assessed using a cashflow projection model.
Risk from short-term asset shocks
1) Relates to whether the company would continue to be able to meet its supervisory reserving requirements if market investment conditions were to change suddenly.
Identified through resilience testing
Resilience testing
Analysis of solvency position under different assumptions of current investment conditions
List two ways a company can approach holding buffers to meet risks
1) Holding additional reserves (i.e. reserving on a prudent basis)
2) Reserving on a best estimate basis and holding additional solvency capital separately
STEPS to using an Asset-Liability model as a basis for determining an optimal investment strategy
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 the excess of assets over liabilities exceeds any minimum capital requirement for the entire projection period for the majority of the model runs.
4) Calculate some measure of profitability in aggregate.
5) Repeat steps (2)-(4), varying investment strategies, until the target probability of insolvency is achieved.
6) Identify which of the possible strategies, having equal insolvency risk, produces the highest profitability.
The decision on assets for discretionary benefits, and whether this will affect the investment approach for guaranteed benefits, will depend on…
1) The bonus philosophy of the company
2) The level of free assets
3) The risk appetite of the company
4) The published (or expected) investment strategy of the company
5) The views of the company as to the relative performance of the asset classes concerned
