Investments

Question 1

ESG concerns

Answer 1

Economic, Social, Governance

Question 2

An ESG model

Answer 2

Economic Scenario Generator

Question 3

Liability outgo calculation

Answer 3

Benefit outgo
+ Expense outgo
- Premium income

Question 4

Goal of investment

Answer 4

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.

Question 5

How should assets be selected for investment?

Answer 5

To match liabilities by CUNT

Currency
Uncertainty (timing and amount)
Nature (guaranteed, investment linked, discretionary)
Term (discounted mean term / duration)

Question 6

DMT

Answer 6

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

Question 7

Why might a company want to invest overseas?

Answer 7

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

Question 8

List the possible variations in nature of liabilities

Answer 8

1) Guaranteed in money terms
2) Guaranteed in terms of some non-investment index
3) Discretionary
4) Investment-linked

Question 9

Give examples of the types of liabilities by nature

Answer 9

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

Question 10

Disadvantages of Immunisation Theory

Answer 10

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

Question 11

How does deviation from a matched investment position benefit policyholders?

Answer 11

1) Higher expected returns
2) Higher expected bonuses
3) Lower expected premiums

Question 12

How does deviation from a matched investment position benefit shareholders?

Answer 12

1) Higher expected returns
2) Higher expected dividends

Question 13

Blue chip companies

Answer 13

Secure, established companies in mainstream sectors

Question 14

Overall strategy of investing for a life company

Answer 14

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

Question 15

List the uses of Asset-Liability modelling

Answer 15

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

Question 16

List the generic implications of tje rax treatment of investments

Answer 16

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)

Question 17

Risk from cashflow mismatching

Answer 17

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.

Question 18

Risk from short-term asset shocks

Answer 18

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

Question 19

Resilience testing

Answer 19

Analysis of solvency position under different assumptions of current investment conditions

Question 20

List two ways a company can approach holding buffers to meet risks

Answer 20

1) Holding additional reserves (i.e. reserving on a prudent basis)
2) Reserving on a best estimate basis and holding additional solvency capital separately

Question 21

STEPS to using an Asset-Liability model as a basis for determining an optimal investment strategy

Answer 21

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.

Question 22

The decision on assets for discretionary benefits, and whether this will affect the investment approach for guaranteed benefits, will depend on…

Answer 22

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