Key Things Flashcards
What are the 1st set of factors affecting Investment Strategy (ch25)
SOUNDER TRACTORS
Size of assets (abs/rel)
Objectives (consisten with)
Uncertainty of liabilities
Nature of liabilities (fixed in monetary/real or varying terms)
Diversification
Expertise/expenses
Return (long term, from all asset classes)
What is the second half of factors affecting Investment Strategy? (ch25)
Tax (assets/investor/company) Restrictions (statutory/voluntary) Accrual of liabilities (future) Currency/geographic location of liabilities Term of liabilities Other investors Risk appetite - amount prepared to take on Solvency/valuation requirements
Why might you prefer a low yield (possibly bonds over equity)
Radioactive Matrices Trash Values
Reinvestment of income is less->lower dealing costs
Matching - may be little short term outgo to meet
Taxed more on income that CGT
Volatility - low income assets have longer DMT so are more volatile, expect higher return
State the 2 principles of investment
- Select investments appropriate to the
Nature/term/currency of the liabilities and the providers risk appetite - St (1), select investments to maximise overall expected returns on assets (income and capital gain)
“To the extent the company doesn’t follow these, it opens itself to risk”
What is the formula for net liabilities?
NL=BPEP
NL =Benefit payments + expense outgo - premiums/contributions
=Benefits+expenses-premiums
What assets match liabilities guaranteed in money terms?
Assets providing flow of income/capital to match liab outgo
Cash, FI bonds
What assets match gurantees in terms of an index?
Assets whose returns are linked to the relevant index (prices, pay awards etc.)
Real assets, index components
What assets match discretionary liabilities?
Pursue maximum returns subject to members reasonable expectations
Equities
What assets match investment linked liabilities
The matching investments
What restrictions might you have on investment strategy? (ch27)
ACE TERMS
Amount of specific assets allowed to be held e.g. to demonstrate solvency
Custodianship of assets
Exposure to single counterparty
Types/quality of assets invested in Exchange/currency matching for A and L Requirement to hold a given asset Mismatching reserve / allowable amounts Self-investment
What are the actuarial and non-actuarial techniques for developing investment strategy? (ch28)
Ha! Pimp Rim!
Hedging
ALM
Peer group benchmark (non-act)
Index tracking (non-act)
MVPT without liabs (non-act)
Pure-matching
Risk budgeting (stra/active/struct risk)
Immunisation
MVPT with liabilities
What factors affect individuals investment strategy (as well as SOUNDER TRACTORS)
DUFF VENDER
Diversification
Uncertainty of income/outgo in future
Freedom/constraints for investments
Feel good factors/returns
Volatility of market values Excess asset level Nature of assets/liabilities Direct investment difficulty like cost Expertise required, expenses incurred Risk appetite and cashflow requirements
What should you think about before a tactical allocation switch?
FRED
Free asset level
Returns additions vs risk additional
Expense incurred
Difficulties in switching a large portions and constraints
Why choose monetary assets?
SDVR
Short term investment
Diversify
Value is good
Risk appetite (risk averse)
What are the 4 categories of liability outgo?
GID
Guaranteed: Money-terms In terms of an index (price index mainly) Discretionary Investment linked
What does actual liability outgo depends on?
Value of constituent parts
Frequency of payment (probability of it)
What factors come together to create a companies risk appetite?
Nature of institution
Constrains of governing body
Legal and statutory controls
What reasons might Actual return differ from benchmark? (active and passive funds)
PEP SET
Performance impacted by market conditions
Errors in tracking, lack of exact match of investments
Poor stock or sector selection
Size of investment funds in each year affects MWRR measurement
Errors in benchmark data, for example publication of it, leads to errors in tracking correct assets
Timing of cashflows, possibly through forced disinvestment makes a difference
What factors might a Pens scheme consider in choice of an invesmtent manager (as well as all the investmen return)
QQ PA COCK
Quality of operations and audit
Qualifications of personnel and training
Publicity surrounding them
Access to investments limits, e.g. withdrawal penalties
Charges - size and frequency
Objectives, can they keep in line with them
Communication quality
Key personnel changes frequent or not
What 3 risks make up overall risk of a fund investment?
Active risk
Strategic risk
Structural risk
What is Active risk?
The risk of the fund performance not matching the benchmark due to investment manager decisions
What is Strategic risk?
The risk that the strategic benchmark we’re following doesn’t actually match the liabilities
What is Structural risk?
The aggregate of the inidivdual benchmarks doesn’t match the overall benchmark
e.g. x% FTSE 350 + (1-x%) Small cap returns doesn’t equal FTSE All-share return
What are the problems with matching liabilities?
Liability timing is uncertain
Terms of available assets not long enough
Asset income > liability outgo in earlier years
Trading costs prohibitive whether fequent or one-off large trade
Excessive amount of securities might be bought when the matching porfolio should cost the least with regard to the level of certainty required to meet liabs
What is liability hedging and give 2 examples
Where assets perform in line with liabilities, immunisation and currency matching
What are the problems with immunisation?
DRASTIC-Profits
Dealing costs are 0 Rebalancing constantly Aimed at fixed monetary liabs Suitable long durations may not exist Timing of liabilities unknown Int rate changes are small Curve of yields is not flat Profits immunised against except for small second order profit
What are the 3 things immunisation does?
1) Same PV’s of assets/liabs
2) Same DMT
3) ConvA>ConvL
How do you measure active risk?
Using active money positions - amount of over/under exposure of each stock relative to strategic benchmark
Retrospective tracking error - annualised sd of difference between fund and benchmark performance
Prospective tracking error - modelling future experience based on current holdings, expected volatility and correlations
What is risk budgeting, and what decisions do you make about active risk?
Establish how much risk to take and most efficient place to take it
Decide on allocation of max overall risk between active and strategic
Decide on allocation of active risk across component portfolios
What other things apart from SOUND ATTRACTORS effect investment strategy
Liquidity, if immediate large cash needed for liabilities
Ethical/consistent aim investment
Cost of investing
Features of available assets
Risks associated with assets relative to liabs
ACTUAL AIM OF INV STRAT!
How do you match expenses in your funds?
Linked to prices/inflation
Match it to real assets - equities or IL bonds
What assets match liabilities of known amount, know times (providing mortality fluctuations can be ignored). What is a slightly riskier match, and the problem with it?
Fixed interest guaranteed bonds.
Corporates/equity, risk is insolvency
What risk comes with not being able to match assets with term of liabilities?
Reinvestment risk
How can we minimise risk in our investment policy?
We could match liabilities, using immunisation
What effects the extent to which we go away from the ‘minimise risk’ principal and mismatch instead!
Level of free assets
Can invest in ordinary shares for long term and use free assets to protect from short term volatility
Why invest in equities in your pension fund, what problems can it cause?
Expected long term return higher than others
Volatile so larger capital requirements
No guarantee of the return
Can’t match with liabilities of annuities
Why invest in corporate bonds in your pension fund, what problems can it cause?
Higher return than govt because less marketable, default risk
Bonds by the EIB, World Bank are guaranteed by groups of government, very secure but higher yield than govt because less marketable
Marketability not an issue since assumed kept till maturity for matching liabilities
Default risk lower than equity
What alternative investments than equity and corporate bonds can increase return for a DB scheme?
Switching activity when invested in governemtn bonds
Overseas assets, but currency risk
Derivatives/swaps/options strategy, but costs high
When a mismatching reserve is required, what do regulations do with the surplus level?
The more an investor decides to invest in riskier assets with higher expected return, the higher any resulting reserve
This increases liabilities and reduces available surplus
How can we monitor the experience of investment fund management?
Regular reassessment of A and L to ensure current investment objective correct
Investment manager level - peformance monitoring and risks undertaken
Mnagement structure level - check overall balance of investments still appropriate
Strategic level - investment limits and asset types
Any new asset classes to be considered?
What are the 3 main reasons you’d prefer passive investment?
Lower costs
Higher returns
Uncomplex to discuss
Describe actuarial techniques to determine investment strategy
Objectives stated wrt A and L
Model created to project liability and assets cashflows into future
Outcome compared to objectives and process repeated to find optimum strategy
Deterministic or stochastic modelling can be used, the pros and cons
What 5 things make up the risk control cycle?
IMCFM Identify Measure Control Financing Monitoring
What 5 things help u identify risk?
DR RUB Desktop analysis Risk register Risk analysis at high level Upside potential Brainstorm with roject experts and senior management
How do you mitigate risk?
FAT SIR Further research Avoid Transfer Share Insure reduce
What are the sources of financial risk?
Credit
Market
Business
Liquidity
What are the non financial risks?
Ops
External
What are the canons of lending (things u check before u lend)
CASPAR Character and ability of borrower Amount of loan Security of loan Purpose Ability to repay Risk vs Rewards
What 3 things do u need for insurable risk?
- Interest in the risk (ph has interest in it)
- Financial and quantifiable nature is the risk
- Amount paid by insurer related to financial loss incurred
What 6 things is it nice to have for an insurable risk?
MUDPIS Moral hazard avoided Ulitmate liabliity limit Data with which to price the risk Pooling of similar risks Independant risk events Small prob of occurence
What is in risk matrix, where we identify risks in the company
PNE FC PB Political Natural Economic Financial Crime Project Business
What’s the difference between diversification and hedging?
D takes on uncorrelated risks
H takes on negatively correlated risks
How can we manage risks, what are the tools, which risks are retained in the business?
MURDA Managments control systems (r) Underwriting and claims control (r) Reinsurance Diversification (r) ART
What management control systems exist?
DAMS Data checks Accounting/auditing Monitoring liabs Special care with options and gtees
How can we diversify?
GIA-C Geographical Insurer Asset sector and stock picks Class of business
What is the process from a policyholder wanting a policy and claiming?
UPCC Underwrite Policy inception Claim Claim control
What types of underwriting can you have?
MiLF
Medical
Lifestyle
Financial
What stages of u/w do u have? e.g. proposal form
Proposal form
Doctor report
Medical exam
Specialist tests
What does a company do underwriting?
SAFERR
Substandard lives - identify and offer speciali terms
Anti slectionand moral hazard avoid
Financial underwriting reduces risk of over/under insurance
Experience ensured close to that expected in pricing
Risk classification, relevant and fair premiums to all
Reinsurance easier to obtain
What types of ART are there?
PISSDD Post loss funding Integrated risk covers Securitisation Swaps Insurance derivatives Discounted covers
What are the advantages of ART?
DESCARTES Diversification Exploit risk as an opportunity Solvency management, capital management Cheaper than reinsurance sometimes Availability when reinsurance isn't there Results smoothed Tax advantages Effectibe risk management Secuirty improved
Why do insurers need capital?
REG CUSHION Regulatory requirements for solvency demonstration Expenses at start up or launch new product Gtees and options solvency being greater Cashflow timing and management Unexpected events Smoothed divis/bonus/profit Help maintain credit rating/NB Investment freedom Opportunites e.g. merger NB strain
What are the sources of capital?
SCRIBES Subordinated debt Contingent capital Reinsurance like fin reins Internal restructure Banking products Equity Securitisation
How might banking products give us capital?
SLCD Senior undescured financing Liquidity facilities Contingent capital Derivatives
What types of internal restructuring give us capital?
WD-MCR Weaken basis Defer surplus Merging Change assets Retain profits
