Objective of Pension, Life and General Insurance Companies

Question 1

UK Institutional Investors affect on Retail Investors

Answer 1

Indirect investment through an institution is now the most popular way for retail investors to invest

Allow investors to purchase stakes in large, well-diversified portfolios they would be unable to access

Question 2

Pension Fund - Two types

Answer 2

Defined Benefit
- sponsor to pay member benefits equal to a proportion of salary at retirement (final or average) subject to members years of service.

• Occupational only (sponsor is employer)

Defined Contribution
- contributions are used to buy investments, the return on these investments determines the pension benefits

• Occupational or Personal

Question 3

Advantages / Risks of DB

Answer 3

Member - advantage of certainty of benefit

Sponsor - risk of meeting this benefit lies with employer / sponsor

Calculation example: 1/80 scheme, £50k final, 40 year contributions

(50,000*40)/80 = £25k p.a until death

Question 4

Advantages / Risks of DC and Annuities

Answer 4

Member - bears risk of meeting pre-determined level of benefit so advantages for the employer / sponsor

However, an ‘Annuity’ can be entered into to give certainty of benefit during retirement

If individual dies before 75, they can leave DC pension to anyone tax free. After 75, lump sum (55%) or income (25%) will be charged on recipient

Question 5

Pension Fund - Reasons for switch to DC

Answer 5

1. Increasing Longevity - therefore increasing costs to scheme
2. Increasing Pension Deficits - partly by longevity but also falling returns on assets held

Question 6

Pension Fund - Strategy for DB schemes in Deficit

Answer 6

• switch from equities towards bonds (reliable returns and ageing members want certainty of cash flows)
• Liability-Driven Investments (LDI) which switch to bonds and use swaps / derivatives to match assets to liabilities

However, using these LDI strategies simply locks in the deficit, so some use partial to mitigate deficit, whilst keeping equities to reduce it

Question 7

Pension Fund - Tax Position

Answer 7

+ Contributions from individuals receive Income Tax relief

+ accumulated interest and Capital Gains are not liable to taxation

+ Part of proceeds (25%) are available as a tax-free PCLS

• However, pension income is liable to income tax

Question 8

Pension Fund - Occupational Scheme Trustee’s Role

Answer 8

Appointed to ensure the fund managers are acting competently to meet the future liability stream

Determine strategy of fund and asset allocation

Question 9

Pension Fund - Asset Class Distributions

Answer 9

Largely long term liabilities (large % equities)

AA depends on maturity. Funds with employees nearing retirement, need more liquidity and certain cash flows (fixed income)

DC schemes with Annuity businesses require certain cash flows (fixed income)

Question 10

Pension Fund - DB vs DC calculating Asset Allocation

Answer 10

• DB focuses on maturity of plan (mature = more liquid)

- DC also uses employer turnover rate (high tech company requires high liquidity for turnover)

Question 11

Pension Fund - Growth by Dividend vs Capital Gains

Answer 11

Despite not having to pay CGT, pension fund managers may prefer to receive Dividend Income

Adjusting a portfolio by realising gains incurs transactions costs (through purchase AND sale of securities)

Where as re-balancing with dividend or coupon income, ‘costs will only be incurred on the purchase’

Question 12

Pension Fund - Pound Cost Averaging

Answer 12

Due to pension funds ‘regular flow of income’, assets may be bought at market peaks and troughs

Using PCA, fund manager can pay the ‘average price’ of the asset

Question 13

Life Assurance - Term vs Life Definition, Asset Allocation

Answer 13

Term assurance - covers life over a specific period instead of a capital sum on holders death

Since liabilities are long term in nature, portfolios are matched and illiquid

Question 14

Life Fund - Tax Position

Answer 14

• Investment returns subject to BOTH Income and CGT, therefore life fund managers use a strategy to minimise tax they pay on their funds
• Life assurance premiums are paid by policy holders out of post tax income

+ Some policies can be ‘qualifying’, which means proceeds of policy are not taxable (contrasting to Pension where income is taxable)

Question 15

General Insurance - Definition, Asset Allocation

Answer 15

Provide cover against specific contingencies (fire, theft etc) over fixed period (usually annual)

Since liabilities are short term, GI companies pool premiums into reserves (usually highly liquid short term securities)

Question 16

OEIC and Unit Trusts (unrelated to section)

Answer 16

Open ended, therefore fund manager can create new units or shares to meet demand
Price of unit / share depends on NAV
Dividends can be paid as income or reinvested
Unit Trust = governed by law
Quote bid and offer price

OEIC - company law, makes investors owners (shares)
Only one price