QA Bank Part 5 Flashcards
State the characteristics of an insurer’s liabilities that should be taken into account so that the appropriate assets can be selected.
- term
- amount
- currency
- nature (fixed, increasing with inflation, or super-inflation)
of the liabilities
7 Reasons why in practice the assets held by a general insurer may not be a perfect match for the liabilities.
- The company may choose not to match liabilities (if it has plenty free reserves)
- If the company is making underwriting losses, an unmatched position may be taken to try to make investment profits to offset these losses.
- The company may be forced to invest in much shorter, liquid assets with a more stable market value, in order to protect its statutory solvency position.
- The timing of the liabilities will be uncertain and therefore difficult to match.
- It may not be possible to match, eg if claims inflation is different from the inflation protection available from real assets.
- There may be regulatory limits on the amount of assets that can be invested in certain asset classes.
- Matching assets may not be available.
Comment on the suitability of government bonds as investments for:
- meeting claims from household contents insurance
Short-term bonds are suitable for household contents.
Longer-term bonds are unsuitable as the liabilities are short-tailed.
Comment on the suitability of government bonds as investments for:
Employer’s liability insurance
Bonds would not be appropriate for employers’ liability, as real assets would be a better match.
Comment on the suitability of government bonds as investments for:
Free reserves
Bonds are normally NOT appropriate for free reserves. We prefer assets with a higher expected return and offer better protection against inflation.
Comment on the suitability of direct property investments for:
- meeting claims from household contents insurance
Direct property would be unsuitable for household business because of lack of marketability and large unit size.
The investments would also be too long term.
Comment on the suitability of direct property investments for:
- employers’ liability insurance
Property would be UNSUITABLE. Although the nature and term may be about right, the lack of marketability could be a problem.
The large unit size would also make it difficult to hold a sufficiently diversified portfolio.
Comment on the suitability of direct property investments for:
Free reserves
Direct property could be ACCEPTABLE for a portion of the free reserves. The insurer’s own office may form part of the assets.
Define a “risk clash”
Risk clash is correlation that occurs between risks in the same class.
Define a “class correlation”
Class correlation refers to the correlation that occurs between risks in different classes.
8 Factors a firm should consider when modelling market risk
- changed market values of investments
- variation in interest rates and the effect on the market value of investments
- the level of investment income
- counterparty / issuer defaults, unless addressed under credit risk.
- severe economic or market downturn or upturn leading to adverse interest rate movements and/or equity market falls.
- inadequate valuation of assets.
- currency movements
- the extent of any mismatch of assets and liabilities, including reinvestment risk.
3 Ways in which assets can be modelled
- Model EACH ASSET INDIVIDUALLY
This can be time consuming.
2. Model ASSET GROUPS The groups will be chosen based on the class of asset, term of the asset and the currency in which the assets are denominated.
- Model a NOTIONAL PORTFOLIO
A notional portfolio may be based on the long-term investment strategy of the firm, rather than the actual asset mix currently held by the insurer.
This can involve less computation than the other methods, and ensures that investment and capital management decisions are not influenced by any short-term deviation from the benchmark holding.
Consideration should be given to:
- Specific attributes to the firm’s portfolio, eg concentrations of asset holdings
- The freedom of the investment managers to move away from their benchmarks - this would increase the riskiness of the investment strategy and the consequent capital charge required.
this method may be appropriate where the actual assets are widely spread, or the investment strategy is based on indices.
Define liquidity risk
The risk that a firm is unable to meet its obligations as they fall due as a consequence of having a timing mismatch or a mismatch between assets and liabilities.
The risk is associated with the process of managing timing relationships between assets and liabilities.
9 Factors to consider when assessing liquidity risk
- the extent of mismatch between the assets and liabilities
- the amount of assets held in highly liquid forms
- the uncertainty of the liability cashflows
- the variation in the level of free assets over each stage of the underwriting cycle
- correlations with both insurance and market risk
- failures to forecast cashflow requirements accurately
- process weaknesses, such as poor credit control and poor management of disputes
- ability to manage unplanned changes in funding sources
- severity of the scenarios used in any scenario testing, and correlations between variables in each scenario.
3 Components that should be incorporated within a risk measure
A risk measure should incorporate:
- an actual measure, eg Value at risk, balance sheet surplus
- a level of confidence that this is achieved, eg 99.5%
- a time horizon over which it must be achieved.
