Test 2: Ch 23-28 and 32-34 Flashcards by jp swanepoel

Ways to value assets:

SHAM FADS

Smoothed market value
Historic (book) value
Adjusted book value
Market value
Fair value
Arbitrage
Discounted cashflow model
Stochastic model

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Main factors influencing investment strategy :

SOUNDER TRACTORS

Solvency requirements and statutory valuation requirements
Objectives of the institution
Uncertainty of liabilities
Nature of L 
Diversification
Existing asset portfolio
Risk appetite of the institution

Term of the liabilities
Return expected over long term from various asset classes
Accrual of future liabilities
Currency of current liabilities / Correlations between various assets
Tax and cashflow requirements
Other funds strategies / Opportunity cost of capital when mismatching
Restrictions on how the fund may (statutory, legal and voluntary)
Size of the assets in relation to liabilities and in absolute terms

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Three main definitions of risk in institutional investment strategies: PVPR

Probability of default (unlikely)

Variability of return (also unsatisfactory because liabilities change too)

Probability of failing to achieve the investor’s objective (most practical)

Relative performance risk

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Factors to consider prior to a tactical asset allocation switch:
CEPEL

Constraints on the changes that can be made to the portfolio

Expected extra return relative to any additional risk

Problems involved switching a large portfolio

Expenses

Level of assets available

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Main factors influencing individual investment strategy:

PRINCES

Practical considerations
DEK (no direct investment, high expenses, no
knowledge)
Returns on different assets FUT
(tax considerations, ‘feel-good’ and
undervalued assets, speed of changing assets)
-Investment freedom and
constraints LURE (excess assets, uncertainty,
insurance risk appetite (WAD) and liquidity)
Nature of assets and liabilities (CANTC)
Cashflow requirements
Expenses/expertise
Spread(variability) of market values

Considerations
DORA

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Types of benefit payment and asset strategy:

GIDI

Guaranteed in nominal terms:

pure/approx. matching assets
seek immunisation

Index linked

index linked bonds
equities

Discretionary

real assets - highest expected return possible
requirement to match PRE- policyholder reasonable expectations

Investment linked

assets to replicate/match index
(assets used to determine the benefits , derivative strategy or CIS)

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Regulatory framework limitations in developing an investment strategy: (TECH SCAM)

Type of asset can invest in
Extent of mismatching allowed
Currency
Hold certain proportion in a certain class of assets
Single counterparty maximum exposure
Custodianship of assets
Amount of any one asset used to demonstrate solvency
Mismatch reserve

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Limitations of Redington’s immunisation theory:

FAT DRY PI

Fixed nominal values assumed (but can use ILG)
Assets of long enough duration may not exist
Timing of asset proceeds/liabilities unknown
Dealing costs ignored
Re-balancing needed after interest rate change
Yield curve assumed to be flat
Profit from mismatching eliminated
Interest rate changes assumed to be small

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Expenses for securing new business:

PUMaCR

Processing/ product design
Underwriting 
Marketing
Commission 
Research

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Factors affecting cost of benefit:
(TIERCCCOP)/
(ICC COPTER)

Tax
Investment income 
Experience rating – adjust future premiums - how was the actual claim experience? better or worse than
Reinsurance cost
Commission – possibly expense? 
Cost of capital – still to be covered 
Contingency margin
Options + Guarantees 
Provisioning bases – cost of establishing solvency capital, becomes positive a termination-- cost of capital
 expected? (connect to data chapter)

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Factors affecting the marketability of products:

ICE

Internal issues: Product quality, reputation etc
Competitors’ actions
External environments (economic situation, trends, policy changes)

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Factors affecting benefit paid in discontinuance:

FRACPENCS

Frequency of change of discontinuance terms - PRE, Cost
Regulation and market practice
Asset share of a policy (retrospective res)
Competitiveness
Practical considerations – cost, calculation ease.
Expectations - PRE, short and long duration
New business disclosure
Cost of implementing the discontinuance terms
Suitable terms - Lump sum, paid up value

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Insolvency and closure of a life insurer why this rarely happens:
(RIPTC)

Regulation 
Intervention - Reinsurance, Investment strat, New Bus 
Projecting solvency 
Takeover of business
Compensation schemes

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Factors affecting the level of benefit paid out in the case of insolvency:
(ARE)

Asset level - surplus or deficit
Rights of beneficiaries – terms of scheme or overriding legislation
Expectations – benefits if did not cease, future, accrued, discretionary.

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Factors considered when modeling future solvency RECSO

Redemption of debt - Amount and timing
Estimated future loss/profit net of tax
Current value of surplus assets 
Staff - Relationships &amp; employee benefits 
Outstanding financial obligations

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When taking over discontinuance business or for a merger/acquisition, consider:
RIEL SyCRETS

Relocation of staff
integration of system platforms
Effect on unit costs
Location of Business

Synergy of the products
Cost vs Reward of the takeover/merge
Regulatory differences if in different sectors
Employee benefit scheme new members
The effect on the company’s long term goals
Shareholders on both sides

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Options for benefit provision of discontinued benefit scheme CLiBPr / CT4

Continue scheme with no benefits accrual
Liabilities transferred to new scheme of the same sponsor
Beneficiary receives funds as lump sum
New Provider of benefits are given the built up assets
/
Continuation of the scheme without any accrual of future benefits.
Transfer liabilities to another scheme with the same sponsor
Transfer the funds to an insurance company to invest and provide some form(lower or guaranteed) of benefits to members
Transfer benefits as a lumps sum to the member
The scheme can close to new members

Merits of valuing assets with the market price

ARCOE FFARBB

Objective
Reliable
Easy
Well understood and accepted
Comparable with other valuation methods to determine anomalies

Fluctuates over time
Future value not reflected 
Availability lacks
Not realistic value for sale
Bid/Offer conflict 
Basis inconsistency between A and L

Issues with valuing equities with the discounted dividend model TURA/ TULA

Tax ignored
Unknown dividend and required return rate and assumed fixed
Lack of Rigor in results
Annual dividend assumed

Methods to compare returns on different asset classes/ categories of tests to determine if an asset class is overvalued:
GRaNTR

yield Gap
yield Ratios
yield Norms
Technical analysis
Reverse yield gap

Property risk premium compensates for: U VOLD

Unit size/ Uniqueness
Refurbishment
Void risks
Obsolescence
Liquidity
Dealing and management costs

Valuation of A and L with MARKET VALUE, Merits CAMV:

Consistency with L difficult
Assets usually valued with MV
Market based discount rate hard to find
Volatile

Valuation of A and L DISCOUNTED CASHFLOW merits SASH/CASH:

Stable and consistent valuation of L
Assumptions about valuations consider both A and L
Subjective
Hard to explain

Merits of Active investment JEL JED

Judge future performance of assets
Expected returns are higher
Limited Restrictions on investment  
Judgment error risk exists 
Efficient  market - inability to outperform
 Dealing costs

Merits of Passive investment EIS LT

``` Expenses are less Index tracking is possible Smaller expected return Little investment freedom Tracking errors ```

The technique of risk budgeting APEAR EDIT-----------------

``` Active and strategic risk allocation Portfolio risk allocation Efficiency of active management measured Appetite of risk at given level determined Risk correlation considered ```

Non-Actuarial Techniques of investment strategies MAS

Mean-variance optimisation Asset allocations based on market capitalisation Similar strategies as other institutions

The three components of risk when quantifying ASS: | Three key investment risks

Active - fund manager not meeting benchmark Strategic - benchmark does not match liabilites Structural - aggregate benchmark of managers does not meet total benchmark

Aspects of an Asset Liability model OPHACC:

``` Objectives of investment formulated Performance target set Horizon of performance set Assumptions of model set Confidence levels of performance determined Continuously run and assess the model ```

Factors causing differences - price and cost of products: DCLP

Distribution system – exploit economies of scale or sell above market price Competition – underwriting cycle Loss leader: Cheap products attract customers to profitable products Premium frequency

Factors when assessing premium rates MOP:

Marketability Other features: lapse rates, policy terms, cross- subsidies Profitability

Forms of funded products JuSTLuReT

``` Just in time funding Smoothed PAYG Terminal funding Lump sum advance Regular contributions Tax ```

Factors to consider when choosing a financing method FLiRTS SORRi

``` Flexibility of the contributions Liquidity needs of sponsor Realism of method Tax incentives Stability of contributions needed Security of the benefits Opportunity cost of funding method - none for PAYG Regulation Risk allocation - sponsor vs. beneficiary ```

Constraints individual investors have that institutions do not have: (4 Lack of Cash SADD)

Lack of access to research facilities Lack of up to date investment information Lack of expertise to invest directly Lack of time available Not always have cash available for - Short notice investment opportunities - Achieve economies of scale - Direct investment and remain well diversified - Directly invest in large unit sizes

Advantages of PAYG method WTF ExO

No need to wait for contribution accumulation to provide benefits Lower transaction costs Funds not tied up Easier to Organise the payments of benefits Experience cannot cause difference between contributions and benefit

Advantages of risk budgeting | BaIn

Bases asset allocations not only on expected return but also on its risk contribution Increases the attention paid to low correlation investments which reduces total risk of the portfolio

Benefits of funding in advance | GASER T

``` Gives security to members Avoids sudden and unexpected cash calls that could cause liquidity problems Smooths costs Expected by members to fund in advance Required possibly by legislation Tax advantages possible ```

Treating the surplus or deficit of a discontinued benefit scheme: (DPEL SERB)

``` Deficit: Priority given to certain members Expenses of the calculation Legislation Surplus: Employer's right to receive surplus Rights of members Benefits improvement ```

The steps of an expense analysis CFTIL

Class - Fixed/variable or Direct/Indirect Function - Initial, Renewal, Termination Type - Salaries, Rent, Computing etc. Identification of costs - Time sheets, floor space, etc. Loading method - Once off, recurring premium proportion

When matching assets and liabilities keep the following in mind CNT CRRD

``` Currency Nature Term Certainty Return Regulation or Legislation Diversification of assets ```

Steps required to perform a stochastic ALM modelling exercise: OSNeP SAPI

1. The objectives of the strategy need to be defined clearly 2. The company will be required to produce simulations of assets and liabilities over the full run off period of the liabilities 3. The model may include or exclude future new business, depending on the objectives 4. If NB is included, projected sales can be obtained from business plans and input from marketing and sales departments 5. Depending on the size of the book and computing power, it may be necessary to select model points 6. Appropriate input assumptions are required such as distribution parameters of assets, correlation between assets and liabilities 7. Projections should be based on best estimate assumptions 8. An initial strategy is tested by projecting the Assets and Liabilities under several thousand simulations to derive a probability distribution and to determine the suitability of the strategy