CHAP 19

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Questions and Answers

What is the key aspect to consider when projecting liability outgo for future time periods?

Predicting the exact amount of premiums to be received

Determining the appropriate investment strategy based on the projected outgo

Estimating the total liability outgo on a best estimate basis (correct)

Accurately forecasting the total gross claim payments

What is the primary factor that distinguishes between different liability outgo projection scopes?

The level of detail required for each item of income and outgo

The time period over which the projection is made

The specific risk groups being analyzed

The inclusion of premium income and outgo for future business (correct)

Why is it crucial to split business into homogeneous risk groups when projecting liability outgo?

To increase the accuracy of individual claim payment projections

To enhance data credibility and minimize potential bias (correct)

To better account for potential seasonal effects on liability outgo

To ensure the projections are consistent with the overall investment strategy

Which of the following is NOT a component of the overall liability outgo calculation?

Expected investment returns on assets (D) Signup and view all the answers

Why is it preferable to project claim payments gross of reinsurance and other recoveries?

To accurately reflect the overall financial impact of claim payments on the insurer (D) Signup and view all the answers

What does the acronym IBNR stand for, as used in the context of liability outgo projections?

Incurred But Not Reported (C) Signup and view all the answers

What is the purpose of carrying out "testing" on different bases for liability outgo projections?

To ensure the investment strategy is robust and can withstand unexpected events (C) Signup and view all the answers

What is the primary advantage of projecting liability outgo on a monthly or quarterly basis?

It enables the insurer to identify and manage potential seasonal fluctuations in liability outgo (A) Signup and view all the answers

What term is commonly used for assets that can be considered when assessing an insurer's statutory solvency?

Admissible assets (C) Signup and view all the answers

What is the primary responsibility of a custodian of assets in an insurance context?

Safeguarding and administering the insurer's assets (A) Signup and view all the answers

Which of the following asset types is an insurer likely to be prohibited from holding?

Derivatives held for speculative purposes (B) Signup and view all the answers

What type of asset might an insurer be required to hold, according to the text?

A minimum holding in government bonds (D) Signup and view all the answers

What is the purpose of a mismatch reserve?

To address the difference between asset maturity and liability maturity (B) Signup and view all the answers

Which of the following is NOT a potential control that supervisory authorities might use to influence an insurer's investment policy?

Mandating diversification of assets (D) Signup and view all the answers

What is the primary reason for supervisory authorities to impose restrictions on an insurer's investment policy?

To protect policyholders from investment losses (A) Signup and view all the answers

What is the relationship between the supervisory authorities and the insurer's investment policy?

The supervisory authorities may impose restrictions and guidelines on the insurer's investment policy (A) Signup and view all the answers

What is a key consideration when projecting premium income, particularly for new business and renewals?

The expected rate of premium growth in the light of the company's business plan. (D) Signup and view all the answers

How are expenses related to handling claims typically accounted for in cash flow projections?

Either explicitly or implicitly, such as through an additional percentage loading to the claim payment. (A) Signup and view all the answers

What factor is expected to influence the projection of premiums and the related claims and expenses for new business and renewals?

The competitive landscape and insurance cycle, impacting profitability, claims, and expenses. (C) Signup and view all the answers

What is the most important consideration when projecting premium income related to new business and renewals?

The company's expected rates of premium growth and profitability in line with its business plan. (C) Signup and view all the answers

When are reinsurance and other recoveries included in cash flow projections?

As an offset to the liability outgo, allowing for when these recoveries are expected to be received. (E) Signup and view all the answers

What is the primary reason for considering premium income separately by source of business in cash flow projections?

To ensure accurate accounting for delays in premium collection and acquisition costs. (E) Signup and view all the answers

What is the primary assumption made when projecting premiums for annual business?

The majority of premium cashflows will be received within a short timeframe. (D) Signup and view all the answers

How should expenses related to investment be considered in cash flow projections?

They should be treated as an offset to the projection of asset proceeds, recognizing their effect on investment returns. (E) Signup and view all the answers

What is the impact of inflation on the settlement amount of claims?

Inflation can impact most aspects of claims settlement, including earnings inflation and judicial inflation. (C) Signup and view all the answers

In the long term, what is the relationship between price inflation and judicial inflation?

Judicial inflation generally exceeds price inflation. (D) Signup and view all the answers

What investment strategy is appropriate for insurance contracts with fixed claim amounts?

Fixed-interest vehicles, which provide predictable returns. (B) Signup and view all the answers

When is it most important for an insurer to maintain access to ready funds?

When writing business in a class with a history of fluctuating claim levels. (D) Signup and view all the answers

Which of the following factors is NOT a key consideration in an insurer's investment policy?

The number of claims received in the previous year. (B) Signup and view all the answers

What is the primary concern regarding the liquidity of assets for an insurer?

Ensuring sufficient funds are available to fulfill future claims obligations. (A) Signup and view all the answers

Why is it important for insurers to consider the marketability of assets in their investment policy?

To ensure that the insurer can easily convert assets into cash if needed. (D) Signup and view all the answers

Which type of insurance contract poses the least concern regarding inflation?

Personal accident insurance with fixed claim amounts. (D) Signup and view all the answers

What is a primary advantage of using a model point approach to analyze the experience of a group of policyholders?

It requires a smaller volume of data compared to other methods. (B) Signup and view all the answers

Which of the following is NOT a typical component of liability outgo in an ALM?

Investment returns (B) Signup and view all the answers

How can an ALM be used in capital management?

To assess the company's solvency position. (D) Signup and view all the answers

What is a critical factor in determining the effectiveness of an ALM for calculating solvency capital?

The accuracy of the model's assumptions. (D) Signup and view all the answers

Why is the choice of asset mix crucial in an ALM for solvency capital adequacy?

All of the above. (D) Signup and view all the answers

What is the purpose of incorporating statutory requirements for asset and liability valuation in a projection model?

To ensure compliance with regulatory guidelines. (B) Signup and view all the answers

What is an ESG model in the context of asset management?

A model that quantifies the environmental, social, and governance risks of investments. (A) Signup and view all the answers

In which part of an ALM would you typically find a description of the target asset portfolio?

Inputs and Assumptions (D) Signup and view all the answers

What is the primary reason for general insurers historically investing in low-risk, liquid assets?

To match their liabilities efficiently. (B) Signup and view all the answers

What external pressure has driven the need for a more holistic risk management approach in general insurance?

The introduction of Solvency II regulations. (B) Signup and view all the answers

What is the core concept behind Asset Liability Management (ALM)?

Integrating asset and liability models within one framework. (B) Signup and view all the answers

In the ALM process, what does comparing asset proceeds to liability outgo in each future period help to determine?

The adequacy of the insurer's asset allocation. (D) Signup and view all the answers

What is the primary purpose of an ALM model in the context of investment strategies?

To optimize asset allocation for a specific risk appetite. (A) Signup and view all the answers

How do future business considerations affect the ALM process?

By requiring adjustments to the liability projections. (B) Signup and view all the answers

What is the benefit of using model points for ALM projections in insurers with numerous policyholders?

Reduced computational complexity. (B) Signup and view all the answers

Which of the following is NOT a potential use of an ALM model in an insurance context?

Assessing the effectiveness of the insurer's marketing campaigns. (D) Signup and view all the answers

Study Notes

Investment Principles and Asset Liability Matching

Investment and asset liability management (ALM) considers investment principles, asset-liability matching requirements for general insurers, and uses projection models for appropriate investment strategies.

Introduction

The chapter examines the issues related to a general insurer setting an appropriate investment strategy, reviewing the effect of liabilities on asset selection, the impact of free assets and non-investible funds, cashflow projections' importance, solvency requirements, and asset liability modeling.
A case study is provided at the end of the chapter.

Features of General Insurance Liabilities

Key features of general insurance liabilities are described, including the term of liabilities, amount, nature (fixed or real), and currency.
Investment principles applicable to all investors should be considered.
Asset characteristics should align with liabilities (claims and expenses) to maximize investment returns and meet contractual obligations, ensuring risk tolerance of the company.

Outstanding Term of Investments

The interval between premium receipt and claim payment is crucial because only a portion of the premium can be invested during this time.
The remainder funds are used to cover initial expenses.

The Influence of Inflation

Inflation affects the final claim amounts (e.g., property repairs, medical expenses, and administrative costs).
Claims and expenses are subject to inflation. Assets should generate income and capital values increasing with inflation to maintain a matching position.

How Liquid Do The Assets Need To Be?

Liquid assets, like money market instruments or short-term bonds, are crucial in case of uncertainty.
The aim is to match the short-term and uncertain nature of liabilities with the marketability and liquidity of assets.

The Effect of Free Assets on Asset Selection

The company's free assets (assets exceeding liabilities) are available for maximizing long-term returns for shareholders/policyholders, considering liquidity and future plans, and regulatory requirements.
The size of free assets and the technical provisions should be included in considerations. An insurer seeks to maintain free reserves to meet future liabilities, thus influencing investment decisions.

Non-investible Funds

Some funds (like those held by agents, policyholders, or reinsurers) aren't available for investment.
These funds can be a significant part of total assets, depending on business mix and arrangements.
These funds represent tangible, short-term assets, and risk of non-recovery is considered.

Estimating Liability Outgo in Future Time Periods

The projection should consider premium income and outgo, relating to business already written or future business, and include solvency and investment policies.
The aim is to estimate the overall liability outgo by calculating gross claim payments, reinsurance recoveries, expenses, outstanding premiums, and tax/dividend payments for each period.
A realistic view of likely outgo is essential to develop the investment strategy.

Claim Payments and Recoveries

Claims payments are a major liability, including all future payments, IBNR (incurred but not reported) claims, and claims from yet-to-expire risks.
Expenses related to claim handling could be explicitly or implicitly considered.

Premium Income

Premiums are usually calculated gross, deducting commissions and initial costs.
Allowance for outstanding premiums is needed when projected cash-flows aren't annual.

Tax and Dividend Payments

Future tax and dividend payments are projected, considering investment returns, tax rates, and dividend policies.
Dividends and tax are primarily driven by profitability estimates.

Sensitivity of Cashflow Results to Changes in Assumptions

Liability and asset sensitivities are crucial to assess how investment projections react to various circumstances.
Stochastic models can indicate the impact of varying assumptions on asset and liability outcomes..

Solvency Requirements

Solvency positions depend on asset volatility, especially when market-based valuation methods are used.
The method to value liabilities should align with the valuation of assets to ensure accuracy and consistency.
Regulation requires that insurers ensure future solvency by considering how well assets are matched to liabilities in terms of risk, as well as the insurer's strategy to build an adequate solvency base.

The Influence of Supervisory Authorities on Investment Policy

Supervisory authorities may impose restrictions on assets held and their valuation methods.
These restrictions could be based on general or specific product lines, or specific insurer situations.

Objectives and Constraints

The primary objective of investment strategy is maximizing return, while meeting claims and expense liabilities.
Risk appetite (as determined by management and shareholders) is a significant constraint, influencing the acceptable level of risk and potential profitability.

External Influences

Tax treatments, legal/ethical/voluntary restrictions, and statutory requirements all impact investment policies.
Competition also influences strategies.
Insurer-specific factors affect a company’s risk appetite. This includes the internal structure, and management decisions regarding risk.

Risks

Liquidity risk arises from the risk of insufficient cash for immediate liability settlement.
Currency risk affects asset/liability values due to exchange rate fluctuations.
Market risk relates to changes in assets' market value and the volatility in asset/liability positions.
Economic risk stems from investing during negative economic periods.
Credit risk involves counterparties' inability to fulfill their obligations, such as reinsurance failures.
Operational risk comes from internal fraud or mismanagement within investment operations.
Relative performance, contagion, and group/entity risk also affect investment strategy.

Investment Policy in Practice

Insurers normally face three different cashflow scenarios (ongoing insurer, run-off insurer, insurer post-large event).
Each situation requires separate investment strategy, matching, and liquidity considerations.

Asset Liability Modeling (ALM)

ALM simultaneously models asset and liability outflows to assess the relationship between them.
This modeling approach accounts for the time-dependent outflows.
Different investment mixes and assumptions are tested in ALM to determine the appropriate investment strategy.

ALM for Developing an Investment Strategy

ALM employs stochastic and deterministic techniques to model both assets and liabilities.
Testing various situations/ scenarios for asset-liability interactions is crucial.
ALM ensures that assets adequately support liabilities, optimizing risk and solvency.

Case Study

The case study focuses on applying ALM to analyze a potential change in an insurance company's retention level, assessing its impact on future profitability.
The process of determining future liability outgo and assessing the best retention level is applied in the case study.

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Description

This quiz covers the investment principles and asset-liability matching requirements for general insurers. It explores the impact of liabilities on asset selection, the importance of cashflow projections, and solvency requirements. A case study at the end provides practical insights into these concepts.