Chapter 15 Flashcards Preview

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Flashcards in Chapter 15 Deck (36)
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1
Q

What is capital management?

A

system used to plan for, obtain and control an insurer’s long-term funds.
for insureres its used to manage risk and generate profits. in

2
Q

Insurers typically use capital budgeting to balance the need to hold capital to manage risk with the need to invest capital to increase profitability. What is capital budgeting?

A

analysis of decisions about the investment of long-term funds.
Allows insurers to evaluate
- allocation of general account funds to specific assets or projects
- allocation of product line capital to specific blocks of business, customer groups, geoprahic markets, new products
- allocation of corporate capital to new product lines, existing prodcut lines, or purchasing NB.

3
Q

profits for a new product are generally measured in terms of either the NET cash flow or the earnings that the new product is expected to generate. define net cash flow.

A

products total cash inflow generated from premiums, investment and other sources minus the total cash outflows generated by such items as commissions, expenses and benefit payment.
*focuses only on CASH

4
Q

profits for a new product are generally measured in terms of either the NET cash flow or the earnings that the new product is expected to generate. define earnings.

A

product are the amount that the product adds to the insurance company’s capital in a given period.
* reflect on cash, and noncash adjustments that the figure into a products contribution to capital.

5
Q

What is the initial investment for a new product?

A

the amount of capital that an insurer must invest to establish the product.

6
Q

Insurers typically must use several tools for evaluating product profitability. What are some common measures used to evaluate product profitability?

A

1) Net present Value (NPV)
2) internal rate of return (IRR)
3) profit margin

7
Q

Define the net present value (NPV)

A

an investment project calculated by subtracting the project’s intiial investment from the present value of the project’s earning.

8
Q

whats the equation for NPV?

A

= (PV of earnings) - (initial investment)

  • it yields a monetary amount representing the present value of the profit that a capital investment project is expected to earn.
  • If NPV is +ve insurer should consider pursuing the product.
9
Q

What is an internal rate of return (IRR)?

A

defined as the interest rate, i, at which the products net cash flow must be discounted, using present value techniques, in order to exactly repay the insurers intitial investment in the product.
* its the nterest rate aty chih the products’ present value of earning is equal to its initial invesment and the NPV is 0.

10
Q

An insurer can use the company’s hurdle rate as its required IRR. What sthe hurdle rate?

A

minimum percentage rate of return on capital that an insuere must ear to cover its cost of capital.

11
Q

What is cost of capital?

A

the overall percentage cost the insurer pays for the funds it employes.
*

12
Q

What is a simple decision rule?

A

is to require that the projected IRR for the product be euqal to or greater than the insurer’s required IRR for the product.
Accept if projected IRR > required IRR
Reject if projected IRR < required IRR.

13
Q

What is profit marging?

A

the ratio of profits to sales revenue.

- profit equal to the products net cash flow, adjusted for investment earnings and reserves.

14
Q

what is profit margin and when is it used?

A

for multiple-premium life insurance or annuities it represemt the value profits divided by the present value of premiums

profit margin = (PV of profit)/(PV of premiums)

15
Q

profitability ratios consist of two measures. What are they?

A

1) measure of gain from operations.

2) measure of resources employed or invested to generate the gain.

16
Q

How do insureres determe if their prupose is to obtain an an overall measure of profitability or identify the sources of profits?

A

1) to determine sources of profits, insurance analysts, typically look in detail at two primary sources of cash flows: investment income and premium income.

17
Q

What is return on capital?

A

represents the percen tage return an insurere has earned on its capital. its calculated by dividing a given measure of earnings by some measure of total capital employed.

18
Q

What is the return on capital equation?

A

= (Net income) / Beginning capital.

  • results show how efficiently the company has used its capital to earn a return .
19
Q

What is return on investment assets and its ratio?

A

return on invested assets (ROLA) ratio- indicated how efficiently a company is using its investmetn portfolio to earn returns.

20
Q

What is the return on invested assets ratio ( ROLA)

A

ROIA = (net income)/ (average invested assets)

21
Q

What is the investment yield?

A

determines the rate of return, or yield, on an insurer’s investment portfolio.
Its calculated by dividing the insurer’s investmetn portfolio income by the company’s average invested assets for the period.

22
Q

Whats the investment yield ratio?

A

= (investment portfolio income)/ (average invested assets)

23
Q

What is the net profit margin?

A

shows how much after-tax profit is generated by each dollar of total revenue.

24
Q

whats the net profit margin equation?

A

= net income/ total revenues.

25
Q

define the term embedded value (EV) for a life insurance company?

A

is euqal to the present value (PV) of expected future distributable profits pertaining to in-force covered business, after sufficient allowance is made for the aggregate risks represented by this business.

26
Q

What are the 3 basic components of EV?

A

1) uncommitted capital
2) required capital
2) value of business in force.

27
Q

What is uncommitted capital?

free surplus

A

market value of any capital and surplus, over and above the required capital, allocated to the in-force covered business.
* could be immediately distributed to shareholders.

28
Q

What is required capital?

A

the amount of capital an insuree must hold to back the liabilities for in-force covered business and for which distribution to shareholders is restricted.
- adjusted for the cost of holding required capital.

29
Q

What is the value of business in force (VBIF)?

A

the present value (PV) of future sharegolder cash flows from the in-force business, discoutned at the appropriate discount rate.
- associated cash valyes: premiums, investment income, fees, benefits and expenses.

30
Q

What is the EV equation?

A

= (uncommitted capital) + ((required capital)-(cost of holding required capital)) + (value of business in force)

31
Q

What is the purpose of tracking changes in the EV value?

A

to assure the company is adding value at a rate in excess fo the hurdle rate.

  • it provides standardied info on the value of a company to analyst and broader invement community
  • pinpoints what operations of the company are creating value
  • provides info on risk exposure through the use of sensitivity, stress, and scenario tests.
  • insurer must be able to identify the reasons for changes in EV over time.
32
Q

What are some drawbacks of EV calculations?

A

1) very sensitive to the choice of assumptions used.
2) complicated to explain to nonactuarial audiance.
3) potentially inconsitent with capital market pricing paradisms.

33
Q

How can companies counter EV limitations?

A

1) use discount rate based on the risk profile of each product line.
- rates might be too optimistic
2) companies need to fidn a way to acknowledge the impact of other sources of value by meausing performance in terms of appraisal value and market value. > but both difficult to measure.

34
Q

define appraisal value and market value.

A

appraisal:L embedded valye (EV) of a compny plus the value of the company’s future sales
Market: is the appraisal value of a compay plus its brand value

35
Q

Why is it difficult to measure a company’s growth?

A

growth rate is not consistent.

its fluctuates and thus predictions are impossible.

36
Q

why is it difficult to measure customer perception?

A

most investment have psychological and emotional components..
- measuring “feeling” is difficult.