Chapter 16 Flashcards
(7 cards)
State the principle of investments
Investments must be chosen appropriate to the (CUNT) of the liabilities and reflect risk appetite of investor. Subject to the aforementioned, they must be chosen to maximise returns
State the conditions of immunisation
- PV(asset proceeds= investment returns and gains)= PV(liability outgos=benefit outgo+expenses-prems)
- Duration of A (weighted ave. time to payments) = Duration of L
- Convexity of A (sensitivity of cis to change in i)> Convexity of L
State the different types of investment matching
Pure match
Approximate match - immunisation
Full hedge
Approximate hedge
How to determine how much free capital we need to mismatch guaranteed benefits?
- Deterministic model -> pure match -> run deterministic economy conditions -> see the shortfall @T0-> that’s the amount of free capital you need
- Stochastic model-> set solvency target-> use economic scenario generator to simulate money market conditions->for each scenario, model how A and L change overtime->count insolvency outcomes-> find capital buffer needed s.t. insolvency occurs 1-alpha of the time
Also need to consider opportunity cost of mismatching vs expansion and writing new business
What kind of controls do regulators have when it comes to investment strategies?
STRICT LAL
Solvency limits on asset recognition
Third-party custodianship
Reserve requirements, like mismatch reserve
Investment type restrictions
Currency matching A and L
Thresholds on single counterparty exposure
Limits on mismatching
Asset class holding requirements like gov bonds
Limits on how much of any one asset class counts for solvency
What are the limits of immunisation
IMMUNITY
Interest rate changes must be small
Market may lack suitable long-duration assets
Maintenance is continuous
Uncertainty in timing of cfs
No room for high-return assets
Indexation lags cause mismatches (index-linked L)
Transaction costs ignored
Yield curve must be flat
Define immunisation
Investment of assets s.t PV(A)-PV(L) is immune to small changes to interest rates.
Reduces risk of meeting L as it falls due due to changing I
