Chapter 21: Investment principles and ALM

Question 1

Primary objectives with investment of assets:

Answer 1

Maximise return subject to:

• Meeting claims and expenses as they fall due
• Maintaining statutory solvency and any internal company solvency constraints

Question 2

Risk appetite of insurer will depend on:

Answer 2

• Liabilities
• Assets
• External influences
• Insurer-specific constraints

Question 3

Liability characteristics to consider when determining investment strategy:

Answer 3

• Nature, currency, term and level of uncertainty of existing liabilities
• Estimated future liabilities arising from portfolio of business planned
• Location of liabilities
• Whether liabilities are discounted

Question 4

Asset considerations when determining investment strategy:

Answer 4

• Size of assets in relation to current liabilities
• Expected long-term return from various asset classes
• Expected volatility within the various asset classes
• Existing asset portfolio
• Non-investible funds
• Economic outlook

Question 5

External influences to consider when determining investment strategy:

Answer 5

• Tax treatment of different investments and the tax position of the general insurer
• Statutory, legal, ethical or voluntary restrictions on how the insurer may invest
• Statutory valuation requirements
• Solvency requirements
• Rating agency constraints on capital required to maintain the insurer’s desired rating, and therefore better image and terms for raising future capital
• Competition – strategy followed by other funds
• Regulatory constraints

Question 6

Insurer specific considerations to consider when determining investment strategy:

Answer 6

• Risk appetite
• Company specific investment objectives

Question 7

In relation to its investment strategy, the general insurer is subject to the following risks:

Answer 7

• Liquidity
• Currency
• Market
• Credit
• Group

Question 8

Basic concept of ALM

Answer 8

• Project liability outgo in each future time period for a chosen timeframe
• Project asset proceeds (consistently with liability outgo) in each future period
• Compare the two for each future period
• Run the comparisons again using different assumptions
• Decide whether the asset proceeds are appropriate for the liability outgo
• If not, investigate alternative asset distributions

Question 9

Main steps in performing a stochastic ALM exercise to derive an acceptable investment strategy:

Answer 9

• Define clear objectives that reflect the company’s risk tolerance
  o Should include a tolerable probability of adverse financial position (e.g. insolvency), over a specified time horizon and a profitability or expected financial position objective
• Set assumptions for the ESG and cashflow projection models from data collected, testing distributions for goodness of fit
• Construct cashflow projection models:
  o Of outflow that include claims and expenses, and liabilities at required dates
  o Of inflows that include premiums, investment income and redemptions and asset values at required dates
  o The cashflow projections will be based on the outputs from the ESG
• Run the ESG model to produce many scenarios over the expected time horizon
• An initial investment strategy must be selected
• Using the ESG scenarios, run the cashflow projection models based on the selected investment strategy
• Summarise the output from the cashflow models to assess how well the objectives have been met
• Repeat the process using different investment strategies and select those that best meet the objectives for further analysis and discussion with decision makers
• Test the robustness of the output using sensitivity analysis to check how sensitive the results are to changes in assumptions
• Summarise the results for decision making, tailoring the documentation for the intended users, e.g. more explanations will be needed for non-technical directors

Question 10

Input assumptions of an ALM to test the investment strategy:

Answer 10

• Target asset portfolio
• Investment rules/guidelines
• Economic scenarios from an ESG
• Inputs for stochastic modelling of general insurance liabilities

Question 11

Modelled variables and interdependencies of an ALM to test the investment strategy:

Answer 11

Depends on the scope of the model. In general terms:

• Assets within the asset portfolio
• Liabilities within the liability portfolio
• Inflationary links
• Interdependencies between correlated variables

Question 12

Outputs of an ALM to test the investment strategy:

Answer 12

• Collection of results for each modelled output variable
• Information is summarised to derive information of interest
• Enables analysis of optimal investment strategies by comparing various statistics of the outputs for various different input strategies
• Projection of expected outcomes for business planning purposes