Investment Strategy

[N_Exam]

Hi,

This is about the 2018 Sept exam, question 6i). Exam Question is:-

"A proprietary life insurance company sells a broad range of products and has recently projected significant future new business growth within its business plan.The company is now reviewing its investment strategy in the light of the business plan.
(i) Describe how a model may be used to determine whether the current investment strategy remains appropriate for the company. "

• In my answer, I talked about projecting assets and liabilities into the future, considering future experience (e.g. change of policyholder mix) and considering the principles of investment: (1)do assets match liabilities by nature, term and currency, (2) can the returns on these matching assets be maximised and (3) as long as company is solvent what is the level and return of the free assets.
• However, the model solution (along with talking about projecting assets and liabilities- which I understand) doesn't talk about the 3 principles above. It instead talks about satisfying scr and ensuring future solvency.

I am not sure why the model solution does this- please someone explain?
Is a company's investment strategy about meeting solvency requirements (i.e. keeping sufficient reserves and scr) or meeting the 3 investment principles?

Thank you for you reply.

 

[Mark Willder]

Hi,

This is about the 2018 Sept exam, question 6i). Exam Question is:-

"A proprietary life insurance company sells a broad range of products and has recently projected significant future new business growth within its business plan.The company is now reviewing its investment strategy in the light of the business plan.
(i) Describe how a model may be used to determine whether the current investment strategy remains appropriate for the company. "

• In my answer, I talked about projecting assets and liabilities into the future, considering future experience (e.g. change of policyholder mix) and considering the principles of investment: (1)do assets match liabilities by nature, term and currency, (2) can the returns on these matching assets be maximised and (3) as long as company is solvent what is the level and return of the free assets.
• However, the model solution (along with talking about projecting assets and liabilities- which I understand) doesn't talk about the 3 principles above. It instead talks about satisfying scr and ensuring future solvency.

I am not sure why the model solution does this- please someone explain?
Is a company's investment strategy about meeting solvency requirements (i.e. keeping sufficient reserves and scr) or meeting the 3 investment principles?

Thank you for you reply.

Hi N_Exam

I agree that it is tricky to decide exactly what is in the scope of the question here. One approach I find useful is to compare the wording of the question with the wording of the Core Reading (as this is what the examiners will have in front of them when writing the question).

The question asks us to describe a model to determine the appropriateness of the investment strategy. This sounds very similar to the wording of Section 4 of Chapter 28: "Developing an appropriate investment strategy" and to Section 4.1: "Using a model office to determine an investment strategy". So Section 4 looks to be the part the examiners are focusing on rather than earlier parts of the chapter.

We can also use the background of the question to point us in the right direction. Presumably the company would already have considered a matched position and the extent that it can mismatch. So we need to ask why would this strategy be no longer appropriate? We're told that the company is expecting lots of new business. This will incur lots of new business strain, ie the solvency of the company is expected to fall. Lower free assets will lead to a more constrained investment strategy. So this explains the solution's obsession with solvency capital requirements.

I hope this helps.

Best wishes

Mark

 

[N_Exam]

Hi Mark.

Thank you. I was thinking about the wrong section of the chapter.
Follow up question:
The exam’s model solution talks of the scr. Why does it not talk of the “Reserves plus scr” as this combination (not just scr alone) needs to be covered for solvency?

Terminology question:
Q1) The course notes for this section 4.1 talks of “solvency capital”. Should I take this as “reserves plus scr” or all company assets available to cover solvency?

Q2) “Model Office”. Is this taken as the companies current and expected future “business, investment strategy, assets and liabilities”.

Thank you.

 

[Mark Willder]

Hi Mark.

Thank you. I was thinking about the wrong section of the chapter.
Follow up question:
The exam’s model solution talks of the scr. Why does it not talk of the “Reserves plus scr” as this combination (not just scr alone) needs to be covered for solvency?

Terminology question:
Q1) The course notes for this section 4.1 talks of “solvency capital”. Should I take this as “reserves plus scr” or all company assets available to cover solvency?

Q2) “Model Office”. Is this taken as the companies current and expected future “business, investment strategy, assets and liabilities”.

Thank you.

Hi N-Exam

Follow up question

The Core Reading says:

"The item of interest will be the excess of the value of the assets over the value of the liabilities. This will need to be sufficient to cover comfortably the level of solvency capital required by the company, which may itself depend on the investment strategy being investigated."

So yes the assets need to be big enough to cover both reserves and SCR. But the way the model is set up is to calculate the available capital (assets less reserves) and then check that this is bigger than the SCR. We could instead consider assets against reserves plus SCR as you suggest, but the solution follows the way it is presented in the Core Reading.

Q1
The available capital is the assets less the reserves. The required capital is the amount the regulator requires the company to hold in excess of the reserves. As above, we're checking that the available capital exceeds the required capital.

A numerical example might help. Assets are 100. Reserves are 70. The solvency capital requirement is 20. The available capital is 100 - 70 = 30, which is good as the available capital of 30 is bigger than the required capital of 20.

Q2
Yes a model office is an internal model of what the business is really like. So it will be able to project assets and liabilities including management actions such as writing new business and the investment strategy.

Best wishes

Mark

 

[N_Exam]

Thank you!