Chapter 28

[kimiko]

In page 3, it says “return split between income and capital redemption” is this referring to the dividend/interest and the initial invested capital amount respectively?

 

[Mark Willder]

In page 3, it says “return split between income and capital redemption” is this referring to the dividend/interest and the initial invested capital amount respectively?

Hi Kimiko

Yes the income is the dividends, interest etc.

The capital redemption is the capital gain, ie the excess of the price the assets is sold for over the price that it was bought for.

Best wishes

Mark

 

[kimiko]

Thanks, Mark!

Can you kindly explain this in page 26 on the notes: "A life company would never normally increase risk by reducing diversification. This is because we are interested in varying sector risk, not specific risk (which should always be minimised)."

 

[Mark Willder]

Thanks, Mark!

Can you kindly explain this in page 26 on the notes: "A life company would never normally increase risk by reducing diversification. This is because we are interested in varying sector risk, not specific risk (which should always be minimised)."

Hi Kimiko

This question looks at ways to increase risk in order to increase the expected return.

For example the insurer could invest in a more risky sector such as corporate bonds rather than government bonds.

However, it wouldn't make sense to increase the specific risk. Specific risk is the risk associated with a particular asset, eg a bond or share issued by a particular company. We could increase the specific risk by placing all our assets into the shares of just one company. However, this would be a bad idea - we could lose everything if this company became insolvent. It would be much better to hold a diversified mix of shares - in theory we could obtain the same expected return for much less risk.

Best wishes

Mark

 

[kimiko]

Thank you, Mark!

Can you kindly help me understand what are shareholders' liabilities in this context (solution to Practice Question 28.3(i)): "Any shareholders’ liabilities (ie their retained funds) should be invested in real assets " I thought they are assets?

Also, in 28.5(a) solution, can you help me understand this sentence: "There will be an investment risk on the deferred annuities, on the assumption that the fixed-interest stock is paying an income, and no outgo is paid to the policyholder."

 

[Mark Willder]

Thank you, Mark!

Can you kindly help me understand what are shareholders' liabilities in this context (solution to Practice Question 28.3(i)): "Any shareholders’ liabilities (ie their retained funds) should be invested in real assets " I thought they are assets?

"

The balance sheet should balance, ie assets should equal liabilities. The shareholders own everything that is left after paying the policyholders, so we can think of the shareholders liabilities as the balancing item, ie it is the total assets less the policyholder liabilities.

 

[Mark Willder]

Thank you, Mark!


Also, in 28.5(a) solution, can you help me understand this sentence: "There will be an investment risk on the deferred annuities, on the assumption that the fixed-interest stock is paying an income, and no outgo is paid to the policyholder."

The insurer is receiving income from the assets but paying out no benefits in the deferred period. So there will be reinvestment risk for the insurer.