Total Return, Surplus Portoflio

CFA Level III Portfolio Management
#1

Among all the institutional types mentioned,

  1. Is life insurance company the only one that is difficult to use the Total Return approach?

  2. Are Life insurance, Non Life Insurance and Banks all have the surplus portfolios? If so, I guess we need to have different return goal for the surplus portfolio, right?

Thank you!

#2
  1. I am not quite sure what you mean by “difficult to use the total return approach.” perhaps you mean ALM vs. return by product/business line segment? :slight_smile: 2. As for return on a surplus, it is dependent on how aggressive the plan sponsor is, and if the surplus is foreseen to be stable and increasing over time (i.e. is the DB able to take on more risk on its surplus, or is there a likelihood that the business will suffer in a cycle downturn, so although there is a surplus now, it might be hard to maintain long-term).
#3

Thanks for you reply!

  1. It is shown in the Kaplan Book “while it is theoretically desirable to look at total return it can be difficult to do in the insurance industry. Regulation generally requires liabilities to be shown at some version of book value. Valuing assets at market value but liabilities at book value can create unintended consequences.”

  2. So if they do have a surplus, do we need a different objective or just include that in one of the IPS sections?

#4

I believe that life insurance companies often focus on earning a positive net interest spread and attempt to simultaneously offer their clients a competitive crediting rate. Usually their minimum return is the actuarially assumed rate of growth in policyholder reserves. The investment portfolio is often invested conservatively as they are subject to risk based capital capital measures, as well as asset valuation reserves imposed by regulators. And remember disintermidiation risk leads to shorter durations, higher liquidity reserves, and closer ALM matching.

#5

Thank you!

Based on Kaplan, the cash value buildup is linked to investment return for variable (universal life). Sounds like the crediting rate changes for the variable life. How about Whole life? does the crediting rated ever change just like variable life?

Also, does it apply to the non life insurance as well?

#6

Insurance companies are special entities they collect premiums for the policies and pay to policyholders if insured event occurs. i.e accident for non life insurance and death for life insurance. Both are very similar and they differ with durations of the liabilities towards policy holders. These are highly complex issue barely covered in CFAI texts.

  • are short up to 1 year,
  • erratic in pmts =.>risky less predictible cash flow
  • surplus is invested in equity (also risky) and debt instruments
  • return objective is “to make money” over the course of business cycle, grow the surplus,grow the assets faster than L and continue to increase allocations to equities etc…to earn more. How the biggest insurance companies attract customers through marketing events sailing match races BIG MONEY,and . collect MORE premiums.
  • total return is dominant measure

life are longer longer duartions more sensitive so ALM matching is of essence premiums collected are invested in set of coupon bearing assets and build value to pay of policy in the future.

Minimum return must be set usually discount rate in policies (actuary rate of growth) to grow the assets actual\ return must be set higher. This higher rate is called net interest spread.I doubt that consistent return will make premium cheaper, more often it will add more value to the owners