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LOS l: Discuss the factors that determine investment policy for pension funds, foundations, endowments, life and non-life insurance companies, and banks.
Q1. Which of the following statements best describes the tax constraints existing for endowments and life insurance companies?
A) Endowments are taxable entities, whereas life insurance companies are tax free entities.
B) Both entities are taxable.
C) Endowments are tax free entities, whereas life insurance companies are taxable.
Q2. Which of the following statements regarding the time horizons for endowments and foundations is TRUE? The time horizon for:
A) an endowment is longer than that for a foundation.
B) a foundation is longer than that for an endowment.
C) an endowment and the time horizon for a foundation are usually infinite and hence will differ mainly due to specific entity considerations.
Q3. The liquidity requirements of a pension fund differ from the liquidity requirements of a life insurance company in that the liquidity requirements of a pension fund:
A) will be dictated by state statutes, whereas the liquidity requirements of a life insurance company will be dictated by federal statute.
B) will be a direct function of the age of employees and the retired-lives portion of participants, whereas the liquidity requirements of a life insurance company will be a function of the liability requirements of products sold.
C) and the liquidity requirements of an insurance company will be dictated by federal statute.
Q4. Manuel Insman, CFA, has just been assigned responsibilities for insurance industry clients at Frontgate, a research and portfolio management boutique. Insman’s first concern is to identify insurance industry investment characteristics. The main purpose of this activity is to formulate a turn-key investment policy statement (IPS) that will increase the efficiency of managing client assets. By doing so, Insman hopes to add value not only to his employer, but to the firm’s investment clientele.
To better understand the nuances of the insurance industry, Insman attends a one-day seminar at a local university with Saul Stetson, another portfolio manager. The seminar instructor feels that it is best to separate life insurance from property and casualty (P&C) insurance companies because of their differing investment objectives and constraints. Therefore, the morning session is devoted strictly to the life insurance industry.
The instructor begins by reviewing how the life insurance industry has changed over the years and briefly discusses a variety of new products. He points out that changes in the industry have resulted in the classification of investment activities into segments having different return objectives. He stresses that although life insurance products have a tremendous variety of features, his research indicates that return objectives are often segmented as follows:
Insman also learns that life insurance companies are often perceived to be quasi-trust funds, and hence, require attention to objectives and constraints that are not typically found in other investment policy statements. Insman makes a list of specific factors often used to determine life insurance risk objectives or liquidity requirements:
The afternoon session of the seminar is devoted to non-life—primarily P&C—companies. The instructor explains the underwriting cycle, as well as key investment policy considerations.
Insman has a hard time keeping up with all of the information the instructor is conveying, and thinks his notes on P&C liabilities might be incorrect. To check, he asks his colleague Stetson to help him clarify the differences between P&C liabilities and those of life insurance companies.
Stetson says “I believe P&C liabilities are unknown in timing and amount, whereas life insurance company liabilities are unknown in timing but known in amount.”
Insman replies “Are you sure? I thought the instructor said that P&C liabilities are unknown in timing but known in amount, whereas life insurance companies are known in amount and timing.”
Insman continues, “Well what about the underwriting cycle? It’s approximately five to seven years and tends to follow the general business cycle doesn’t it?”
Stetson declares otherwise. “I agree that the underwriting cycle is five to seven years long but it runs counter to the business cycle.”
Which of the following best characterizes enhanced margin return?
A) The excess rate of return derived from using enhanced indexing portfolio management strategies.
B) A net interest spread above the returns needed to fund liabilities; thus making it possible to offer competitive premiums.
C) Enhanced returns from equity-oriented investments designed to increase the surplus segment.
Q5. Insman wants to subdivide the list of factors impacting life insurance risk tolerance and liquidity. Which of the following set of factors best encompasses the most important risk considerations?
A) Credit risk, asset-liability mismatches, and portfolio manager style characteristics.
B) Cash flow volatility, disintermediation effects, and asset marketability risk.
C) Cash flow volatility, reinvestment risk, and credit risk.
Q6. When life insurance companies assess liquidity requirements, they do NOT typically address:
A) the effects of disintermediation.
B) risks associated with liability marketability.
C) asset-liability mismatches.
Q7. Which of the following best describes the accuracy of Insman’s and Stetson’s statements about P&C versus life insurance liabilities?
A) Insman is correct; Stetson is incorrect.
B) Insman is incorrect; Stetson is incorrect.
C) Insman is incorrect; Stetson is correct.
Q8. Which of the following best describes the accuracy of Insman’s and Stetson’s statements about the P&C underwriting cycle?
A) Insman is incorrect; Stetson is correct.
B) Insman is correct; Stetson is incorrect.
C) Insman is incorrect; Stetson is incorrect.
Q9. The unique characteristics of P&C liability structure will have the greatest effect on which of the following constraints?
A) Time horizon and taxes.
B) Time horizon and liquidity.
C) The regulatory environment and unique considerations.
LOS l: Discuss the factors that determine investment policy for pension funds, foundations, endowments, life and non-life insurance companies, and banks. fficeffice" />
Q1. Which of the following statements best describes the tax constraints existing for endowments and life insurance companies?
A) Endowments are taxable entities, whereas life insurance companies are tax free entities.
B) Both entities are taxable.
C) Endowments are tax free entities, whereas life insurance companies are taxable.
Correct answer is C)
Endowments are tax free entities but life insurance companies are taxable.
Q2. Which of the following statements regarding the time horizons for endowments and foundations is TRUE? The time horizon for:
A) an endowment is longer than that for a foundation.
B) a foundation is longer than that for an endowment.
C) an endowment and the time horizon for a foundation are usually infinite and hence will differ mainly due to specific entity considerations.
Correct answer is C)
Most endowments and foundations are created to perpetually fund specific operating entities (hospitals, universities, museums, etc.). Hence, their time horizons are typically infinite. Their time horizons may differ, however, due to specific considerations.
Q3. The liquidity requirements of a pension fund differ from the liquidity requirements of a life insurance company in that the liquidity requirements of a pension fund:
A) will be dictated by state statutes, whereas the liquidity requirements of a life insurance company will be dictated by federal statute.
B) will be a direct function of the age of employees and the retired-lives portion of participants, whereas the liquidity requirements of a life insurance company will be a function of the liability requirements of products sold.
C) and the liquidity requirements of an insurance company will be dictated by federal statute.
Correct answer is B)
Pension fund liquidity is often dictated by the age of employees and the retired-lives portion of participants. Life insurance companies, on the other hand, will have liquidity requirements that are generated by the differential products sold to policy holders.
Q4. Manuel Insman, CFA, has just been assigned responsibilities for insurance industry clients at Frontgate, a research and portfolio management boutique. Insman’s first concern is to identify insurance industry investment characteristics. The main purpose of this activity is to formulate a turn-key investment policy statement (IPS) that will increase the efficiency of managing client assets. By doing so, Insman hopes to add value not only to his employer, but to the firm’s investment clientele.
To better understand the nuances of the insurance industry, Insman attends a one-day seminar at a local university with Saul Stetson, another portfolio manager. The seminar instructor feels that it is best to separate life insurance from property and casualty (P&C) insurance companies because of their differing investment objectives and constraints. Therefore, the morning session is devoted strictly to the life insurance industry.
The instructor begins by reviewing how the life insurance industry has changed over the years and briefly discusses a variety of new products. He points out that changes in the industry have resulted in the classification of investment activities into segments having different return objectives. He stresses that although life insurance products have a tremendous variety of features, his research indicates that return objectives are often segmented as follows:
Insman also learns that life insurance companies are often perceived to be quasi-trust funds, and hence, require attention to objectives and constraints that are not typically found in other investment policy statements. Insman makes a list of specific factors often used to determine life insurance risk objectives or liquidity requirements:
The afternoon session of the seminar is devoted to non-life—primarily P&C—companies. The instructor explains the underwriting cycle, as well as key investment policy considerations.
Insman has a hard time keeping up with all of the information the instructor is conveying, and thinks his notes on P&C liabilities might be incorrect. To check, he asks his colleague Stetson to help him clarify the differences between P&C liabilities and those of life insurance companies.
Stetson says “I believe P&C liabilities are unknown in timing and amount, whereas life insurance company liabilities are unknown in timing but known in amount.”
Insman replies “Are you sure? I thought the instructor said that P&C liabilities are unknown in timing but known in amount, whereas life insurance companies are known in amount and timing.”
Insman continues, “Well what about the underwriting cycle? It’s approximately five to seven years and tends to follow the general business cycle doesn’t it?”
Stetson declares otherwise. “I agree that the underwriting cycle is five to seven years long but it runs counter to the business cycle.”
Which of the following best characterizes enhanced margin return?
A) The excess rate of return derived from using enhanced indexing portfolio management strategies.
B) A net interest spread above the returns needed to fund liabilities; thus making it possible to offer competitive premiums.
C) Enhanced returns from equity-oriented investments designed to increase the surplus segment.
Correct answer is B)
Enhanced margin: The rate associated with efforts to earn competitive returns on assets funding well-defined liabilities. Spread management techniques are used. If done successfully, a return in excess of a policy’s crediting rate can be earned, giving life insurance companies a competitive edge in setting policy premiums and adding new business.
Surplus return: The difference between total assets and total liabilities is surplus. The primary objective of surplus management is to generate growth, which is key to expanding insurance volume.
Minimum return: The mandated return applied to assets earmarked to meet death benefits. The minimum rate of return is a statutory rate (normally actuarially determined) that will ensure funding so that reserves are sufficient to meet mortality predictions.
Q5. Insman wants to subdivide the list of factors impacting life insurance risk tolerance and liquidity. Which of the following set of factors best encompasses the most important risk considerations?
A) Credit risk, asset-liability mismatches, and portfolio manager style characteristics.
B) Cash flow volatility, disintermediation effects, and asset marketability risk.
C) Cash flow volatility, reinvestment risk, and credit risk.
Correct answer is C)
Cash flow volatility, reinvestment risk, credit risk, and asset valuation fluctuations are generally considered to be the most important risk factors to be evaluated when determining the risk objectives of a life insurance company. Liquidity is directly affected by the possibility of disintermediation, asset-liability mismatches, and asset marketability risk. The style characteristics of a portfolio manager are considered after risk objectives are determined, not during the formulation of the risk objectives.
Q6. When life insurance companies assess liquidity requirements, they do NOT typically address:
A) the effects of disintermediation.
B) risks associated with liability marketability.
C) asset-liability mismatches.
Correct answer is B)
Life insurance companies are required to pay an increasing amount of attention to disintermediation and asset-liability mismatches. Both of these factors impact the liquidity of asset portfolio investments.
Q7. Which of the following best describes the accuracy of Insman’s and Stetson’s statements about P&C versus life insurance liabilities?
A) Insman is correct; Stetson is incorrect.
B) Insman is incorrect; Stetson is incorrect.
C) Insman is incorrect; Stetson is correct.
Correct answer is C)
P&C liabilities are unknown in timing and amount. Life insurance companies know the amount of the liability (the death benefit), but not the timing.
Q8. Which of the following best describes the accuracy of Insman’s and Stetson’s statements about the P&C underwriting cycle?
A) Insman is incorrect; Stetson is correct.
B) Insman is correct; Stetson is incorrect.
C) Insman is incorrect; Stetson is incorrect.
Correct answer is C)
Evidence indicates the P&C underwriting cycle lasts three to five years and tends to follow general business cycles.
Q9. The unique characteristics of P&C liability structure will have the greatest effect on which of the following constraints?
A) Time horizon and taxes.
B) Time horizon and liquidity.
C) The regulatory environment and unique considerations.
Correct answer is B)
The uncertainty associated with P&C liability structure has the greatest impact on the liquidity and time horizon constraints.
！thanks
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