andytrader

The return objectives for a life insurance company can be broken into two segments, the fixed-income and the surplus segments. Which return objectives are mostly associated with each segment, respectively?

A) Yield maximization and spread management.

B) Spread management and maximizing yield.

C) Spread management and capital gains.

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The return objectives for a life insurance company have mainly been associated with earning a competitive return that helps increase the spread between assets and liabilities. The surplus portfolio, however, has growth in the surplus as its main return objective, which will happen via capital gains.

andytrader

The risk tolerance of a foundation differs from that of the fixed-income segment of a life insurance company in which of the following ways? The risk tolerance of a foundation:

A) will typically be much greater than that of the fixed-income segment of a life insurance company.

B) will typically be much less than that of the fixed-income segment of a life insurance company.

C) and that of the fixed-income segment of a life insurance company will both be relatively low.

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The fixed-income segment of a life insurance company’s portfolio will essentially be dedicated to providing competitive returns in meeting the liabilities attached to policies sold. Hence, the risk tolerance associated with the fixed-income segment of a life insurance company will typically be less than that of a foundation, which usually has a moderate to high risk tolerance depending on spending rates.

andytrader

Which of the following statements concerning foundations and endowments is CORRECT? Foundations are:

A) grant-making institutions and may have variable time horizons; endowments are established to permanently fund some activity, and typically have infinite lives.

B) grant-making institutions and may have variable time horizons; endowments are established to permanently fund some activity, and typically have minimum payout requirements.

C) established to permanently fund some activity and have high degrees of risk tolerance.

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Foundations are grant-making institutions and may have short or long (infinite) lives. Endowments are established to permanently fund some activity (e.g., provide scholarships) and typically have infinite lives. Endowments typically do not have minimum payout requirements. Both types of institutions typically have fairly high degrees of risk tolerance if they are long-lived.

andytrader

Lakeland Life Insurance Company is a U.S. based underwriter of life insurance policies doing business in 23 states. In the past 5 years the company has completely revamped its product offerings, going from a focus on whole life policies to floating rate referred variable and universal life policies. The average duration of the company's insurance liabilities is eight years. Lakeland targets a 1.5% spread on investment assets over liabilities. The current expected nominal actuarial return is 5% (based on current capital market conditions), but management expects the rate environment to get more volatile in the coming months.
The company has segmented its investments into two portfolios: a fixed-income portfolio and a surplus portfolio. The fixed-income portfolio is invested primarily in long-term corporate and U.S. Treasury bonds. The surplus portfolio is currently invested in the common and preferred stock of large, well-known U.S companies. The surplus portfolio has a dividend yield of 3%. Management expects equity markets to earn 12% per year in the long term.The appropriate return objective for the fixed-income portfolio is to earn a return:

A) of 6.5% while maintaining an average duration of 8 years in order to fund insurance liabilities.

B) of 18.5% sufficient to fund long-term expansion in insurance volume and fund insurance liabilities through a total return approach.

C) sufficient to provide a spread of 1.5% over the promised rate on the company's variable rate insurance products while maintaining an average duration of 8 years, in order to fund liabilities.

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The company has segmented its investment portfolio; the purpose of the fixed-income segment is to fund insurance liabilities. The return objective should focus on providing the target spread over policy costs, which float with changes in interest rates. Therefore, while the current target is 6.5% based on current economic conditions, this target rate will change as conditions change; 6.5% is not the appropriate long-term return objective. A reasonable objective for the surplus fund is to earn a return "of 12% sufficient to fund long-term expansion in insurance volume by investing in growth-oriented securities, primarily equity." A total return approach is not appropriate for the fixed-income or the surplus portfolio.

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The appropriate risk tolerance for the surplus portfolio:

A) is the same as that of the fixed-income portfolio. While the portfolios are nominally separated for regulatory purposes, they should actually be managed as a single portfolio, because funds from each can be used to meet both goals of long-term growth and current funding of liabilities.

B) is higher than that of the fixed-income portfolio, because the funds should be used to support long-term growth in insurance volume.

C) is lower than that of the fixed-income portfolio, to guard against loss of principal and maintain a constant income stream, in order to maintain public confidence in the company's ability, in its role as a fiduciary, to fund policyholder liabilities.

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A lower risk tolerance is appropriate for the fixed-income portfolio, on the other hand, to "guard against loss of principal and maintain a constant income stream, in order to maintain public confidence in the company's ability, in its role as a fiduciary, to fund policyholder liabilities." Interest rate volatility over the short-term is not a primary concern of the surplus portfolio. The portfolios are "nominally separated," but not "for regulatory purposes;" each should have its own investment policy statement.

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The appropriate time horizon constraint for the surplus portfolio:

A) is longer than that of the fixed-income portfolio, because the purpose of the surplus portfolio is to support long-term growth in new lines of business.

B) is shorter than that of the fixed-income portfolio, because policies such as universal and variable life have shorter effective maturities than traditional life insurance products.

C) is the same as that of the fixed-income portfolio. While the portfolios are nominally separated for regulatory purposes, they should actually be managed as a single portfolio, because funds from each can be used to meet both goals of long-term growth and current funding of liabilities.

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While it's true that "…universal and variable life have shorter effective maturities than traditional life insurance products…", this does not mean the time horizon of the surplus portfolio (which is not related to the duration of the liabilities), should be shorter than the time horizon of the fixed-income portfolio (which must be matched to the duration of the liabilities). The maturity of the securities in the portfolio depends on the appropriate time horizon, not the other way around. Finally, the portfolios are "nominally separated", but not "for regulatory purposes"; each should have its own investment policy statement.

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Which of the following is NOT appropriate to include as tax or regulatory constraints in the company's Investment Policy Statement?

A) The regulatory constraint should include the recognition that, for U.S. life insurance companies, state law prevails over federal law.

B) The regulatory constraint should include the recognition that, by law, common stock holdings are typically limited to a certain percentage of assets.

C) The regulatory constraint should include a statement that the company is subject to the Prudent Expert Rule.

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This statement is not appropriate in the Investment Policy Statement; unlike pension funds, insurance companies are subject to the Prudent Investor Rule.

clearlycanadian

Endowment investment policy statements usually pay attention to the liquidity constraint determined by spending requirements. Which of the following statements most accurately represents an endowment’s relationship to spending? Endowments:

A) use spending rules to minimize spending volatility.

B) use spending rules to maximize spending.

C) no longer use spending rules to estimate spending levels.

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To minimize adverse impacts of spending volatility, endowments often employ spending rules that tend to minimize spending level volatility.

clearlycanadian

A life insurance company’s liquidity requirement differs from a non-life insurance company’s requirement in that a life insurance company’s liability structure is uncertain in its:

A) timing and amount, while a non-life insurance company's liability structure is also uncertain in its amount and timing.

B) amount, while a non-life insurance company's liability structure is uncertain in both its amount and timing.

C) timing, while a non-life insurance company's liability structure is uncertain in both its amount and timing.

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Life insurance companies have liability structures that are uncertain in timing but not amount. Non-life insurance companies have liability structures that are uncertain in both amount and timing.

clearlycanadian

Which of the following represents the most appropriate objective found in a bank’s investment portfolio?

A) Assist with increasing after-tax income.

B) Assist with generating capital gains-only profits.

C) Assist with generating income-only profits.

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The most appropriate objective is to increase after-tax income, not only profits associated with income or capital gains.

clearlycanadian

Assessing the capital risk position is relevant to the investment management process at a bank because it indicates the appropriate amount of:

A) risk weighted assets.

B) liquidity weighted assets.

C) credit weighted assets.

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Assessing a bank’s capital risk position indicates the level of capital that must be held by the bank to support investment activities.

clearlycanadian

Ed Simon, CFA, has been assigned the arduous task of assessing the slight nuances concerning the investment objectives and constraints for foundations and endowments. Simon’s supervisor has requested a full report on these differences and how they affect the investment policy statements.Simon thought it best to first look at differences in return objectives between foundations and endowments. Which of the following best indicates differences between the return objectives of foundations and of endowments?

A) Endowment returns usually are dictated by a rule-of-thumb of "5.3% + inflation," whereas foundation return objectives are dictated by spending rules.

B) Foundation return objectives are to provide a permanent base of funding whereas endowment return objectives depend on the time horizon of the endowment.

C) Foundation return objectives depend on the time horizon of the foundation, whereas endowment return objectives are to provide a permanent base of funding.

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Foundations may be finite-lived entities, but endowments are created to provide a permanent base of funding.

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Simon next turned his attention to the differences in risk objectives between foundation and endowment investment policy statements. Which of the following best describes the main difference between foundation and endowment risk objectives?

A) Endowment risk tolerance is not dictated by the relationship between the current income requirement and maintenance of purchasing power, whereas this is a crucial factor for foundations.

B) Foundation risk tolerance is dependent on the importance of foundation funds in the sponsor's overall budget picture, while endowment risk tolerance is dependent on the time horizon of the endowment.

C) Foundation risk tolerance is dependent on the time horizon of the foundation, whereas endowment risk tolerance is dependent on the importance of the endowment fund in the sponsor's overall budget picture.

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Risk tolerance of foundations is critically linked to any time horizon structure while endowment risk tolerance is dependent on the importance of endowment funds in a sponsor’s overall budget picture.

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Foundations and endowments often have differential liquidity constraints. Simon found which of the following to be a difference between the liquidity constraints of a foundation and an endowment?

A) Private foundations are required to have a minimum spending rate whereas endowments rarely have minimum spending rates.

B) An endowment's spending rule will have less of an effect on liquidity requirements than a foundation's liquidity requirement due to a minimum spending rate.

C) Endowments are required to have a minimum spending rate whereas private foundations rarely have minimum spending rates.

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Private foundations are required to pay out at least 5% of assets on an annual basis. Endowments do not have minimum spending requirements.

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Simon discovered tax laws seem to differentially impact foundations and endowments. Which of the following most accurately depicts the differential tax treatment between foundations and endowments?

A) Operating foundation investment income is taxable, whereas endowment investment income is not.

B) Private foundation investment income is taxable, whereas endowment investment income is not.

C) Endowment investment income is taxable, whereas private foundation investment income is not.

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Private foundation investment income is taxable, whereas other foundations and endowments are not.

clearlycanadian

Which of the following are characteristics of public foundations’ and endowments’ liquidity needs, respectively?

A) Moderate; moderate.

B) Low; varies.

C) Varies; low.

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A foundation determines what its spending needs are, which thereby causes liquidity to vary for each foundation. Liquidity is low for endowments—usually only for emergencies and spending.