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.

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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.

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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.

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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.