LOS b: Discuss investment objectives and constraints for defined-benefit plans.

Q1. International American Group (IAG) is a leader in the property and casualty (P&C) insurance industry. It is a financially strong firm with a surplus portfolio valued at $50 billion. IAG’s primary business line is the commercial P&C market. IAG competes aggressively by offering the most attractive premiums and lowest expense rates in the industry. Careful underwriting procedures have helped it experience a low claims volume. IAG has been able to keep premiums down and grow their business by maintaining a surplus level larger than its competitors and earning investment returns above the industry average.

Ronald Lott, the Chief Financial Officer, wants to document the investment process that is being used to manage IAG’s two portfolios: fixed income and surplus. He believes it is important to have written Investment Policy Statements (IPS) that can serve as a “blueprints” for internal portfolio managers to carefully follow. Lott is particularly concerned about the surplus segment and has delegated this task to Renee Echinard, a recent hire from a well-known French life insurance company. He assigns the fixed income IPS to Geoff Korman, another talented new employee from the United Kingdom . Lott believes this will give Echinard and Korman the opportunity to better understand the U.S. market, as well as the investment management differences between life and non-life companies.

Before beginning a draft of the IPS for the surplus segment, Echinard decides to review the key differences between life and non-life insurance. At a morning staff meeting, she asks Korman if he would like to collaborate with her on their projects. They decide to meet the next week to gauge their progress and help one another resolve any questions each might have.

A week later Echinard and Korman compare their IPS drafts and discover they are a bit confused about a few issues. Specifically, they disagree about time horizon and liquidity.

Echinard says, “I think that liquidity needs are greater for life insurance companies due to the requirement for a valuation reserve, and the need for funds to pay death benefits. In addition, the chance of disintermediation in a high interest rate environment also mandates higher liquidity. As to time horizon – it’s definitely longer than for a non-life company.”

Korman disagrees, stating “Non-life companies have higher liquidity needs due to the underwriting cycle and the greater uncertainty of claims. And because of long-tailed liabilities, time horizons are just as long as for life companies.”

Following their discussion, Echinard and Korman review the table below that shows the current asset allocations for the fixed income and surplus segments of IAG’s portfolio:

International American Group - Portfolio Segments

With respect to her statements about the differences between life and non-life time horizons and liquidity needs, Echinard is:

A)   incorrect about time horizon and incorrect about liquidity needs.

B)   correct about time horizon and incorrect about liquidity needs.

C)   correct about time horizon and correct about liquidity needs.

Q2. Which of the following are the most important IPS constraints for Echinard to consider?

A)   The long time horizon; low liquidity needs; potentially high taxes.

B)   The impact of the surplus on IAG’s ability to set competitive premium rates; high liquidity needs; the importance of incorporating capital gains into the return objective.

C)   A less strict regulatory environment; above average levels of risk tolerance; the required asset valuation reserve.

Q3. In developing an IPS for IAG, what must Echinard consider with respect to the return objectives and risk tolerance of the surplus portfolio?

Return objective                    Risk Tolerance

A) Capital appreciation           Above average levels of risk

B) Capital appreciation           Average levels of risk

C) Maximum capital preservation    Above average levels of risk

Q4. Lott wants to raise the return target for the surplus without incurring excessive volatility. To do so, which of the following revisions to the asset allocation strategy would be best?

A)   Reduce corporate bonds; increase U.S. small cap stocks; increase emerging markets stocks.

B)   Reduce U.S. Treasury bonds; increase developed international stocks; increase corporate bonds.

C)   Reduce U.S. Treasury bonds; increase U.S. large cap stocks; reduce emerging markets stocks.

Q5. Korman thinks IAG should consider adding venture capital to the surplus portfolio. Which of the following would NOT be a reason to do so?

A)   Enhanced returns.

B)   Improved liquidity.

C)   Improved diversification.

Q6. Echinard believes direct real estate would be a better addition to the surplus portfolio than venture capital. Which of the following attributes of real estate would be least beneficial?

A)   Inflation protection.

B)   Low correlation with U.S. stocks and bonds.

C)   Improved cash flow.

Q7. Helen Smith, CFA, has been assigned the portfolio management responsibilities for her firm’s first institutional investor, Branch Industries Defined Benefit Pension Plan (hereafter referred to as the “Plan”). To date, Smith’s firm has managed money only for high net worth individuals. In addition to her portfolio management duties, Smith has been delegated the task of formulating the investment policy statement (IPS) for the Plan.

Branch Industries manufactures tiny transformers and circuitry used in small electrical appliances, and components for cars and trucks. Silver is a small, but critical, input to the production process, and Branch uses a reliable supplier. Branch’s sales have grown steadily for the past three years despite a rather tepid economic recovery fostered by modest tax cuts and aggressive expansion of the money supply. It appears likely that Federal Reserve policy will remain accommodative, with continued low interest rates. Therefore Branch’s five-year sales forecast is very optimistic. Branch’s profit margins are projected to be in line with its competitors, but the firm is carrying significantly more debt in its capital structure than comparable companies.

Smith has determined the following about the Plan:

• The average employee age is 45.5 years, and the active-to-retired participant ratio is high.
• The Plan should be considered ongoing, and it has a moderate surplus.
• Employees are eligible for retirement at age 62. There are no provisions for lump-sum distributions or early retirement.
• The discount rate for the projected benefit obligation (PBO) is 10%.
• The expected return on plan assets is 10 percent.

Smith decides she needs to review the terminology, accounting, and other factors affecting the Plan’s funding status. Below is her brief synopsis of relevant terms:

Exhibit A: Pension Terminology

Smith recalls that the Pension Committee wishes to minimize the volatility of future contributions. They also expressed concern that the discount rate and expected return on plan assets might need modification. She decides to explore these issues further before finishing the IPS or developing an asset allocation recommendation for the portfolio.

Which of the following best explains two constraints that differ between individuals and pension funds and the way they differ?

A)   Liquidity and time horizon considerations: pensions always have a greater need for liquidity than individual investors; pensions have infinite lives whereas individuals do not.

B)   Legal and time horizon considerations: pensions must follow the Employee Retirement Income Security Act (ERISA) whereas individuals can usually invest as they please; pensions have finite lives whereas individuals do not.

C)   Legal and tax considerations: pensions must follow the Employee Retirement Income Security Act (ERISA) whereas individuals can usually invest as they please; pensions are tax-exempt investors whereas individuals pay taxes.

[此贴子已经被作者于2009-3-5 10:28:57编辑过]