Components of return to shareholders of an insurer
An insurance (or underwriting) result, and an investment result.
Primary objectives of investment
To maximise return subject to meeting contractual obligations: meeting claims and expenses as they fall due, maintaining statutory solvency and any internal company solvency constraints.
The risk appetite of the insurer will depend on
Its liabilities, assets, external influences, insurer-specific constraints.
Liability characteristics that need to be considered
- Nature
- currency
- term
- level of uncertainty (timing and amount) of existing liabilities
- estimated future liabilities arising from the portfolio of business planned
- location of liabilities
- whether the liabilities are discounted.
The nature of existing liabilities
Are they fixed or ‘real’ in monetary terms. The majority of general insurance liabilities will be real in nature.
Currency of existing liabilities
Many domestic, personal and commercial insurers may have portfolios predominantly denominated in their local currency. However, international insurers and reinsurers have portfolios that contain a range of currencies.
Term of existing liabilities
Most general insurers’ portfolios are likely to contain a significant proportion of short-term liabilities (1-3 years), with a smaller proportion of medium-term (4-10 years) and long-term liabilities (10+ years).
Considerations with respect to the assets
- Size of the assets, in relation to the current liabilities
- expected long-term return from various asset classes
- expected volatility within the various asset classes
- existing asset portfolio
- non-investible funds
- economic outlook.
Free reserves
The excess of the value of an insurer’s assets over its technical reserves and current liabilities.
Monies not available for investment include
Monies held by agents (e.g., brokers holding premiums for two months before passing them on), policyholders (e.g., premium payments by instalment, or end-of-year adjustment premiums due to exposure adjustments or experience rating), reinsurers (i.e., delays in making recoveries).
External influences on investments
- Tax treatment of different investment and the tax position of the general insurer
- statutory, legal, ethical or voluntary restrictions on how the insurer may invest
- statutory valuation requirements
- solvency requirements
- rating agency constraints on capital required to maintain the insurer’s desired rating
- competition - strategy followed by other funds
- regulatory constraints.
Insurer-specific investment considerations
Risk appetite, company-specific investment objectives.
Possible insurer situations with respect to cashflow
- Insurer expects that premiums and investment income will continue to exceed claim payments for the indefinite future
- insurer is in run-off and expects to have to rely on the maturity and realisation of assets
- insurer has suffered a major insurance event and needs to obtain short-term liquidity in order to settle claims.
Fundamental choices when modelling future liability outgo
- Whether to include premium income and outgo relating to business that will be written after the accounting date
- whether to use model point data.
Overall liability outgo can be calculated as
Liability outgo = total gross claim payments - reinsurance and other recoveries + expenses - outstanding premiums received + tax and dividend payments.
Claim payment projection must include
- All future payments in respect of unsettled reported claims
- IBNR and reopened claims
- claims that will emerge from unexpired risks
- claims that will emerge from new business.
Important considerations in an investment income projection
- Income from investment
- any capital proceeds, e.g., the redemption payments on any maturing bonds, during the period of consideration
- the expenses of investment
- the future volatility of capital values and investment income.
Possible solvency requirements might be related to
- The length of tail
- the likelihood of catastrophes and accumulations
- the spread of risk groups within the portfolio
- the insurer’s experience in writing the class.
The purposes of a new business projection might be to assess
- The future solvency of the office under different volumes of new business,
- the future solvency under different scenarios for asset distributions
- the likely levels of profitability.
Risks relating to an insurer’s investment strategy
Liquidity, currency, market, credit, group.
Liquidity risk
The risk of not having sufficient cash to meet the liabilities as they fall due.
Currency risk
The risk that changes in the values of the assets, or the liabilities of the company adversely impact the available capital or investment funds.
Market risk
The risk relating to changes in the value of the portfolio due to movements in the market value of the assets held.
Economic risk
The risk of investing in certain asset classes at certain stages in the economic cycle when the assets are overpriced.
