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TopicinCFALevel2-SS1-ETHICS&PROFESSIONALSSSSSSTopicinCFALevel2-SS1-ETHICS&PROFESSIONALSSSSSSSSPORTFOLIOMANAGEMENTFORINSTITUTIONALSSSSASSETALLOCATIONANDRELATEDDECISIONSANDINPORTFOLIOMANAGEMENTSSASSETALLOCATIONANDRELATEDDECISIONSANDINPORTFOLIOMANAGEMENTFIXED-INCOMEPORTFOLIOMANAGEMENTSSFIXED-INCOMEPORTFOLIOMANAGEMENTSSEQUITYPORTFOLIOSSSSRISKSSRISKMANAGEMENTAPPLICATIONSOFSSTRADING,MONITORINGANDSSSSGLOBALINVESTMENTPERFORMANCEFrameworkofSS6:PortfolioFrameworkofSS6:PortfolioManagementforInstitutional3- ManagingInstitutionalInvestorInstitutionalInvestors–4-Securitiesportfolioisresidualuseoffunds,aftermeetingloandemandbutplayskeyroleinmanagingrisk(market&credit)InstitutionalInvestors–4-Securitiesportfolioisresidualuseoffunds,aftermeetingloandemandbutplayskeyroleinmanagingrisk(market&credit)&liquidityvs.liabilitiesNonandcasualty,andsurety)HybridplansofDCplans(portability,byparticipants)andDBplans(benefitguarantees,linkedtoyearsofserviceandsalary)e.g.cashbenefitplans,benefitplans,floorplansDCplansthatinvestall/themajorityofplancontributionisa%ofdependsonvestingschedule,levelofcontributions,andchangeinvalueofstockpertomatchliabilities,plussurplus(grant-Defined(RiskborneandDefined(RiskborneCharitableInstitutionalInvestors–InstitutionalInvestors–SixtypesofinstitutionalinvestorsintheLevel3PensionNon-lifeinsurance5-1.1GeneralPensionGeneral1.1GeneralPensionGeneralPensionApensionplanisaportfolioofassetsthatsupportsfuturebenefits.ThepromiseisaliabilityoftheplanTheplansponsoristheorganization(e.g.,acorporation,agovernmententity,anonprofitorganization)thatfundsthepensionplan.Planparticipantsarethosereceivingapromiseofretirementincome6-1.1GeneralPensionDefinitions1.1GeneralPensionDefinitions—TypesofPensionDefinedContribution(DC)=IndividualEmployer'sonlyobligationistomakecontributionstoemployees'pensionplansandprovideanadequatenumberofalternativeinvestmentchoicesEmployeeownsassets(portable),makesinvestmentdecisions,andbearsallinvestmentrisk,receivestaxdeferralbenefitsandinretirementselectslumpsumorpaymentsDefinedBenefitEmployermustmanagetheplanassetsandbearinvestmentPensionbenefitsaretheemployer'sfinancialEmployeereceivespaymentsbutissubjecttoearlyterminationriskiftheyleavethefirmearly7-1.1GeneralPension1.1GeneralPensionDefinitions—DCPensionDefined-contribution(DC)pensionplanscomeintwoforms:directedandsponsor-Inasponsor-directedDC(e.g.,profitsharingplan),thesponsorselectstheInaparticipant-directedDCplan,theemployeesallocateretirementfunds(employeeandemployercontributions)amongalistofmutualfundsprovidedbythe8-1.1GeneralPensionDefinitions1.1GeneralPensionDefinitions—TypesofPensionCashbalanceAhybriddefined-benefitplanthatmaintainsindividualaccountrecordsforplanparticipantsshowingtheircurrentvalueofaccruedbenefit.Theseplansdifferslightlyfromtraditionaldefined-benefitplansinthatanaccount,ratherthananactualfund,ismaintainedforeachindividual.ProfitsharingDefined-contributionplanwhosecontributionsareestablishedsomewhatbytheprofitabilityoftheplansponsor.9-1.1GeneralPension1.1GeneralPensionDefinitions—CashBalanceLikeaDBplan,employerbearsinvestmentLikeaDCplan,participantreceivesapersonalizedstatementshowingtheaccountbalanceThebalanceonlyrepresentsaliability,notanactualaccountinwhichfundshavebeendepositedFacilitatesportabilitytoanew10-1.1GeneralPensionDefinitions—EmployeestockownershipAn1.1GeneralPensionDefinitions—EmployeestockownershipAnemployeestockownershipPlan(ESOP)isatypeofdefined-planthatallowsemployeestopurchasethecompanystock,sometimesatadiscountfrommarketprice.Thepurchasecanbewithbefore-orafter-taxdollars,andthefinalbalanceinthebeneficiary'saccountreflectstheincreaseinthevalueofthefirm’sstockaswellascontributionsduringemployment.ESOPsreceivevaryingamountsofregulationindifferent11-1.1GeneralPensionDefinitions1.1GeneralPensionDefinitions—EmployeeStockOwnershipTheseareDCplansthatinvestmostoralloftheplan'sassetsinemployerKeyissueforparticipantisifthecompanyfails,participantcouldfindvalueofESOPdropaswellasbeingunemployedESOPvalueatrisk=EmploymentatDiversifyawayfromcompanyCompanieshaveusedESOPsLiquidatelargeblocksofcompanyAvoidpublicFendoffhostiletakeoverssincemoststockheldbycompany12-1.1GeneralPensionDefinitions—DBPension1.1GeneralPensionDefinitions—DBPensionPensionPlanFundedstatusistherelationshipbetweenthepresentvalueoftheplanassetsandthepresentvalueofthepensionplanFullyfundedmeansthepresentvalueofthepensionplanassetsisgreaterthanorequaltothepresentvalueofthepensionliabilities.Sponsorscanatleasttemporarilystopmakingcontributionstotheplan’sassetbase.Underfundedmeansthepresentvalueofpensionplanassetsislessthanthepresentvalueofthepensionplanliabilities.Underfundedplansmayrequirethesponsorstomakespecialcontributionstotheplaninadditiontotheusual,regularcontributions.Surplusisthedifferencebetweenthepresentvalueofpensionplanandthepresentvalueofpensionplan13-1.1GeneralPensionDefinitions—DBPension1.1GeneralPensionDefinitions—DBPensionPensionPlanAccumulatedbenefitobligation(ABO)isthetotalpresentvalueofliabilitiestodate,assumingnofurtheraccumulationofbenefits.Ineffect,ABOisthepensionbenefitsduetoparticipantsiftheplansponsorterminatedexistence.Projectedbenefitobligation(PBO)istheABOplusprojectionsoffutureemployeecompensationincreases.ThePBOisthepensionliabilityforagoingconcernandistheliabilityfigureusedincalculatingfundedstatus.Totalfutureliabilityisameasureofpensionliabilitythatisthemostcomprehensive,becauseittakesintoaccountnotonlycompensationchanges,butalsochangesintheworkforceandbenefitchangesassociatedwithinflation.Totalfutureliabilityisoftenusedwhensettingobjectiveswithintheinvestmentpolicystatement(IPS).Retiredlivesisthenumberofplanparticipantscurrentlyreceivingbenefits(i.e.,retireescurrentlyreceivingretirementincome).Activelivesisthenumberofplanparticipantsnotcurrentlyreceivingbenefits(i.e.,thoseworkingtoward14-1.1SummaryofDB&15-1.1SummaryofDB&15-LiabilityofDeterminedbystatedcriteriausuallyrelatedtoyearsofserviceandsalarySponsor(employer)isresponsibleformanagingtheplanassetsReceiveperiodicpaymentsstartingatretirementorotherdateSubjectto“earlytermination”riskifemployeeisterminatedearlyNotbearrisk/returnconsequencesofFirmkeepsallcontributionsOnlyfinancialliabilityismakingcontributionstoemployee’sTheplanmustoffersufficientinvestmentvehiclesOwntheplanandcantransportaccounttootheremploymentBearallrisk/returnconsequencesofMustmakeallinvestmentdecisionsPensionriskfactors:Plansurplus,sponsorfinancialstatusandprofitability,sponsorandpensionplanfundcommonriskexposures,planfeatures,workforcecharacteristics1.2DBPensionPlans:Return1.2DBPensionPlans:ReturnDBPensionPlans:ReturnGoalisforassetstogeneratereturnsufficienttocoverpensionPVA>Specificreturnrequirementdependsonfundedstatusandcontributions(assets)relativetoaccruedbenefits(liabilities)MinimizationofcontributionsisamorerealisticReturnobjectivemaybehigherifthesponsoristryingtolowerfuturecontributionsorwantstorecognizepensionincomeonitsincomeTypicalreturnobjective:Adequatefundingrate,inflationThereturnobjectiveisgenerallyestablishedbytheactuarialdiscountratedeterminedbyanactuaryusingan"asset-liabilitystudy'16-1.2DBPensionPlans:1.2DBPensionPlans:ReturnDesired/StretchreturnisareturnthatisoftendesiredbymanagementandgenerallyhigherthantherequiredreturnSethigherthanrequiredreturnwiththegoaltoreduceoreliminatefuturepensioncontributionsRatemaybetoohighandexposeassetstounnecessaryriskandMaynotbeintheinterestofplanReturnobjectivemaybemoreaggressivewhentheworkforceisLessaggressiveforretiredlivesReturnobjectivemaybeseparateforactiveandretiredlivesportionofpensionplanontheexam,examinethecasecarefully17-1.3DBPensionPlans:Risk风险目标1.3DBPensionPlans:Risk风险目标:收益确定型养老金的风险容忍度主要取决于计划的盈亏状态，18-PlanPlanfundedstatus(surplusordeficit)HigherpensionsurplusorhigherfundedstatusimpliesgreaterrisktoleranceSponsorfinancialDebttototalassetsCurrentandexpectedprofitabilityLowdebtratiosandhighercurrentandexpectedprofitabilityimplygreaterrisk1.3DBPensionPlans:Risk19-1.3DBPensionPlans:Risk19-CorrelationofsponsoroperatingresultswithpensionassetreturnsThelowerthecorrelation,thegreaterrisktolerance,allelseequal.PlanProvisionforearlysumdistributionSuchoptionstendtoreducethedurationofplanliabilities,implyinglowerrisktolerance,allelseequalAgeofworkforce,ActivelivesrelativetoretiredlivesTheyoungertheandthegreatertheproportionofactivelives,thegreaterthedurationofplanliabilitiesandthegreatertherisktolerance.1.3DBPensionPlans:RiskIncreased1.3DBPensionPlans:RiskIncreasedrisktoleranceGreaterfundedstatus...higher"cushion"Youngeraverageage/greateractivelives...GoingconcernProvisionsforearlyretirementandlump-sumdistributionsreduceabilitytotakerisk20-1.3DBPension1.3DBPensionPlans:RiskForDBplans,riskrelativetoliabilitiesisAsset/LiabilitymanagementisasubsetoftheoverallriskTypicalriskobjectivesStandarddeviationintermsofthe100%fundedstatusvs.futureFundedstatustoavoidreportingpensionObtainacertainleveloffunding21-1.4DBPensionPlans:1.4DBPensionPlans:1.WorkforceMix(retiredvs.activeGreaterretiredlives,increasedliquidity2.Sponsorcontributionsvs.benefitHigherprofitabilityreducesliquidity3.PlanEarlyretirementorlumpsumprovisionsincreaseliquidityTimeDeterminedbytwofactors:Whethertheplanisagoingconcernstage)orisaterminatedplan(singleTheactivelivesportionoftheplanwillindicateatimehorizonassociatedwithexpectedtermtoretirement.Theretiredlivesportionwillindicateatimehorizonasafunctionofexpectancyforthosecurrentlyreceiving22-1.4DBPensionPlans:Legaland1.4DBPensionPlans:LegalandMostcountriesfederallyregulatepensionManagershouldconformtothelocalIntheU.S.,ERISArequiressponsorstoexerciseduediligencewhenmakinginvestmentdecisionsERISA'soverridingstandardisthattheassetsshouldbemanagedfortheplanparticipants,notthesponsorConsultationwithappropriatelegalexpertsisTaxesandUniquePensionplansaretax-exempt,notaxERISArequiresduediligence,butsmallsponsorsmaynothavetheplanresourcesorexpertisetothoroughlyinvestigatealternativeassets(e.g.,derivatives,hedgefunds,etc.) traditionaloralternativeasset 23-InstitutionalInvestors–InstitutionalInvestors–SixtypesofinstitutionalinvestorsintheLevel3PensionNon-lifeinsurance24-2.1FoundationsandFoundations2.1FoundationsandFoundationsandendowmentsprovidevitalsupportformuchofphilanthropicandcharitableFoundationsaretypicallygrant-makinginstitutionsfundedbygiftsinvestmentassets.(Ford,Rockefeller,andGatesfoundations)Endowments,ontheotherhand,arelong-termfundsgenerallyownedbyoperatingnon-profitinstitutionssuchasuniversitiesandcolleges,museums,hospitals,andotherorganizationsinvolvedincharitableactivities.(Harvard,YaleandPrinceton25-2.2Foundation26-2.2Foundation26-Independentgrant-makingorganizationestablishedtoaidsocial,educational,family,orgroupofdonor’sfamily,orAtleast5%of12-monthaverageassetvalue,plusassociatedwithAlegallyindependentorganizationwithclosetiestotheProvidingfromaprofit-bythesponsoringSameas2.2Foundation27-Organizationthatuses2.2Foundation27-Organizationthatusesitsresourcestoconductresearchorprovideadirectservice(e.g.,LargelythesameastboardofMustspendatleast85%ofinterestanddividendincomeforitsownoperation.Somearealsosubjecttoannualspendingrequirementequalto3.33%ofassets.Apubliclysupportedorganizationthatmakesgrantsforsocial,education,charitable,orreligiouspurposes.AtypeofpublicBoardofNospending2.3Foundations:Thereturnobjectivedependsonthetimehorizonstatedforthefoundation.2.3Foundations:Thereturnobjectivedependsonthetimehorizonstatedforthefoundation.Ifthefoundationwascreatedtoprovideperpetualsupport,thepreservationofrealpurchasingpowerisagoal.AminimumreturnequaltotherequiredpayoutplusexpectedinflationandfundexpensesMorefluid,creativeandaggressivethanpensionfundsbecausetheynocontractuallydefinedAsset-onlyapproachtoassetThemaindriveristhelongtimeDuetolowspendingrequirements,theyusuallyhaveabove-averagerisk28-2.4Foundations:Anticipatedandunanticipatedneedsforcash2.4Foundations:AnticipatedandunanticipatedneedsforcashinexcessofcontributionsOtherthanthe5%minimum,foundationscanchooseanyspendingratetheydesireMostfoundationsmaintainareserveof10%to20%ofannualspendingtocompensatefordownyearsinfinancialmarketsTimeEstablishedormanagedwiththeintentoflastingintoperpetuity,usuallyverylongExceptionisthosethatarerequiredtospenddowntheirassetsTaxes—Nontaxable,except.,UBIT—Unrelatedbusinessincome(donatedbusiness).istaxedatcorporateincomerate.(e.g.,museumgiftshop)Investmentincome(Div&Int)lessexpensesistaxedat Reducedto1%ifspendingequaltoorexceeds 29-2.4Foundations:Legaland2.4Foundations:LegalandMoststateshaveadoptedUMIFA(UniformManagementofInstitutionalFundsAct)PrudentInvestorRulegenerallySkill,care,prudence,diligence,defraycosts,diversify,delegateInvestmentsshouldbeconsideredinadiversifiedportfolioCanvarybyUniqueCircumstances:issuerstolookConcentratedholdingsofalargesinglestockthattheyareprohibiteddonorfromUnrelatedbusinessincome—donatedSociallyresponsibleAdequatepersonneltoperformdue30-InstitutionalInvestors–InstitutionalInvestors–SixtypesofinstitutionalinvestorsintheLevel3PensionNon-lifeinsurance31-3.1Endowments:ReturnObjective—SpendingSimplespendingSpendingt=S3.1Endowments:ReturnObjective—SpendingSimplespendingSpendingt=S(marketwhere:S=thespecifiedspendingRolling3-yearaveragespendingDampenvolatilitythatcanimpacttheendowment’sportfoliovalueandsponsor’soperating3GeometricspendingThisspendingruleaddressesoneofthecriticismsoftherollingaveragespendingruleinthatextraordinarychangesinportfoliovaluemaycausedramaticshiftsinspending.Spendingt=(R)(Spendingt-1)(1+It-1)+(1-R)(S)(marketvaluet-1) R=smoothingrate(0.6~0.8),I=rateofinflation,S=spending 32-3.1Endowments:ReturnEndowment:ReturnEndowmentsaredesignedto3.1Endowments:ReturnEndowment:ReturnEndowmentsaredesignedtopermanentlyfundandprovidesupportforuniversities,colleges,hospitals,MaintainperpetualpurchasingpowerisCreativetensionexistsbetweentheneedforincomeagainstpreservationofpurchasingpower3S's=significant,stableandsustainablecashflowtosupportTotalreturnapproachisappropriate(spendfrombothincomeandcapitalThelong-termspendingratemustbelessthantheexpectedrealrateofProblem:spendingrate>5%canleadto-erosionof Minimizingspendingvolatilityusingaspendingruleisalso 33-3.2Endowments:RiskMost3.2Endowments:RiskMostendowmentshavehighrisktoleranceduetotheirlongtimeLowerabilitytotolerateriskHigherspendingHeavyrelianceupondonations,10%ormoreitsabilitytotolerateriskisdiminishedGreaterbudgetdependencyNospendingruleinplaceSmallersizeof34-3.3Endowments:3.3Endowments:LiquidityandTimeLowliquiditySpendingneedsvs.giftsandLargecashoutlaysmaysometimesbeneededforcapital–newTimehorizonisverylongterm(typicallyCanbemultistageifamajoroutlayis35-3.3Endowments:TaxesandLegal3.3Endowments:TaxesandLegalandTax-Dividendsonnon-U.S.securitieswithholdingUnrelatedbusinessincomemaybeMoststateshaveadoptedUMIFA—delegation,care,prudence,maintaincorpusandrespectdonorrestrictions.Prudentinvestorrulesapply.501(c)(3)IRSregulationsstatethatincomeshouldbenefitagroupnotLittlegovernmentUniqueInvestmentinalternativeinvestmentsrequiresignificantresourcesandSocialissues(e.g.,defensepoliciesandracialbiases)aretypicallytakenconsiderationwhendecidinguponindividual36-InstitutionalInvestors–InstitutionalInvestors–SixtypesofinstitutionalinvestorsintheLevel3PensionLifeinsuranceNon-lifeinsurance37-4.1LifeInsuranceLifeInsurance4.1LifeInsuranceLifeInsuranceWholelifeinsurancepoliciesprovidealeveldeathbenefitforthe“whole”ofinsured’slife.thepolicyprovidesdeathbenefitandcashvaluecomponentswherethedeathbenefitportionremainsconstantbutthecashvalueportionincreaseswiththecreditedrate(i.e.,theinterestratecreditedtothepolicyholder).Termlifeinsurancepoliciesprovidealeveldeathbenefitforastated“term”ofthepolicyholder’slife.Mosttermlifepolicieshavenocashvalue,buttheirpremiumsaremuchlowerthanwholelifepolicies.Universallife(万能险)policiesarecomposedofalifeinsurancepolicypayinganadjustabledeathbenefitandanattachedsavingsaccountofferingcompetitivecurrentmarketreturns.IncomeonthesavingscomponentaccumulatestaxVariablelife(可变保费寿险)productslinkthedeathbenefitandthecashvaluecomponentstoreturnsgeneratedbyabroadrangeofinvestmentvehicleschosenbythe38-4.2LifeInsurance4.2LifeInsuranceCompanies:ReturnMinimumreturn:RatesetbyactuariesbasedonmortalityratestomeetfundaccumulationratesEnhancedmargin:Spreadmanagement(abovecreditedrates)usedtobemorecompetitiveSurplus(PVassets-PVliabilities):Focusongrowth;useequityinvestmentsinrealestate,venturecapital,taxableaccount39-4.3LifeInsuranceCompanies:RiskPublicpolicyviewsinsurance4.3LifeInsuranceCompanies:RiskPublicpolicyviewsinsurancecompanyinvestmentportfoliosasquasi-trustAssociationofInsurancecommissioners(NAIC)directslifeinsurancecompaniestomaintainanassetvaluationreserve(AVR)asacushionagainstsubstantiallossesofportfoliovalueorinvestmentincomeValuationconcerns:Marketvolatilitycanleadtosurpluswrite-down,whichlowerrisktolerance(ability)andcreateacapitaladequacyCashflowvolatility:Loss,delayorvolatilityofcollectingincomecreatessignificantTimelyreinvestmentofcashflowisessentialtoincreasethesurplusReinvestmentrisk:reinvestingcouponincomeataratelowerthanthecouponorpurchaseIfinterestratesfall,profitabilityfalls;thisriskismanagedusingPrevalentwithannuityCreditriskisamajorconcernandismanagedthroughdiligentcreditanalysisportfolio40-4.4LifeInsuranceCompanies:4.4LifeInsuranceCompanies:ThreeprimaryDisintermediation:asinterestratesincreaseduetoinflation,borrowagainsttheirpoliciesorsurrenderpoliciesleavingLifeInsuranceCompanieswithsignificantoutflowsConsequently,liabilitydurationsshorten,andliquiditybecomesmoreUtilizemultiplescenarioforecastingofinterestrateexposuretomanageliquidityneedsAsset-liabilitymismatch:Asinterestratesincrease,disintermediationoccurs,andthecompanymayhavetoliquidateorconvertlongdurationassetstocash,sometimesataloss,tomeetliquidityneedsMismatcharisessinceliabilitydurationschangemoreslowlythanassetManagingdurationandliquiditybecomes41-4.4LifeInsuranceCompanies:4.4LifeInsuranceCompanies:Assetmarketabilityrisk:Traditionally,insurancecompanieshaveinlessliquidassetssuchPrivateplacementdebt,commercialmortgageloans,equityrealandventureconstrainedcommitmentstotheseasset42-4.5LifeInsuranceCompanies:Time4.5LifeInsuranceCompanies:TimeLifeInsuranceCompanies:TimeTraditionally,lifeinsuranceportfoliosconcentratedonholdingperiods20–40ThetimehorizonforlifeinsurancecompanieshasbecomeprogressivelyshorterasthedurationofliabilitieshasdecreasedduetoincreasedinterestratevolatilityandcompetitivemarketfactorsIndividualsegmentsoftheoverallportfoliowillhavetheirownhorizons.Ingeneralterms,timehorizonshavesimplybecome43-4.6LifeInsuranceCompanies:4.6LifeInsuranceCompanies:TwosegmentsofthePolicyholder'sshare(notCorporateshare,namelyfundstransferredtosurplus(taxed),whichaccruestoshareholder'softhecompany44-4.7LifeInsuranceCompanies:Legal&4.7LifeInsuranceCompanies:Legal&LegalandThreemainareasofEligibleinvestments:TherearequalitystandardsandlimitsplacedassetEquitieslimitedtoNon-USinvestmentsarealsolimitedtosomeextentasa%ofadmittedassetsBondsinterestcoverageratiomustmeetminimumstandardsorminimumcreditratingPrudentInvestorRule:AllowsinsurancefirmsincreasedflexibilityininvestmentchoicesandoptionsValuationMethods:UniformvaluationofsecuritiesismandatedbytheNAICthroughtheuseoftheSecurityValuationBookUniqueConcentrationofproductofferings,companysize,andlevelofsurplusaresomeofthemostcommonfactorsimpactingtheuniquenessoflifeinsurancecompanies.45-InstitutionalInvestors–InstitutionalInvestors–SixtypesofinstitutionalinvestorsintheLevel3PensionNon-lifeinsurance46-5.NonlifeInsuranceAsset/LiabilityLiabilities5.NonlifeInsuranceAsset/LiabilityLiabilitiesofacasualtycompanydifferfromthoseofalifecompanyinthattheclaimsreporting,processing,andpaymentprocesscantakeyearstocomplete.Thisisreferredtoasthe“long-tail”natureofcasualtyliabilities.Theliabilitystructureismainlyafunctionoftheproductmixthatacompanysells.LiabilitydurationstendtoberelativelyTheunderwritingcycletendstofollowgeneralbusinessTheliquidityneedsofanonlifecompanyaregenerallydictatedbyitsunderwritingcycle.Theunderwritingcyclecorrespondstoa3-to5-yearcycleinwhichunderwritinglossesarenegligibleattheoutsetandbecomeprogressivelyworse,turningintosignificantlossesattheendofthe47-5.1NonlifeInsuranceCompanies:ReturnNonlifefirms5.1NonlifeInsuranceCompanies:ReturnNonlifefirmsfacegreateruncertaintythanlifeinsuranceduetotheofhigherclaimsHowever,theyarenotasinterestratesensitivesincetheirpoliciesdonottypicallypayperiodicreturns.TheprimaryMaximizethereturnontheirfixed-incomeportfolioforpurposesofmeeting(i.e.,immunizing)claims.UsereturnsfromtheequityportionoftheirportfoliotogrowtheUsethesurplusportfoliotoprovidefundsforunexpected,largeliabilityNonlifeinsurancecompaniesholdagreaterpercentageofequity-typeinvestmentsintheirportfoliosthanlifeinsurancecompanieshold.Largestockandbondholdingsaredesignedtoprovidehighlevelscurrentincome,andcapitalappreciationtobuildthesurplus48-5.1NonlifeInsuranceCompanies:Return5.1NonlifeInsuranceCompanies:ReturnThemainfactorsimpactingnonlifeinsurancecompanyreturnCompetitivepricingpolicy.Today,mostnonlifecompaniesrecognizeinvestmentincomecanbeusedtoreducepremiumsand,hence,makethefirmmorecompetitive.Competitionisamajorinfluenceinsettingpremiums.Profitability.Investmentincomeandtotalreturnoftheinvestmentportfolioarenowprimarydeterminantsofprofitability.Investmentreturnusuallyservestosmooththeearningsvolatilityofthetypicalunderwritingcycle.Growthofsurplus.Commonstocks,convertiblesandalternativeinvestmentsarethefavoredinvestmentsforsurplusgrowth.Bondportfoliosareusuallymaintainedtofundinsurancereserverequirements,whereascommonstocksareusedtoprovidegrowthtothesurplus.After-taxreturns.Nonlifeinsurancecompaniesaretaxableentities.After-taxreturnsareextremelyimportanttononlifecompanies.Totalreturn.Activebondportfoliomanagementstrategieshavebeenadoptedmanylargenonlifecompaniesinanattempttomaximizetotalreturn.Afocusonyieldhasbeenshiftedtoincomeandcapitalgaingeneration.49-5.2NonlifeInsuranceCompanies:Risk5.2NonlifeInsuranceCompanies:RiskRiskDuetotherelativelyhighuncertaintyassociatedwithclaims,risktoleranceofnonlifeinsurancecompaniesmustbetemperedbytheirliquidityCasualtycompaniesgenerallyhavelimitedriskSincemostnonlifecompaniesofferreplacementcostcoverage,inflationriskisalsoabigconcern.TwoimportantThecashflowcharacteristicsofnonlifecompaniesareoftenerraticandThecommonstock-to-surplusratioaveragesbetweenone-halfto50-5.3NonlifeInsuranceCompanies:5.3NonlifeInsuranceCompanies:Liquidity:relativelyHighliquidityrequirementsareoftenmetthroughholdingaportfolioofshort-termsecurities,highlymarketableU.S.Governmentdebt,andbymaintainingabalancedorladderedmaturityscheduleofinvestableassets.Strangely,theaveragematurityofanonlifecompany’sbondportfolioislongerthanthatofalifecompanybecauseofthepredominanceoflong-termtax-exemptbondsheldtomaximizeafter-taxreturns.Equitiesareheldtogrowanonlifecompany’ssurplusportfolio.theequitiesheldtendtohavegrowthcharacteristicsand,onaverage,areheldforlongtimeperiods.Taxconsiderations.Nonlifeinsurancecompaniesaretaxableentities.Taxissuesarecomplex,sofrequentdiscussionwithappropriatetaxcounselare51-5.3NonlifeInsuranceCompanies:5.3NonlifeInsuranceCompanies:Anassetvaluationreserve(AVR)isnotrequired,butrisk-basedcapital(RBC)requirementshavebeenestablished.Uniquecircumstances:thecurrentfinancialstatusofnonlifecompanies,coupledwithmanaginginvestmentriskandliquidity52-InstitutionalInvestors–InstitutionalInvestors–SixtypesofinstitutionalinvestorsintheLevel3PensionNon-lifeinsurance53-6.BankSecurityBanksare6.BankSecurityBanksarerequiredtoclassifythesesecuritiesintothreedistinctcategories:holdtomaturity,availableforsale,andtrading.Duration,CreditRisk,Income,andThemannerinwhichfundsareallocatedtothethreeclassificationswilltheoveralldurationofthesecuritiesInthisway,managerscanadjustthebank’sassetdurationtokeepitinthedesiredrelationshiptoitsliabilitydurationIfmanagersforecastincreasinginterestrates,theycandecreasethedurationoftheassetsbydecreasingthedurationofthesecuritiesportfolio.Ifinterestratesareexpectedtodecrease,theywillincreasethedurationoftheAbankcanuseitssecurityportfoliotomanagethecreditriskanddiversificationofitsassetsBanksecuritiesportfoliocangeneratesignificantSincenotallloanscanbereadilysold,bankstypicallyusethesecuritiesportfolioasasourceofliquidityforneededcash54-6.1BankBank6.1BankBankReturn:EarnapositiveinterestTheinterestspreadisthedifferencebetweenthebank’scostoffundsandtheinterestearnedonloansandotherinvestments.Riskrelativetoliabilitiesratherthanabsoluterisk,isofprimaryUsuallyhaveabelow-averagetoleranceforrisksincetheycannotletlossesinthesecurityportfoliointerferewiththeirabilitytomeettheir55-6.1BankObjectives:RiskBankriskmeasures6.1BankObjectives:RiskBankriskmeasuresLADGLADG=leverageadjustedduration=durationofthebanks’=durationofthebanks’L/A=leveragemeasure=marketvalueofliabilitiesovermarketvalueForanincreaseininterestIfLADG<0,marketvalueofequityIfLADG>0,marketvalueofequityIfLADG=0,marketvalueofequityunchanged(immunized)Forandecreaseininterestrates:IfLADG<0,marketvalueofequityIfLADG>0,marketvalueofequityincreaseIfLADG=0,marketvalueofequityunchanged56-6.2BankBankLiquidity.6.2BankBankLiquidity.Abank’sliquiditypositionisakeymanagementandregulatoryconcern.bank’sliquidityneedsaredrivenbydepositwithdrawalsanddemandforloansaswellasregulation.Timehorizon.Thetimehorizonforthesecuritiesportfolioisdrivenbytheaveragematurityofitsliabilities.Sincemostbankliabilitiesareshortterm,theaveragematurityofsecuritiesintheportfoliotendstobeshorttointermediateterm(3-7Taxes.Banksaretaxableentities.Bank’ssecurityportfoliosarefullytaxed.Taxesmustbeconsider