(Papers) ACET Paper May 2010 "SA6 – Investment"

Q 1)

You have been appointed as Secretary to the Investment Committee of a life insurance company. The terms of reference of the investment committee indicate that the committee has responsibility for overseeing the investment process of the committee to ensure that appropriate assets are selected to meet the company’s liabilities in a risk controlled manner and in compliance with regulation but also to give top quartile performance return to policyholders.

The company has five lines of business:

i) Individual unit linked policies
ii) Immediate annuities, including escalating annuities
iii) Pure term insurance policies (no return of premium)
iv) Watermark unit linked product guaranteeing policyholders, at the end of ten years, the highest NAV in the first seven years
v) Universal life contract where the earned rate less a margin is credited to the policyholder, with a guaranteed minimum crediting rate of 2%pa.

As part of your role, you have been asked to prepare a number of papers to be presented to the investment committee

(a) Prepare an overview of the current Indian economy and financial markets.
(b) The necessary regulatory changes have been made to allow outsourcing of fund management activities. The company has decided to consider such an approach and wish to issue a request for proposal to various fund managers. The company is considering outsourcing both equity and bond fund management, though discussions are independent. Set out the procedure you would recommend to the investment committee for selecting and appointing a fund manager.
(c) The investment committee has asked you to explain the following terms

 Growth investment style
 Value investment style
 Momentum investment style
 Contrarian investment style
 Rotational investment style
 Top –down approach
 Bottom –up approach
 Passive investing (tracker)

Write brief notes to explain each of these terms

(d) The investment committee has asked you to produce a summary report on the in-house investment mandate compliance and violations. List the compliance reports you would review to produce your summary report.

(e) The investment committee has also asked for an Asset Liability Management (ALM) report on the assets and liabilities of the life office.

i) Explain what is meant by ALM
ii) How you would implement an ALM approach
iii) How will you apply the ALM for each of the life office’s lines of business ?

(f) The RBI/Finance Ministry has issued a joint consultation paper proposing to issue long term index linked government securities and asking for responses from the banking, insurance & financial services sector . Draft a response on behalf of your company setting out the features of an index linked government security and the advantages and disadvantages to the company of the government issuing such a security.

Q2)

You work in the investment team of an insurance company as an Investment Actuary. The company has a significant portfolio of Unit Linked Insurance Policies (ULIPs) providing various fund options. The company is trying to compete by providing higher return performance through better investment strategies (both long term and short term). The company is constantly trying to understand the investment opportunities in Indian Equities and Debt markets and available derivatives to make the best out of such opportunities.

You’re presented with various issues which the investment team likes to consult with you before taking a decision.

The company has a traditional group retirement portfolio (consisting of gratuity and superannuation funds) of employees in various companies. This being a traditional portfolio, the company invests the same as per IRDA regulations. The company management has decided to invest some amount of the portfolio in equities so as to enhance the returns on the portfolio and be more competitive. There is an argument in favour of equities citing that the equity risk premium in India has been historically around 6.5 % and is likely to be maintained. You feel that the equity risk premium, which is the extra return expected over the debt returns, is likely to come down in future and a very high equity exposure may not be warranted. As an investment actuary you have suggested that the expectations of the customers from this portfolio is to have a smoothed return and equity component will create volatility, hence the equity component needs to capped. You’re comfortable with a maximum of 20% of equity exposure which is well within the maximum allowed by IRDA but you’ve suggested that the range of equity in the group retirement portfolio should be varied between 2% to 20% to give appropriate equity exposure depending on the market expectations.

You’ve been thinking as to what should be the main criterion to change the equity proportion from 2% to 20% trying to optimise the value. You have found that Indian markets have been moving in a P/E ratio range of 11 -25 and have suggested that if the P/E ratio drops to 12 then the investment should be 20% into equities and when it is 24 it should be reduced to 2% and a table based on P/E like one given below may be used (the relevant column for Group Retirement portfolio needs to be considered for the same).

Your company also does a significantly large business through Unit Linked products sold to Individual policyholders through agents and bank channel. Amongst many funds offered to your policyholders one is an Index Fund based on Nifty Index and another is a money market fund.

Your company is contemplating offer a new “fund of fund” option to policyholders purchasing Individual life policies. In such “fund of fund” option the policyholder’s money would partly be invested in Index Fund and partly in the Money Market Fund depending on the P/E ratio of the Equity Index. The Index Fund exposure at different levels of P/E is given below. Please read the column relevant for the Individual business from the table based on P/E as given below.