10. Insurance Investments, Treasury and Asset–Liability Management

Introduction and context

Insurance is a promise to make uncertain payments in the future. The insurer therefore receives funds today—through premiums, investment income, capital contributions and other receipts—and must preserve and deploy those funds so that claims and expenses can be paid when due. Investment management in insurance is consequently different from investment management in a pure asset-management business. The central question is not simply how to maximise return. It is how to earn an appropriate risk-adjusted return while maintaining solvency, liquidity, policyholder protection and regulatory compliance.

An insurer’s balance sheet links underwriting, investment, treasury and capital management. The characteristics of liabilities determine the amount, timing and currency of assets that should be held. A life insurer writing long-duration annuities may require long-term bonds and inflation-sensitive assets, whereas a general insurer writing motor insurance needs substantial liquidity for frequent and relatively short-term claims. Asset–liability management (ALM) provides the framework for coordinating these decisions.

The chapter examines the investment universe available to insurers, valuation and risk measurement techniques, treasury processes, liability-sensitive portfolio construction, hedging and derivatives, credit analysis, strategic asset allocation, governance and emerging analytical tools. The emphasis is on decisions that reconcile return objectives with the insurer’s promises to policyholders.

Learning objectives

After studying this chapter, the student should be able to:

1. Explain the investment and treasury functions within an insurance company.

2. Evaluate fixed-income, equity, property and alternative investments.

3. Apply duration, convexity, immunisation and cash-flow matching techniques.

4. Assess liquidity, credit, market, currency, concentration and reinvestment risks.

5. Develop an ALM and strategic asset-allocation framework.

6. Explain the use, benefits and risks of derivatives and hedging.

7. Analyse regulatory, ethical, governance and technology-related issues in insurance investment management.

8. Apply these ideas to an integrated insurance balance-sheet case.

The insurance investment function: purpose and constraints

Insurance investment has four connected purposes. First, it supports the payment of claims and benefits. Second, it contributes to profitability through investment income and capital appreciation. Third, it helps preserve the real value of policyholder funds, particularly in long-term life and pension products. Fourth, it supports solvency by ensuring that asset values and cash flows remain adequate under adverse conditions.

The investment mandate is constrained by the nature of the liabilities. Important liability characteristics include duration, expected claim frequency, severity, payment uncertainty, inflation sensitivity, currency, surrender behaviour and embedded options. A portfolio that is suitable for predictable ten-year annuity payments may be inappropriate for catastrophe insurance, where claims can become immediately payable after a major event.

Insurance investment decisions are also constrained by capital requirements, admissible-asset rules, exposure limits, related-party restrictions, valuation rules, tax considerations and accounting treatment. Solvency regulation generally encourages insurers to hold assets of adequate quality and liquidity and to maintain capital against market, credit, insurance and operational risks. Accounting values may differ from economic values; consequently, managers should distinguish accounting performance from economic risk.

The investment process normally includes defining objectives and constraints, analysing liabilities, setting a strategic asset allocation, selecting securities and managers, executing transactions, monitoring exposures, rebalancing and reporting. Investment performance should be judged against liability-sensitive benchmarks rather than against an unrelated market index alone.

The investment universe and its economic role

Fixed-income securities

Bonds are central to insurance portfolios because their contractual cash flows can be aligned with expected benefits and claims. Government securities generally have low default risk in the issuer’s domestic currency, although they remain exposed to interest-rate, inflation, liquidity and sovereign risks. Corporate bonds provide additional yield but require analysis of default probability, recovery value, spread volatility, covenants and sector concentration. Covered bonds, municipal securities, asset-backed securities and infrastructure debt may provide diversification, but their legal structure and cash-flow behaviour must be understood.

The price of a conventional bond is the present value of its future coupons and principal:

P = Σ [C/(1+y)^t] + [F/(1+y)^n]

where P is price, C is the coupon, F is face value, y is the yield per period and n is the number of periods. Bond prices generally fall when market yields rise. The sensitivity of price to yield changes depends principally on duration and convexity.

Floating-rate notes have coupons linked to a reference rate and generally have lower interest-rate duration than fixed-rate bonds. Inflation-linked bonds adjust principal or coupons according to an inflation index and can be valuable where liabilities rise with inflation. However, index mismatch, liquidity and real-yield volatility must be considered.

Equities

Equities offer participation in economic growth, dividend income and protection against long-term inflation in some circumstances. They are, however, exposed to market volatility, sector risk, valuation risk, currency risk and potentially substantial short-term losses. Equity holdings may be appropriate for long-duration liabilities and surplus funds, but their suitability depends on risk capacity, solvency capital and the insurer’s ability to withstand market declines.

Equity analysis may use fundamental measures such as earnings quality, cash-flow generation, dividend sustainability, return on equity, leverage and valuation multiples. Passive strategies provide broad diversification and usually lower management costs, while active strategies may exploit security mispricing but introduce manager, style and tracking risks.

Property and infrastructure

Direct property can generate rental income and potential capital appreciation, while infrastructure assets may produce long-term, contract-based cash flows. These investments can diversify listed securities and sometimes provide partial inflation linkage. Their risks include illiquidity, valuation subjectivity, development risk, tenant or concession risk, leverage, environmental exposure and concentration in particular locations or projects.

Valuation of unlisted property and infrastructure is less frequent than valuation of listed assets. This can make reported volatility appear lower without eliminating economic risk. The insurer must therefore assess liquidity under stress, independent valuation, governance arrangements and the possibility that assets cannot be sold quickly at their reported carrying value.

Alternative investments

Private equity, private credit, hedge funds, commodities, catastrophe bonds and other alternatives may improve diversification or provide distinctive sources of return. Private credit can offer attractive spreads but requires detailed underwriting, documentation and monitoring. Catastrophe bonds transfer specified insurance-event risk to capital-market investors and can be useful to insurers seeking reinsurance capacity, although the investor faces event and model risk.

Alternatives should not be classified as safe merely because their accounting prices are stable. Their economic risks may be obscured by infrequent valuation, lock-up periods, leverage or complex contractual arrangements. Due diligence should cover strategy, liquidity terms, valuation policy, legal structure, service providers, conflicts and operational controls.

Valuation, performance and risk measurement

Investment valuation begins with identifying whether an instrument is actively traded, valued through observable market inputs or valued using models. Fair-value models require assumptions about discount rates, default, prepayment, volatility, recovery and liquidity. Model governance is therefore essential.

Total return consists of income, realised gains or losses and unrealised changes in value, adjusted for transaction costs and other expenses. Performance attribution separates allocation effects, security-selection effects, currency effects, duration positioning and fees. A high return may be compensation for hidden credit or liquidity risk rather than evidence of superior skill.

Market risk can be described through volatility, value at risk (VaR), expected shortfall, stress testing and scenario analysis. VaR estimates a loss threshold at a specified confidence level and horizon, but it does not describe losses beyond that threshold and may rely heavily on historical relationships. Expected shortfall estimates the average loss beyond the VaR threshold and can provide a more informative tail-risk measure. Neither replaces judgement or scenario analysis.

Credit risk analysis examines the probability of default, loss given default and exposure at default. The expected credit loss concept may be expressed simply as:

Expected loss = Probability of default × Loss given default × Exposure at default.

The analysis should include the issuer’s financial strength, cash-flow coverage, leverage, business model, management quality, industry conditions, security ranking, collateral, covenants and refinancing needs. Ratings are useful information but do not replace independent analysis. Credit migration can cause losses even when an issuer does not default, because a downgrade generally increases required yield and reduces market value.

Duration, convexity and immunisation

Macaulay duration is the weighted average time to receive a bond’s cash flows, with weights based on the present value of each cash flow. Modified duration approximates the percentage price change for a small change in yield:

ΔP/P ≈ −Dmod × Δy.

For example, if a bond portfolio has modified duration of 6 and yields rise by 0.50 percentage points, the first-order estimated price decline is approximately 3 per cent, before considering convexity and other effects.

Convexity improves the estimate for larger yield movements. A second-order approximation is:

ΔP/P ≈ −DmodΔy + ½C(Δy)^2,

where C is convexity. A portfolio with greater positive convexity generally loses less when yields rise and gains more when yields fall, all else equal. Duration and convexity are approximations and may be unreliable for instruments with embedded options, such as callable bonds or mortgage-backed securities.

Immunisation seeks to make the value of assets sufficiently insensitive to changes in interest rates relative to the value of liabilities. A basic single-rate immunisation strategy requires the present value of assets to equal the present value of liabilities, asset duration to approximate liability duration and asset convexity to be adequate. In practice, immunisation is difficult because liabilities are uncertain, yield curves shift in non-parallel ways, policyholders exercise options, cash flows change and assets require rebalancing.

Cash-flow matching is more direct: asset cash inflows are scheduled to cover liability payments in each relevant period. It reduces reinvestment and liquidation risk but can be costly and may restrict investment flexibility. A combination of cash-flow matching for highly certain payments and duration matching for uncertain or longer-dated payments is often more practical.

Key-rate duration measures sensitivity to changes at particular maturity points on the yield curve. It is superior to a single duration measure when the curve twists or steepens. ALM teams should examine parallel shifts, steepening, flattening, basis changes and changes in credit spreads.

Treasury and liquidity management

Treasury management converts the insurer’s balance-sheet promises into a rolling plan for cash receipts, payments, funding and liquidity reserves. It covers premium collections, claim payments, reinsurance recoveries, investment settlements, collateral calls, expenses, taxes, debt service and capital transactions.

Liquidity risk arises when an insurer cannot meet obligations when due without unacceptable losses. It differs from insolvency: an insurer may own assets exceeding its liabilities but still be unable to obtain cash promptly. Liquidity planning should include a base cash-flow forecast and stressed forecasts incorporating claim acceleration, delayed premiums, reduced reinsurance recoveries, collateral calls, market closures and asset-sale discounts.

A useful liquidity architecture contains operating cash, highly liquid short-term assets and a secondary reserve of assets that can be sold or repo-financed under stress. The size of the reserve should reflect claim volatility, payment concentration, access to funding, asset liquidity and the reliability of incoming cash flows. Liquidity buffers should not be invested solely according to yield objectives.

Treasury controls include segregation of duties, payment authorisation, bank-account controls, daily cash reconciliation, counterparty limits, collateral monitoring, settlement controls and contingency funding plans. Concentrating cash with one bank or assuming that all high-quality securities can be sold immediately are common errors.

Asset–liability management as an integrated process

ALM begins with liability segmentation. Policies can be grouped by product, duration, currency, guarantee, policyholder behaviour and claim uncertainty. The insurer then projects liability cash flows under base, adverse and severe scenarios. For life business, the analysis may include mortality, longevity, lapse, expenses, guarantees and option exercise. For non-life business, it includes reported and incurred-but-not-reported claims, settlement patterns, catastrophe events, inflation and reinsurance recoveries.

The asset portfolio is projected under corresponding interest-rate, spread, equity, inflation, currency, default and liquidity scenarios. The analysis focuses not only on asset returns but on the surplus—the difference between assets and liabilities—and on the probability that surplus falls below required capital.

A practical ALM cycle includes:

• identifying liability cash flows and behavioural uncertainty;
• setting risk appetite and solvency constraints;
• measuring duration, convexity, key-rate and currency gaps;
• selecting strategic asset allocation and liquidity reserves;
• implementing hedges or matching portfolios;
• monitoring limits, stress results and emerging risks; and
• rebalancing when exposures, markets or liabilities change.

Strategic asset allocation is a long-term policy choice among asset classes. It should be based on scenario-generated risk and return, liability requirements, capital charges, liquidity, tax, accounting effects and governance capacity. Tactical asset allocation may temporarily vary exposures when permitted by the mandate, but it should not undermine the long-term liability strategy.

Hedging and derivatives

Derivatives can manage interest-rate, currency, equity and credit exposures. Interest-rate swaps can exchange fixed and floating cash flows; futures can adjust duration efficiently; options can protect against adverse movements while retaining upside; and currency forwards or swaps can hedge foreign investments. Credit derivatives may transfer selected credit exposure, subject to counterparty and basis risks.

A hedge is effective only if the risk being hedged and the hedging instrument respond sufficiently similarly. Basis risk arises when the instrument’s price does not move in line with the liability or asset exposure. Other risks include counterparty default, collateral liquidity, legal enforceability, model error, margin calls and accounting mismatch. Derivatives should be used within documented mandates, with independent valuation, collateral rules, legal agreements and regular effectiveness testing.

For example, an insurer holding long-term foreign-currency bonds against domestic-currency liabilities may hedge currency risk through forwards. If the hedge is rolled frequently, however, the insurer faces rollover risk and possible cost increases. A currency hedge may also change liquidity needs because adverse market movements can generate collateral calls.

Governance, regulation and professional judgement

Sound investment governance establishes who owns the risk, who makes decisions and who independently challenges them. The board or investment committee normally approves investment policy, risk appetite, strategic allocation, limits and eligible instruments. Senior management implements the policy, while risk, actuarial, compliance, finance, internal audit and treasury functions provide challenge and control.

The investment policy should address eligible assets, concentration limits, quality standards, duration and currency ranges, liquidity requirements, derivatives, outsourcing, valuation, related parties, conflicts and escalation procedures. The actuarial and investment functions must communicate continuously: liability assumptions determine investment needs, while investment returns and risks affect product pricing, reserves and capital.

Regulation commonly seeks to protect policyholders through prudent-person requirements, diversification, asset eligibility, valuation discipline, solvency capital and reporting. Exact requirements vary by jurisdiction and product. Managers must therefore consult applicable legislation and supervisory guidance rather than relying on general principles alone.

Ethical issues arise when investment incentives encourage excessive risk, when affiliated investments receive preferential treatment, when sustainability claims are misleading or when policyholder interests are subordinated to short-term reported profit. Fiduciary reasoning requires decisions to be documented, conflicts disclosed and policyholder outcomes considered.

Technology, analytics and emerging developments

Modern ALM uses data warehouses, liability projection engines, scenario generators, portfolio systems and dashboards that combine asset and liability information. Automation can improve cash forecasting, limit monitoring, reconciliation and regulatory reporting. Machine-learning tools may assist in detecting unusual transactions, estimating lapse behaviour, forecasting claims or identifying credit deterioration.

These tools do not remove the need for professional judgement. Models can reproduce biased data, fail under unprecedented conditions, obscure assumptions or create false precision. Model validation, data lineage, access controls, explainability, change management and human oversight are essential.

Important developments include climate and transition-risk analysis, private-market expansion, real-time liquidity monitoring, more sophisticated collateral management, inflation-sensitive products and greater use of scenario-based solvency analysis. Climate risk can affect physical assets, credit quality, claims, property values and the future insurability of risks. It should be incorporated into both asset analysis and liability projections rather than treated solely as an ethical overlay.

Illustrative case study: Meridian Assurance Company

Background

Meridian Assurance is a fictional composite insurer with two major divisions. Its life division sells participating savings policies and immediate annuities. Its general division writes motor, health and commercial property insurance. The group has a strong capital position but has historically managed investments through a common portfolio with limited liability segmentation.

Situation and problem

A rapid increase in market yields has reduced the market value of Meridian’s long-duration bonds. At the same time, inflation has increased health and property claim costs. A severe storm has generated claims that must be paid within three months, while a portion of reinsurance recoveries will arrive later. The investment department proposes selling liquid government bonds and purchasing higher-yielding private credit. Treasury, however, is concerned that the proposed private assets would be difficult to sell if claims exceed expectations.

The life division also has annuity liabilities with an effective duration of approximately nine years, while the supporting bond portfolio has a duration of six years. The resulting duration gap exposes economic surplus to further rate changes. The group holds foreign assets without a complete currency hedge and has a material concentration in one domestic banking group.

Analysis

The common portfolio conceals different liability requirements. General-insurance claims require liquidity and should not be funded primarily with illiquid assets. The life annuity portfolio requires longer duration and better cash-flow alignment. The foreign-asset exposure creates currency risk, and the bank concentration creates correlated credit and liquidity risk.

A simple duration analysis shows that the life portfolio is under-durationed. If rates fall, liabilities may increase in present value more than assets, weakening surplus. If rates rise, asset values may fall, but the effect on liabilities may differ depending on guarantees and discounting. The analysis must therefore include both sides of the balance sheet, not merely bond price sensitivity.

Stress testing should include: a further rate increase, a rate decline, a non-parallel yield-curve shift, a widening of corporate spreads, a second severe storm, delayed reinsurance recoveries, equity-market decline and collateral calls on derivatives. Liquidity stress should apply realistic sale discounts to private and less-traded assets.

Approach and strategy

Meridian adopts separate strategic portfolios for the life and general divisions. It establishes a three-tier liquidity reserve for the general division: operating cash, short-term government securities and a secondary pool of highly marketable investment-grade bonds. Private credit purchases are suspended until the liquidity assessment is completed.

For the life division, Meridian increases duration through a ladder of high-quality bonds and a carefully documented interest-rate swap programme. It uses cash-flow matching for near-certain annuity payments and duration and key-rate matching for longer-dated uncertain cash flows. The portfolio is diversified across issuers and sectors, with explicit limits for the banking group.

The foreign portfolio is reviewed against liability currency. Currency hedges are introduced where the exposure is not justified by diversification or expected return. Treasury establishes daily cash reporting, collateral forecasts and a contingency funding plan. The investment committee requires independent risk review before any new alternative investment.

Outcome

The revised structure reduces the probability that a claims shock will force distressed asset sales. The life division’s interest-rate exposure becomes more consistent with its annuity liabilities, while the general division retains sufficient liquid assets. Returns may be lower in some scenarios because the insurer gives up part of the illiquidity premium, but risk-adjusted performance and resilience improve.

Learning points

The case demonstrates that investment policy cannot be separated from liability design. A higher-yielding asset is not necessarily attractive if it creates liquidity or capital risk. Duration must be measured relative to liabilities, derivatives require collateral planning, and group-level diversification can conceal concentrations within related entities. Most importantly, ALM is a continuing management process rather than a one-time portfolio exercise.

Challenges and common mistakes

Several errors recur in insurance investment management. Managers may chase yield without recognising default, liquidity or capital costs. They may use ratings mechanically, ignore downgrade risk or assume that historical correlations will remain stable. Another mistake is to match average duration while ignoring the timing of individual cash flows, key-rate exposures and embedded options.

Reported volatility can be understated for unlisted assets because valuations are infrequent. Conversely, short-term market volatility may be overemphasised when liabilities are genuinely long term and the insurer has sufficient capital. Effective analysis distinguishes temporary price movements from permanent impairment while remaining alert to liquidity needs.

Other weaknesses include inadequate stress testing, weak model governance, poor data quality, fragmented communication between investment and actuarial teams, insufficient derivative documentation and failure to include collateral calls in liquidity forecasts. Outsourcing investment management does not outsource accountability; the insurer remains responsible for oversight, compliance and policyholder protection.

Best-practice principles

A professional insurer should maintain a liability-sensitive investment policy; combine cash-flow, duration and scenario analysis; hold liquidity in relation to stressed claims; diversify by issuer, sector, geography and risk factor; perform independent credit and valuation analysis; document derivative purposes and hedge effectiveness; integrate capital charges into portfolio decisions; monitor concentrations continuously; and ensure that boards and committees receive clear, decision-useful reports.

The strongest practice is not the pursuit of the highest return in isolation. It is the disciplined construction of a balance sheet that can meet promises across plausible adverse environments while earning a fair return for the risks undertaken.

Chapter Summary

Insurance investment management coordinates the deployment of premium and capital funds with the timing, uncertainty and risk of policyholder liabilities. Fixed income supports cash-flow matching and income; equities, property and alternatives may provide growth and diversification but introduce market, valuation and liquidity risks. Duration, convexity, key-rate analysis, immunisation and cash-flow matching help manage interest-rate exposure, while credit analysis evaluates default and spread risk.

Treasury ensures that claims, expenses, settlements and collateral obligations can be paid when due. ALM integrates liability projections, asset allocation, stress testing, capital and liquidity constraints. Derivatives can hedge interest-rate and currency exposures, but they create counterparty, basis, collateral and model risks. Effective governance requires board-approved policy, independent challenge, clear limits, ethical conduct, regulatory compliance and robust technology controls. The appropriate objective is resilient, risk-adjusted performance consistent with policyholder obligations.

Key Terms

Asset–liability management: The coordinated management of assets and liabilities to control surplus, liquidity and solvency risks.

Cash-flow matching: Structuring asset cash inflows to coincide with scheduled liability payments.

Convexity: A measure of the curvature of the relationship between a bond’s price and its yield.

Credit spread: The additional yield demanded over a reference risk-free rate for bearing credit and related risks.

Duration: A measure of the sensitivity or timing of a fixed-income instrument’s cash flows and price.

Expected shortfall: The average loss beyond a specified value-at-risk threshold.

Immunisation: A strategy designed to reduce the sensitivity of asset–liability surplus to interest-rate changes.

Key-rate duration: Sensitivity of value to changes in yields at particular maturity points on the yield curve.

Liquidity risk: The risk of being unable to meet obligations when due without unacceptable loss.

Modified duration: An estimate of the percentage price change for a small change in yield.

Strategic asset allocation: The long-term policy allocation among asset classes consistent with objectives and constraints.

Tactical asset allocation: Permitted short- or medium-term deviations from strategic asset weights.

Value at risk: A loss threshold associated with a specified confidence level and time horizon.

Basis risk: The risk that a hedge instrument does not move sufficiently in line with the exposure hedged.

Reinvestment risk: The risk that future cash flows must be reinvested at lower-than-expected rates.

Credit migration: A change in an issuer’s credit quality or rating that can affect market value.

Surplus: The economic or accounting excess of assets over liabilities and required obligations.

Liquidity buffer: Highly available cash or assets held to meet stressed payment needs.

Review Questions

Short Answer Questions

1. Why is insurance investment management different from ordinary portfolio management?

2. Define modified duration and state what it measures.

3. What is the purpose of a liquidity buffer?

4. Distinguish cash-flow matching from duration matching.

5. Identify three risks associated with derivatives used by insurers.

Long Answer Questions

1. Explain how liability characteristics influence an insurer’s strategic asset allocation.

2. Discuss the role of fixed-income securities in insurance portfolios, including their principal risks.

3. Explain immunisation, convexity and key-rate duration and show how they support ALM.

4. Describe the governance and control framework required for responsible insurance investment.

5. Examine the relationship between treasury management, liquidity stress testing and solvency.

Analytical / Application Questions

1. A bond portfolio has a modified duration of 7.5. Estimate its approximate percentage price change if yields rise by 0.40 percentage points. What additional information would be needed for a more accurate estimate?

2. An insurer has short-term catastrophe liabilities but proposes investing a large share of its assets in private infrastructure. Analyse the decision and recommend controls or alternatives.

3. An annuity portfolio has liability duration of nine years and asset duration of five years. Explain the risks created by this gap and design a suitable combination of portfolio and derivative actions.

22. Multiple Choice Questions with Answers

Question 1

An insurer’s primary investment objective is best described as:

A. Maximising short-term capital gains regardless of risk

B. Earning risk-adjusted returns while supporting policyholder obligations and solvency

C. Holding only equity securities to offset inflation

D. Avoiding all market and credit exposure

Correct Answer: B. Earning risk-adjusted returns while supporting policyholder obligations and solvency

Question 2

If a bond portfolio has modified duration of 6 and yields rise by 0.50 percentage points, the approximate first-order price change is:

A. A 0.5% decline

B. A 3% decline

C. A 6% increase

D. A 12% decline

Correct Answer: B. A 3% decline

Question 3

Which technique directly schedules asset inflows against expected liability payments?

A. Cash-flow matching

B. Tactical asset allocation

C. Credit migration analysis

D. Value at risk

Correct Answer: A. Cash-flow matching

Question 4

The main purpose of convexity in bond analysis is to:

A. Measure issuer default probability

B. Estimate the curvature of the price–yield relationship

C. Determine the insurer’s liquidity reserve

D. Calculate equity dividends

Correct Answer: B. Estimate the curvature of the price–yield relationship

Question 5

Which statement about private-market assets is most accurate?

A. Infrequent valuation eliminates their economic risk

B. They are always more liquid than government bonds

C. They may provide diversification but require analysis of valuation and liquidity constraints

D. They cannot create concentration risk

Correct Answer: C. They may provide diversification but require analysis of valuation and liquidity constraints

Question 6

Expected credit loss is commonly assessed using which combination?

A. Duration, convexity and yield

B. Probability of default, loss given default and exposure at default

C. Liquidity, inflation and equity beta

D. Coupon, maturity and tax rate only

Correct Answer: B. Probability of default, loss given default and exposure at default

Question 7

A duration gap in which asset duration is materially below liability duration generally means that:

A. Assets and liabilities have identical interest-rate sensitivity

B. The insurer may be exposed to changes in rates because liabilities and assets respond differently

C. The insurer has no reinvestment risk

D. Liquidity risk has been eliminated

Correct Answer: B. The insurer may be exposed to changes in rates because liabilities and assets respond differently

Question 8

Which is a significant risk specific to derivative hedging?

A. The complete elimination of all balance-sheet risks

B. Basis risk and collateral-related liquidity pressure

C. Guaranteed positive investment income

D. Removal of counterparty exposure

Correct Answer: B. Basis risk and collateral-related liquidity pressure

Question 9

Why should an insurer perform stressed liquidity forecasts?

A. To assume that all assets can be sold at book value

B. To assess its ability to meet accelerated claims and other adverse cash demands

C. To replace all solvency analysis

D. To justify investing all cash in illiquid assets

Correct Answer: B. To assess its ability to meet accelerated claims and other adverse cash demands

Question 10

In the Meridian Assurance case, separating life and general-insurance portfolios was appropriate primarily because:

A. The two divisions have different liability timing, uncertainty and liquidity requirements

B. General insurers cannot own bonds

C. Life insurers are prohibited from using derivatives

D. Separate portfolios always produce higher nominal returns

Correct Answer: A. The two divisions have different liability timing, uncertainty and liquidity requirements