How an Actuary establish the Investment Strategy for a company ?
The main aim of Actuary is to match assets with the
liabilities. In case of insurance companies, actuary major role is to find the
capital requirement. In a layman language, capital requirement means the amount
that an insurance company has to set aside to ensure that they are able to meet
the liabilities in the future with a given degree of confidence.
Therefore, the more risk company possess, more will be the
capital requirement. Actuary try to reduce this risk by matching asset and
liability.
Matching asset and liability: Let’ understand
a simple example. Suppose you have to pay your friend Rs. 10,000 next year. So,
today you can invest Rs.9500 in a Bank as a Fixed deposit that that can provide
a return of 5.26% per annum. So you can use bank deposit money after one year
that will be 10,000 to pay your friend 10,000. That’s how you match your
liability outgo with your asset income and thus reduces the risk of being
default. Same concept applies to insurance companies as well.
To establish an investment strategy, we have to consider a
lot of points such as:
Characteristics of Liabilities:
·
If liabilities are real in nature, then we match
with real assets such as equities, properties etc.
·
If liabilities are long term in nature (as in
case of pension and life insurance), then we match with assets of long term
nature i.e. long term bonds, equities etc.
Regulatory restrictions
·
Sometimes regulator describes which assets you
cannot invest in or which assets should hold atleast minimum percentage in your
portfolio. For ex,
o
Regulator can say that you cannot invest in
derivatives as an insurance company because this asset class in too risky and
there is a threat that you are not able to pay your liability to policyholders
o Regulator can say that you have to invest atleast 35% of your portfolio assets into government bonds because these are risk free investment and it helps in reducing overall risk of the insurer and ultimately reduces the capital requirement.
Taxation: Different types of asset classes will have
different taxes. For ex, investment in ELSS(Equity linked savings scheme) can
help in getting tax deductions or some returns on asset classes can be
considered as an income and capital gain will have different tax rates.
Expected return and risk: Every company has its own
risk appetite (risk appetite means the maximum risk a company can take in
order to achieve its objectives) so companies try to make a balance between
risk and return of a particular asset before investing
Diversification: Suppose Company X has invested a lot
of there assets in Domestic Large Cap Bank based equity, so more
investment in same asset class will lead to decrease in diversification and
increases the concentration risk. The more the risk, the more will be the
capital requirement.
Competitors Strategy: Monitoring of competitor’s
strategy plays a major role in own investment strategy
Financial position: If company X has a huge amount of
assets and company Y has relatively less amount of assets. Then, technically X
has a high risk appetite as compare to Y and they can invest in more risky assets
to enhance returns
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