Learning outcomes: Describe defined benefit plans and defined contribution plans and explain the differences between them. Compare the various types of life insurance policies. Calculate and interpret loss ratio, expense ratio, combined ratio, and operating ratio for a property-casualty insurance company.
21.4.1. For its most recent fiscal year, Acehouse Property-Casualty (APC) reports revenue of $300.0 million. Losses due to payouts (aka, loss and loss adjustment expense) were $213.0 million. Expenses (aka, underwriting expenses) were $69.0 million. Dividends paid were $6.0 million. Investment income was $9.0 million. What was the Operating ratio; aka, Combined ratio after dividends (CRAD) adjusted for Investment Income?
a. 7.0%
b. 23.0%
c. 93.0%
d. 106.%
21.4.2. Acme pension started the quarter with a pension plan that was fully funded with neither a surplus nor a shortfall. During the quarter, the discount rate used to estimate the projected benefit obligation (PBO) was increased by a rather dramatic 1.5%. If we (unrealistically) assume no other assumptions changed (aka, ceteris paribus), which of the following is most likely to be TRUE?
a. The pension fund will need to shift its asset allocation to include a higher percentage of equities
b. The pension fund may be able to shift its asset allocation to include a lower percentage of equities
c. The plan's sponsor should be able to reduce earned benefits but will not be able to alter future benefit accruals
d. The plan's sponsor probably will be required to increase its contribution to the fund above the previously expected level
21.4.3. Acme is a large, diversified insurance company with an AA+ rating and a complex capital structure owing to its size. This year Acme will issue two debt instruments. One is a regular corporate bond that pays a 6.0% per annum coupon. The other is a CAT (catastrophe) bond triggered by Florida hurricane event(s). Given Acme's strong credit rating and financial cushion, the probability of a hurricane event is significantly greater than Acme's default probability. Of course, a CAT bond has unique features that suggest the motivations, for the issuer (aka, Acme) and its investors, will differ from the motivations related to a regular bond. In regard to these motivations and the advantages/disadvantages of a CAT bond, which of the following statements is TRUE?
a. To the issuer (Acme), an advantage of the CAT bond is that it can be offered a lower yield (i.e., cost of capital) than Acme's regular bond
b. To the issuer (Acme), a disadvantage of the CAT bond is the counterparty (risk) exposure to the investors who might default in the event the CAT bond is triggered
c. To investors, an advantage of the CAT bond is that yield will be higher will probably be higher than Acme's regular bond
d. To investors, a disadvantage of the CAT bond is that its high idiosyncratic risk (aka, specific risk) will confer poor diversification benefits
Answers here:
21.4.1. For its most recent fiscal year, Acehouse Property-Casualty (APC) reports revenue of $300.0 million. Losses due to payouts (aka, loss and loss adjustment expense) were $213.0 million. Expenses (aka, underwriting expenses) were $69.0 million. Dividends paid were $6.0 million. Investment income was $9.0 million. What was the Operating ratio; aka, Combined ratio after dividends (CRAD) adjusted for Investment Income?
a. 7.0%
b. 23.0%
c. 93.0%
d. 106.%
21.4.2. Acme pension started the quarter with a pension plan that was fully funded with neither a surplus nor a shortfall. During the quarter, the discount rate used to estimate the projected benefit obligation (PBO) was increased by a rather dramatic 1.5%. If we (unrealistically) assume no other assumptions changed (aka, ceteris paribus), which of the following is most likely to be TRUE?
a. The pension fund will need to shift its asset allocation to include a higher percentage of equities
b. The pension fund may be able to shift its asset allocation to include a lower percentage of equities
c. The plan's sponsor should be able to reduce earned benefits but will not be able to alter future benefit accruals
d. The plan's sponsor probably will be required to increase its contribution to the fund above the previously expected level
21.4.3. Acme is a large, diversified insurance company with an AA+ rating and a complex capital structure owing to its size. This year Acme will issue two debt instruments. One is a regular corporate bond that pays a 6.0% per annum coupon. The other is a CAT (catastrophe) bond triggered by Florida hurricane event(s). Given Acme's strong credit rating and financial cushion, the probability of a hurricane event is significantly greater than Acme's default probability. Of course, a CAT bond has unique features that suggest the motivations, for the issuer (aka, Acme) and its investors, will differ from the motivations related to a regular bond. In regard to these motivations and the advantages/disadvantages of a CAT bond, which of the following statements is TRUE?
a. To the issuer (Acme), an advantage of the CAT bond is that it can be offered a lower yield (i.e., cost of capital) than Acme's regular bond
b. To the issuer (Acme), a disadvantage of the CAT bond is the counterparty (risk) exposure to the investors who might default in the event the CAT bond is triggered
c. To investors, an advantage of the CAT bond is that yield will be higher will probably be higher than Acme's regular bond
d. To investors, a disadvantage of the CAT bond is that its high idiosyncratic risk (aka, specific risk) will confer poor diversification benefits
Answers here:
