CIA Investment Strategies 2 — Questions and Answers
Question 1: An insurance company holds a large portfolio of investment-grade corporate bonds. If interest rates rise significantly, the PRIMARY impact on this portfolio will be:
- Increased coupon income on existing bonds
- Decreased market value of the bond holdings (Correct answer)
- Higher credit ratings for the issuers
- Improved liquidity of the portfolio
Correct answer: Decreased market value of the bond holdings
Rising interest rates cause existing bond prices to fall because newer bonds offer higher yields, making older bonds less attractive in the secondary market.
Question 2: Which investment strategy is MOST appropriate for an insurer trying to match the duration of its long-tail liability reserves?
- Investing in short-term Treasury bills
- Holding a diversified equity portfolio
- Purchasing long-duration bonds with similar maturity profiles (Correct answer)
- Concentrating assets in money market instruments
Correct answer: Purchasing long-duration bonds with similar maturity profiles
Asset-liability matching requires investing in assets whose duration closely aligns with the duration of long-tail liabilities to reduce interest rate risk.
Question 3: A property-casualty insurer allocates 15% of its investment portfolio to equities. This allocation is PRIMARILY limited by:
- Federal Reserve monetary policy
- Regulatory surplus requirements and risk-based capital rules (Correct answer)
- The company's reinsurance agreements
- GAAP depreciation schedules
Correct answer: Regulatory surplus requirements and risk-based capital rules
State insurance regulations and risk-based capital (RBC) requirements limit equity holdings because equities carry higher capital charges than investment-grade bonds.
Question 4: In the context of insurance company investments, 'unrealized gains' on available-for-sale securities are reported:
- Directly on the income statement as earned income
- As a component of other comprehensive income in equity (Correct answer)
- As a liability offset on the balance sheet
- Only upon sale of the security
Correct answer: As a component of other comprehensive income in equity
Under GAAP, unrealized gains and losses on available-for-sale securities flow through other comprehensive income (OCI) rather than the income statement until realized.
Question 5: Which of the following BEST describes the concept of 'immunization' in insurance investment management?
- Avoiding all equity investments to reduce risk
- Structuring the asset portfolio so that interest rate changes have minimal net impact on surplus (Correct answer)
- Purchasing credit default swaps on all bond holdings
- Diversifying across geographic regions to eliminate market risk
Correct answer: Structuring the asset portfolio so that interest rate changes have minimal net impact on surplus
Immunization is a strategy that matches asset and liability durations so that interest rate movements affect both sides of the balance sheet equally, protecting surplus.
Question 6: An insurer's investment policy statement (IPS) should PRIMARILY address:
- The personal financial goals of the chief investment officer
- Permissible asset classes, quality constraints, duration targets, and return objectives (Correct answer)
- Competitor portfolio allocations and market share data
- Tax strategies for individual policyholder accounts
Correct answer: Permissible asset classes, quality constraints, duration targets, and return objectives
An IPS defines the investment framework including allowed asset classes, quality minimums, liquidity requirements, and performance benchmarks consistent with the insurer's risk tolerance.
Question 7: When evaluating the credit quality of a municipal bond for an insurance portfolio, which factor is MOST critical?
- The bond's trading volume on secondary markets
- The issuing municipality's revenue sources and debt service coverage ratio (Correct answer)
- The bond's coupon payment frequency
- The broker-dealer's markup on the transaction
Correct answer: The issuing municipality's revenue sources and debt service coverage ratio
Credit analysis of municipal bonds focuses on the issuer's ability to service debt, examining revenue streams, coverage ratios, and economic base stability.
CIA Investment Strategies 2
An insurance company holds a large portfolio of investment-grade corporate bonds.
If interest rates rise significantly, the PRIMARY impact on this portfolio will be: