CIA Investment Strategies 3 — Questions and Answers
Question 1: A Certified Insurance Appraiser reviewing an insurer's Schedule D filing would find information about:
- Reinsurance recoverables and ceded premiums
- The insurer's bond and stock investment holdings (Correct answer)
- Outstanding claims and loss reserves
- Policyholder dividend distributions
Correct answer: The insurer's bond and stock investment holdings
Schedule D of the NAIC Annual Statement reports details of an insurer's bond and stock portfolios, including cost, fair value, and investment income.
Question 2: Which type of investment risk is associated with the inability to sell an asset quickly at its fair market value?
- Credit risk
- Inflation risk
- Liquidity risk (Correct answer)
- Reinvestment risk
Correct answer: Liquidity risk
Liquidity risk arises when an investor cannot sell an asset at or near its fair value in a timely manner, which is especially problematic for insurers facing unexpected claim payouts.
Question 3: An insurance company invests in mortgage-backed securities (MBS). The MAIN prepayment risk associated with MBS is that:
- Borrowers may default on mortgage payments during recessions
- Principal is returned faster than expected when interest rates fall, forcing reinvestment at lower yields (Correct answer)
- The securities cannot be traded in secondary markets
- Federal agencies may stop guaranteeing the underlying mortgages
Correct answer: Principal is returned faster than expected when interest rates fall, forcing reinvestment at lower yields
When interest rates drop, homeowners refinance their mortgages, returning principal to MBS investors early, who must then reinvest at the lower prevailing rates.
Question 4: The investment income ratio for an insurer is calculated as:
- Net investment income divided by net premiums earned (Correct answer)
- Total investment gains divided by total liabilities
- Investment expenses divided by invested assets
- Net investment income divided by total admitted assets
Correct answer: Net investment income divided by net premiums earned
The investment income ratio measures how much investment income an insurer earns relative to its premium volume, reflecting the contribution of investments to overall profitability.
Question 5: Under statutory accounting principles (SAP), bonds in an insurance company's portfolio that are classified as 'held-to-maturity' are generally carried at:
- Fair market value with unrealized gains in surplus
- Amortized cost (Correct answer)
- The lower of cost or market value
- Original purchase price without any adjustment
Correct answer: Amortized cost
Under SAP, investment-grade bonds intended to be held to maturity are carried at amortized cost, smoothing out market value fluctuations from the balance sheet.
Question 6: An insurer's portfolio manager uses a 'barbell strategy.' This means the portfolio is concentrated in:
- Mid-duration bonds exclusively
- Short-term and long-term maturities with little in the intermediate range (Correct answer)
- High-yield and investment-grade bonds equally
- Domestic and international equities in equal proportions
Correct answer: Short-term and long-term maturities with little in the intermediate range
A barbell strategy splits bond holdings between very short and very long maturities, balancing liquidity from short-term bonds with higher yield from long-term bonds.
Question 7: Which measure BEST captures the sensitivity of a bond's price to a 1% change in interest rates?
- Yield to maturity
- Modified duration (Correct answer)
- Current yield
- Convexity adjustment
Correct answer: Modified duration
Modified duration estimates the percentage change in a bond's price for a 1% change in yield, making it the primary measure of interest rate sensitivity.
CIA Investment Strategies 3
A Certified Insurance Appraiser reviewing an insurer's Schedule D filing would find information about: