Financial Chapter 3

  1. What is the Required Rate of Return formula?
    Required rate of return = Risk-free rate of return + Risk premium
  2. contractual reserve
    A liability which represents the amount that, together with future premiums and investment earnings, the insurer estimates it needs to pay benefits on in-force policies as they come due.
  3. capital
    In the context of minimum capital standards, is excess of an insurer's assets over its liabilities.

    In context of a balance sheet, refers to the amt of $ invested in a co. by its owners, usually thru the purchase of the co's stock.
  4. return
    Any reward, profit, or compensation an investor hopes to earn in exchange for taking a risk.
  5. investment
    Any use of a co's resources that is intended to generate a positive return of some type.
  6. maturity date
    For a bond, the date on which the bond issuer must pay the bondholder the bond's par value.
  7. par value
    For a bond, the amt owed on the bond's maturity date.
  8. coupon rate
    For a bond, the interest rate that determines the amount of the periodic interest payments made to the bondholder.
  9. corporate bond
    A bond issued by a corp.
  10. government bond
    bond issued by a gov't
  11. common stock
    Stock that entitles its owner to share in the issuing corp's dividends and gives owner right to vote on certain matters, like for the co's board of directors.
  12. preferred stock
    Stock that entitles its owner to privileges that common stockholders don't have, like the 1st right in receiving dividends.
  13. amortization
    The reduction of debt by regular payments of principal and interest that result in full payment of the debt by the maturity date.
  14. commercial mortgage
    A loan secured by commercial real estate, like shopping centers, office builddings, hospitals, factories, and retail stores.
  15. collateralized mortgage obligation (CMO)
    A bond secured by a pool of residential mortgage loans.
  16. residential mortgage
    A loan secured by a single family home
  17. cash
    The amount of currency on hand or on deposit at an insurer's bank.
  18. cash equivalent
    A short term asset that is not cash, but can be converted to cash within 90 days with little or no risk of losing value.
  19. risk-return trade-off
    The interplay b/t risk & return; according to this interplay in general, the greater the risk, the greater the return, and the lower the risk , the lower the return.
  20. required rate of return
    For a given investment, the sum of the risk-free rate of return and the risk premium.
  21. risk-free rate of return
    The return on a risk-free investment.

    In the US, it's the return on a US Treasury bill. Elsewhere, can use the average long-term growth rate of the economy.
  22. U.S. Treasury bill
    An obligation issued by the U.S. Treasure as part of its ongoing process of funding the national debt.
  23. risk premium
    The compensation that investors demand for taking on the risk for a specific investment.
  24. credit risk aka default risk
    borrower could be late with or not make payments.
  25. default
    Failure to meet financial obligation
  26. market risk
    risk from movements in direction of an entire financial market.

    Includes equity risk, interest rate risk, reinvestment-rate risk, liquidity risk, currency risk.
  27. equity risk
    when market risk applies to the stock market
  28. interest-rate risk
    uncertainty from fluctuations in market interest rates.
  29. reinvestment-rate risk
    the risk that a decline in interest rates will lead to lower income when bonds are paid off and the insurer must reinvest the funds.
  30. currency risk
    risk from changes in currency exchange rates for co's that operate in more than one country.
  31. liquidity risk
    not having enough liquidity to meet obligations as they come due.
  32. operational risk
    risk of financial losses from failed internal processes & controls, ppl, systems, external events
  33. business risk aka marketplace risk
    risk that changes in a co's external environment will affect its operations.

    2 types: Competition Risk & Regulatory Risk.
  34. competition risk
    risk from competitors, changes in an industry's structure, changes in industry standards for use of technology
  35. regulatory risk
    us laws/regs can change.

    The risk from changes in the regulatory environment.
  36. pricing risk
    Risk that insurer's actual experience will be worse than expected, causing them to lose money.
  37. mortality risk
    Risk that mortality will be worse than expected, insurer loses $
  38. expense risk
    The risk that actual expenses will be higher than expected, insurer loses $.

    A type of Pricing Risk.
  39. policyholder behavior risk
    The risk of results of choices made by policyholders.

    Type of Pricing Risk, aka customer behavior risk.
  40. diversification
    A technique for spreading risk by investing in different assets with different characteristics.
  41. asset concentration risk
    Risk of excessive concentration of assets in any single category.
  42. diversifiable risk
    Risk specific to an individual asset or issuer. Aka nonsystematic risk.

    Ex. The risk of a bond issuer defaulting is diversifiable cos insurer can diversify this risk by investing in bonds from a wide variety of issuers.
  43. nondiversifiable risk
    A risk that affects all assets in an economy, and is not specific. Like the risk of an economic depression.
  44. portfolio
    A collection of various risky assets, usually assembled to meet a defined set of goals.
  45. asset portfolio
    holds investor's securities and other invested assests.
  46. liability portfolio
    represnts the insurer's obligations to customers.
  47. asset-liability management (ALM)
    the practice of coordinating the admin of an insurer's asset portfolio with its liability portfolio, so as to manage risk and still earn an ok level of return.
  48. enterprise risk management (ERM)
    A system that identifies & quantifies risks from both potential threats & opportunities and manages these risks in a coordinated approach that supports the org's strategic objectives.
Card Set
Financial Chapter 3
Chapter 3: Managing solvency and Profitability