Investments and Cash Allocation
- 02:33
Learn how to model the investments and cash allocation in a life insurance balance sheet
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Transcript
The final step when we are modeling the balance sheet of an insurance company is to use the investments in cash as a balancing item in the balance sheet. So that's gonna be a residual item that makes sure that the balance sheet balances. But it isn't sufficient just to plug the balance sheet with one line item, and there's two reasons for that. Firstly, because we want to be a little bit more sophisticated about how we model investment returns and so we're gonna need to take a view on the proportion of that balance which relates to cash and the proportion of it which relates to the investments of both the insurance activities and also any other investments that the insurance company has. But secondly, because actually we are going to want to model the investments and the investment returns by the different types of insurance business. So that's for the life business and also for the P&C business. And to do that, we are therefore gonna have to think about how we allocate investments and cash across the different activities and business lines. So the first thing we have to do, is think about how we allocate the residual balance across the insurance activity investments, any other investments and cash. And that's relatively straightforward. We just allocate a percentage of that total residual across each of those areas. And we can do that using, for example, the historic allocation across those items. The next step is to think about how we allocate those life and P&C investments across the different business lines and remember, in this example, we have unit linked investments, we have traditional life investments and we have P&C investments. Now, the first thing that we tackle is the unit linked investments and remember that these are largely a function of the unit linked provisions on the liability side of the balance sheet. So we typically just set these as equal to the unit linked insurance provisions. Once we've done that, we've actually then got a residual item that we can allocate across the traditional life and P&C insurance business, and we typically allocate those using the percentage weightings of the insurance provisions for life versus P&C. Once we've done that, we now have an investments in cash balance for each of our insurance activities, our other investments and our cash to allow us to forecast our investment returns for each of these. Now, what we could do is go a step further and take those investment balances by insurance business and allocate those by asset class. And that would be useful in helping us to generate our expectations of the investment returns by asset class. But in this example, we're just gonna keep things nice and simple and keep it as an allocation just by business line.