Question of the Week

Which of the following statements is(are) true with respect to the factors that a manager must take into account when managing the portfolios of casualty insurance companies?

I. The amount of new underwriting business that may be undertaken is solely dependent upon the firm's capital, and is irrespective of the firm's investment income.
II. The degree of inflation protection may be reduced with the firm's ability to raise premiums.
III. Long term asset appreciation is of greater importance than short-term liquidity.
IV. Income from underwriting activities are fully taxable.

a) I, II, and III only
b) III only
c) II and IV only
d) I and III only

Answer:

The correct answer is: c)

(I) is incorrect because while he amount of new underwriting business that may be undertaken is dependent upon the firm's capital, any investment income will only add to that capital. Thus, the greater the investment income, the higher will be the firm's capital, and therefore its ability to underwrite more insurance.
(II) is true because raising premiums has the same effect as earning an inflation premium from the investments.
(III) is incorrect because casualty insurers have unpredictable cash flow streams, thus liquidity is extremely important.