What is the difference between income & liquidity needs? For instance, the income needs of insurance company are typically quite low. However, the liquidity needs are high to meet claims?? Is there any difference between liquidity and income needs?
Then, similarly, endowments have income needs to meet spending commitments, but the liquidity needs are very low??
Is the need of insurance company to meet claims not a spending commitment? If yes, it shoudl be categorized into income needs if we go by endowmwnt funds.
As far as I can recall from L1 material, income needs here indirectly refers to risk. An insurance company is typically risk-averse, and have high need for liquidity.
Income needs and liquidity needs are usually interrelated, since a need for high liquidity demands a lower return on investment, so the business model in question must have a low need for income as well.
I am not good at explaining, but I’ll give this a shot:
By definition liquidity indicates how fast an asset can be transform into cash without losing (much) of its market value. Thus liquidity needs indicate that there is a need for actual cash (at will) rather than the asset appreciation. On the other hands income implies that there should increase in the wealth, therefore income needs mean a need for asset to gain value or earning additional cash flow (income > expense), but not neccessary be transformed into cash at will.
For example, If you own a real estate, while it can appreciate in value substatially, but if you need cash quickly you’d probably have to sell it at discount to the current market price. On the other hand, if you own T-bills, you could sell instantly it at the market price.
Going back to the insurance vs endowment. Insurance company earns income from their day-to-day operation that using probability theory and actuary science therefore should generate increase in wealth. But in order not to waste the extra money they have coming in (due to cash flow timing mismatch between premium coming ij and claims going out), they use it to invest into capital or money market. While additinal income is welcome, due to unexpected nature of the demand on the claims, they are more interested in ability to pay off those claims on time rather earn extra % on the investment. Therefore higher need for liquidity, rather income.
For university endownment, the situation is different. Except for occasional investment projects (building campuses, etc.) that are usually raised seperately thru fund raising, the principal part of the capital is not needed. However, there are some spending committement that are not covered enough by tuition fees. Therefore, endowment fund should generate enough income to pay for those without decreasing the value of the principals (so it can further generate cash flows).