Beruflich Dokumente
Kultur Dokumente
January 6, 2014
Key elements contributing to investment risk LT nature of most products (insurance companies in particular) Guarantee benefits Early withdrawal provisions
Mortgages Include prepayment provisions can pay down principal earlier Influenced by interest rate movements
Managements objective
Increase surplus by producing returns on assets in excess of returns promised on liabilities
Unpredictability of returns due to changes in capital market variables leads to investment risk
Annuities
Annuity Contract providing regular payments to the contract holder (annuitant) for a specified period or for the annuitants life
Variable annuity Contract holder buys the policy with a single premium Proceeds allocated among a selection of funds underlying the contract
VA Risk
The living benefit guarantees and PH behaviour increase insurers risk
PH Behaviour Options to lapse Shifting underlying asset mix
But the general administrative costs do not vary with the equity market
A sustained downturn in the equity market will squeeze profits unless an insurers cost structure can be quickly adjusted
Challenges in ALM
Measurement Basis Economic Value In asset side, economic value is its market value (the value can be immediately realized) In liability side, economic value is its fair value (calculate in a way consistent with valuing its assets)
Challenges in ALM
Economic Analysis of A&Ls is Complicated Characteristics of the assets and liabilities Capital market uncertainties involved Long-range time horizon
Steps to Perform Economic Analysis Specify the CF pattern (timing and amounts) Model the capital market variables (that affects CF pattern) and the sensitivity of the instruments CFs to those variable determined Model the insurance contracts and the actual assets and aggregate the results Perform a large numbers of economic scenarios to quantify the effect of the economic sensitivities
Challenges in ALM
Communication Proper communication of ALM exposures, strategies and outcomes to company management and other interested parties (e.g. regulators and rating agencies) Effort and resources will be more easily obtained if all parties understand the importance of ALM ALM also requires cooperation between the actuarial and investment areas
Difficult to Achieve Consensus Threats posed by investment risk may not be readily apparent to all Indicated risk mitigation actions may involve complex techniques and concepts Few experienced practitioners in the market
Approaches to ALM
Investment Strategy Take the inforce liability structure as given and aim to manage investment risk by a complementary investment strategy Demand a thorough understanding of the dynamics of both A&Ls Standard asset types (bonds and mortgages) and nonstandard asset types (derivative) can be used to offset the risk dynamics of the liabilities
Product Design Proper coordination of product design with investment strategy must be considered in ALM
Approaches to ALM
Traditional insurance risks are non-systematic Fluctuations in experience are random and average out over larger populations Investment risk is systematic All insured risks are strongly affected by certain variables Pooling investment risk will concentrate the exposure (instead of diversifying it)
Securitization Sell a stream of contingent revenues to another party at a discount to the expected value
Approaches to ALM
Holism Focus on risk at the enterprise level (rather than at the product or line-of-business level (LOB)) Seek to identify and exploit existing or potential synergies in a companys diverse business activities o e.g. sell life insurance and annuity business to diversify mortality risk
Two Consequences of Analyzing LOBs Separately Aggregated investment risk will likely be overstated Insurer will either incur unnecessary reparative costs or forego potential profits
Approaches to ALM
Benefits of Holism Evaluate total-company risk on an integrated basis to show the synergy benefits among different LOBs
Free up the cost of managing the risk Enable company to assume more risk Design complementary products to enhance overall risk reduction effects Review ALM implications of strategic initiatives to guide better strategic decision-making
Immunization
A strategy employed to ensure that a change in interest rates will not affect the value of a portfolio
Methods Cash flow matching Duration matching Convexity matching
Duration
A measure of the first-order interest rate sensitivity of a financial instrument Quantify the effect on MV of a one-percentagepoint change in interest rates
e.g. 1% increase in interest rate 4% decrease in MV of a bond if Duration of the bond = 4
Duration Matching
Eliminate interest rate risk immunize its surplus against adverse fluctuations by matching its A&Ls A difficulty arises because the duration changes both as time passes and as interest rates change
Immunization requires constant monitoring of the durations of A&Ls and rebalancing the asset portfolio to match its liabilities
Duration Matching
Segmentation Establish separate asset portfolios for LOBs with different duration values Assets of the segment can be managed in a manner appropriate to the liabilities Limitations of Duration
Duration cannot accurately predict the changes in value for a large change in interest rates Because duration changes as interest rate changes Duration assumes a parallel shift in yield curves In reality, yield curves shift in non-parallel fashion Duration does not consider the uncertainty of the CFs It does not capture the effects of calls and prepayments in assets and premature surrenders in liabilities
Refinements to Duration
Convexity A measure of the second-order interest rate sensitivity of a financial instrument The sensitivity of duration to changes in interest rates Insurer can protect against a wider range of interest rate movements by matching convexity and duration
Key Rate Durations Address the issue of non-parallel shifts in the yield curve Reflect the interest sensitivity of an instrument to the change in corresponding terms on the yield curve All key rate durations of A&Ls must be matched to protect surplus against non-parallel shifts in the yield curve
Rating Agencies
Evaluate insurers A&Ls, capital adequacy and business plans and strategies Act as another line of protection for policyholders and investors Issue letter-ratings of insurers claims-paying and debt repayment abilities Request copies of CFT reports and any supplementary ALM studies