asset liability management in insurance companies

The objective is to settle an approach of the asset-liabilitiy profile of the bank in accordance with its funding requirement legal and general home insurance reviews. In fact, how effectively balancing the funding sources and uses with regard to liquidity, interest rate management, funding diversification and the type of business-model the bank is conducting (for example business based on a majority of short-term movements with high frequency changement of the asset profile) or the type of activities of the respective business lines (market making business is requiring more flexible liquidity profile than traditional bank activities). Setting of an administrative structure and crisis-management team. Overview of potential and viable contingent funding sources and build up of a central inventory. The role of the bank in the context of the maturity transformation that occurs in the banking book (as traditional activity of the bank is to borrow short and lend long) lets inherently the institution vulnerable to liquidity risk and can even conduct to the so-call risk of 'run of the bank' as depositors, investors or insurance policy holders can withdraw their funds/ seek for cash in their financial claims and thus impacting current and future cash-flow and collateral needs of the bank (risk appeared if the bank is unable to meet in good conditions these obligations as they come due). This aspect of liquidity risk is named funding liquidity risk and arises because of liquidity mismatch of assets and liabilities (unbalance in the maturity term creating liquidity gap). Even if market liquidity risk is not covered into the conventional techniques of ALM (market liquidity risk as the risk to not easily offset or eliminate a position at the prevailing market price because of inadequate market depth or market disruption), these 2 liquidity risk types are closely interconnected.

asset liability management in insurance companies and banks quantitative models

The Book presents a survey on the principal quantitative models on Asset Liability Management in Insurance Companies and Banks. It goes through the duration and the market value approach till the stochastic optimization. The model, by using a contingent claim approach, determines the fair value of the insurance life policies. Furthermore, it shows that the value of equity can be immunized with respect to the movevement of interest rate. Moreover, the model determines the fair value of the banks liabilities accounting for the protection and the surrender possibility.

Implications for the immunization are also treated. In recent years is born the stochastic optimization by combining the asset allocation with the liabilities side by maximizing the surplus with some constraint. An analysis of interest rate models are also treated. Cambridge University Press, vol . 32(02), pages 239-248, June.

operator. Alexandre is now responsible for the Financial Models. 97-44, Wharton School Center for Financial Institutions, University of Pennsylvania. We use cookies to give you the best possible experience on ResearchGate. Read our. Dr.

Asset Liability Management in Insurance Companies and Banks: Quantitative Models. Team, where his team contributes to the ALM models and indicators. Association of Asset and Liability Managers asset liability management in insurance companies and banks quantitative models. Since 2005, Alexandre.

asset liability management in insurance companies and banks

Increasingly, managers of financial firms focused on asset-liability risk asset liability management in insurance companies and banks. The problem was not that the value of assets might fall or that the value of liabilities might rise. It was that capital might be depleted by narrowing of the difference between assets and liabilities—that the values of assets and liabilities might fail to move in tandem. Asset-liability risk is a leveraged form of risk. The capital of most financial institutions is small relative to the firm’s assets or liabilities, so small percentage changes in assets or liabilities can translate into large percentage changes in capital. Wilson J .S.G.
Brewer, E monumental general insurance. (1985), “Bank Gap Management and the Use of Financial Futures, ” Economic Perspectives , Federal Reserve Bank of Chicago, March/ April. (e .g figure, table, text extract, chapter, page numbers etc), the way in which you wish to re-use it, the circulation/print run/number of people.

asset liability management in insurance companies and banks quantitative models pdf

A version of this paper appears as a chapter in CCAR and Beyond: Capital Assessment, Stress Testing and Applications , Jing Zhang, ed., London, UK: Risk Books, 2013. Authors Booksellers Customers Journalists Lecturers Librarians asset liability management in insurance companies and banks quantitative models pdf. A major source of firm funding and liquidity, credit lines can pose significant credit risk to the underwriting banks.

S. financial institutions, we empirically study the credit line usage of middle market corporate borrowers. We examine to what extent borrowers draw down their credit lines and the characteristics of those firms with high usage. We study how line usage changes with banks’ internal ratings, collateral, and commitment size and through various economic cycles.
They also increase their usage when approaching default. Risky borrowers tend to utilize a higher percentage of their credit lines as well. Prices are valid for United Kingdom bridge insurance plan. to view local pricing and availability.

Since 2005, Alexandre. SME Financing: Measuring Private Firm Credit Quality - Disintermediation and the Rise of SME Loan Funds . Required economic capital (EC) and regulatory capital (RegC) are two measures frequently used in loan origination and other decisions related to portfolio construction. EC accounts for economic risks such as diversification and concentration effects. When used in measures such as return on risk-adjusted capital (RORAC) or Economic Value Added (EVA™), EC can provide useful insights that allow institutions to optimize risk-return profiles, facilitate strategic planning and limit setting, as well as define risk appetite. Meanwhile, when RegC is binding, an institution faces a tangible cost, in that additional capital is needed for new investments that face a positive risk weight. Given these observations, both EC and RegC should influence decision making.

asset liability management in life insurance companies

Life insurance companies face considerable interest rate risk given their investments in fixed-income securities and their unique liabilities asset liability management in life insurance companies. For life insurance companies, their assets and liabilities are heavily exposed to interest rate movements. Interest rate risk can materialize in various ways, impacting life insurers’ earnings, capital and reserves, liquidity and competitiveness. Moreover, the impact of a low interest rate environment depends on the level and type of guarantees offered. Much of the business currently on life insurers’ books could be vulnerable to a sustained low interest rate environment (e.
, spread between their portfolio earnings and what they credit as interest on insurance policies. During times of persistent low interest rates, life insurers’ income from investments might be insufficient to meet contractually guaranteed obligations to policyholders which cannot be lowered. interest rate risk can be greatly exacerbated when funds are continuously invested in a low interest rate environment that suppresses life insurers’ earnings. Should interest rates continue to hover at low levels, life insurers’ earnings could continue to be pressured for some time. At the same time, while it is true that life insurers’ typical long-duration investments tend to increase their portfolios’ duration risk, the current steepness of the yield curve means a long-duration strategy could produce a comparatively higher certain guarantees regarding the level of income over the life of the policy, which could be 30 years or more.

As most life insurance contract liabilities are long-duration contracts, it is not always easy to achieve a perfect match of long-duration assets. In a low interest rate environment, it is challenging to find relatively low-risk, high-yield, long-duration assets to match annuities that guarantee a minimum annual return (e.g., 4%).

For example, older fixed income insurance products that guarantee rates of around 6%—closely matching or conceivably even surpassing current investment portfolio yields—are likely to put a strain on life insurers as a result of spread compression or interest rate risk for insurers, relative exposure to interest rate risk could be gauged by considering the type and the proportion of interest rate risk-sensitive products of each insurer. Figure 2 below presents the degree of interest rate sensitivity of each life product type, from high to low. interest rate risk because they are guaranteed to earn a fixed rate of return throughout the life of the product. Products that combine protection with asset accumulation guaranteeing minimum returns (e.

, universal life) have more interest rate risk than protection-oriented products (e.g., whole and term life). At the same time, companies offering universal life products can offset some of the interest rate risk with built-in non-guaranteed elements, such as absorb risk. A prolonged period of low interest rates would not only negatively impact life companies’ investment income (particularly those with more long-term exposure) but would also push reserves higher impacting their life insurers’ liquidity. Liquidity management is critical for life insurers.
Most life insurance companies strive to match liability cash flows with asset cash flows to avoid setting up an additional asset/liability mismatch reserve. While most life companies’ essentially employ buy-and-hold strategies with well-matched liabilities and assets, spread volatility risk and prepayment risk can undermine the best asset/liability spreads, low interest rates), assets and liabilities can be significantly mismatched by cash flow, exposing insurers to losses from uneconomic asset sales to meet current obligations. While it is true that, in a prolonged low interest rate environment, increased pressure on earnings is a significant risk, life insurers’ liquidity demands also tend to diminish as policyholders are more likely to keep their money in annuities and other accumulation products due to the scant availability of higher-yielding alternatives. rates to be competitive and benefit from a steep yield curve because they can offer more attractive returns for their long-term investments (Figure 3).
This advantage becomes particularly pronounced during volatile and uncertain times, when demand for conservative investments tends to be higher. Fixed annuities registered record sales in 2008 during the peak of the financial crisis before they gradually retreated as the equities markets started to asset-liability management programs are best prepared to manage through a low interest period. Furthermore, the utilization of new sophisticated enterprise risk management (ERM) techniques, can enhance insurers’ ability to monitor their asset/liability positions by employing cash-flow analysis, duration, convexity, earnings and capital at risk and focusing on tail returns and expected shortfall. Also, life insurance companies can take action before rates drop and effectively hedge interest risk through interest rate floors or persistently low interest rates. Increasing the duration of their assets to ensure better matching between assets and liabilities is at the core of life companies’ interest rate risk strategies as part of their overall ALM. Insurers also can lower the terms of new policies (i.

, by lowering guaranteed rates), thereby challenge for insurers’ ALM is that current lower-yielding investments cannot meet past return assumptions (reinvestment rate risk). As higher-yielding investments mature and roll over into lower-yielding assets, the degree of risk faced by an insurer depends on the extent of the duration mismatch between assets and liabilities. The duration of some life insurers’ liabilities exceed the longest duration assets that may be available for purchase and, as a result, companies could be exposed to reinvestment rate risk.  of duration match seems straightforward enough in theory, in practice it is much harder to achieve a perfect hedge against interest rate risk.

Companies with diversified books ordinarily tend to have less overall exposure to interest rate risk if their interest-sensitive product lines are well-balanced with non-interest-sensitive lines. Furthermore, adjusting the pricing and/or the features and terms of new policies (i.e. by lowering guaranteed rates) can help progressively lower liabilities providing a relief to insurers that face spread income and counter the impact of low interest rates, albeit at the cost of potentially assuming more credit risk, might be another option that life companies could exercise.

The NAIC Capital Markets Bureau has begun analyzing changes in asset mix from year-end 2010 to year-end 2011 and found significant dollar increases in two areas; structured securities and investments in commercial real estate, either through mortgage loans or equity. In the case of structured securities, the increase is largely attributable to additional investments in agency-backed Residential Mortgage-Backed Securities (RMBS), which are effectively supported by the Federal government. In the case of commercial real estate investments, growth was higher than overall growth in invested assets. However, the increase as a percent of invested assets was modest and the current percentage remains below strategies based on derivatives that allow them to manage and mitigate risk by “locking in” higher interest rates. On the other hand, hedging with derivatives could also pose certain risks, such as counterparty risk, which increases substantially with the length of time required for the hedging strategy.

According to 2010 year-end NAIC data, about 64% of insurers’ total notional value of outstanding over-the-counter (OTC) derivatives and futures contracts is used in mitigating risks resulting from were the most common swaps derivative instrument utilized by insurers in their hedging strategies, representing approximately 75% of the swaps exposure. Furthermore, interest rate swaps comprised about 73% of the hedges with maturity dates of 2021 and beyond, and 45% of the hedges with maturity dates mitigate interest rate risk, are fixed-income futures (which obligate the insurer to sell a specified bond at a specified price to a counterparty at a future date), floors (which entitle the insurer to receive payments from a counterparty if interest rates drop under a specified level) and “swaptions” (which give the insurer an option to enter into a fixed swap with an interest rate environment on the life insurance industry in the United States. The data used in the study was gathered from the financial annual statements filed by life insurance companies for the years 2006 through 2010. The objective of the study was to determine the effect the low interest rate insurance company legal entities that had submitted data for all five years of the study (2006—2010).

The reserves from these 713 legal entities represented 99.99% of the total industry in the life insurance industry’s gross portfolio yield from 2006 through 2010. This drop in yield reflects the lower interest rate environment within which the industry had to invest any positive cash flows (premiums plus investment income less policy claims). The industry lost 66 basis points of gross yield between 2006 and 2010 (89 basis points of gross yield between the high in 2007 and the low in 2009).
It is also interesting to note that the smaller-size companies (i.e., those with reserves of less than $5 million) had a larger decline in gross portfolio yield. Smaller-size companies are less able to leverage their investment activities and must purchase smaller-sized assets than larger competitors.

Again, the data show a decline in the life insurance industry’s yield between 2006 and 2010. The industry lost 49 basis points of net yield between 2006 and 2010 (71 basis points of net yield between the high in 2007 and the low in 2009). The drop in net portfolio yield is less than the drop in gross yield which could be due, in part, to cost-cutting measures companies have taken as spreads have declined and a shift to less asset-intensive securities. The difference between the gross and net portfolio yields reflects investment expenses, as well as investment taxes, licenses and fees.

The proxy was the weighted average valuation interest rate. Credited interest rate guarantees may be less than the valuation rate of interest; however, state insurance law dictates the minimum valuation interest rate that must be used in valuing insurance liabilities (policy reserves). This, in effect, means that the insurance company must have a net portfolio yield at least as great as the minimum valuation interest rate in order to fund the growth in policy reserves. Valuation interest rates for life insurance are determined each calendar year and apply to business issued in that calendar year.
The calendar year statutory valuation interest rate IR shall be determined as follows and the months and the average over a period of 12 months, ending on June 30 of the calendar year preceding the year of issue, of the monthly average of the composite yield on seasoned corporate bonds, as published by Moody’s Investors rate declined by 13 basis points between 2006 and 2010.  This is due in part to the decline in the composite yield on seasoned corporate bonds as published by Moody’s Investors Service, Inc., and due in part to a change in the mix of new business written difference between the net portfolio yield and the guaranteed interest rate (Figure 8), we can see the impact the low interest rate environment has had on the insurance industry. Investment net spreads declined 36 basis points between 2006 and 2010 (65 basis points of spread between the high in 2007 and the low in 2009).

2 billion of lost spread revenue over the five-year still in a position of positive net investment income spread of around 136 basis points. So, to date, the low interest rate environment has created spread compression on earnings, but has not yet impacted insurance company solvency, which would begin to occur when the spread compression drops below zero.  It is important to note that the pricing of life insurance products in the United States not only contains an investment spread margin, but also a spread margin built into the mortality rates and the expense component (e.g., contract fees and policy expense charges).

In fact, statutory valuation law requires insurance companies to perform an annual cash flow testing exercise where the life insurance company must build a financial model of their in-force assets and liabilities. The company must run the financial model for a sufficient number of years, such that any remaining in-force liability at the end of the projection period is not material. difference between liability and asset cash flows and accumulates this difference forward under a given interest rate scenario. The metric analyzed is typically the ending market value of surplus or the present value of the ending so surplus is zero.
The American Academy of Actuaries (AAA) has developed an economic scenario generator that randomly generates interest rate scenarios as well as market rate scenarios. Companies typically use the AAA’s economic scenario generator to develop the stochastic interest rate increasing over five years at 1.0% per year and then uniformly decreasing over decreasing over five years at 1.0% per year and then uniformly increasing over tests to help ensure that life insurance companies have either well matched asset and liability cash flows or have established additional reserves that are available to cover any interest rate or reinvestment rate risk that is embedded insurance companies to post an additional reserve if the appointed actuary determines that a significant amount of mismatch exists between the company’s asset and liability cash flows. As part of this study, the NAIC pulled the additional reserves liabilities that were established by companies at year-end 2010. The life insurance industry posted an additional asset/liability cash on the life insurance industry is something that bears watching.