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Interest Rate Risk & Duration Matching: A Regulatory Perspective

This study by Chet Szczepanski, Chief Actuary at the Pennsylvania Insurance Department, discusses the importance of Duration Matching, showing that long duration strategies may outperform matched ones. The paper questions the necessity of adopting a duration matching strategy in the P&C insurance sector and emphasizes the significance of considering future cash flows in risk assessment. The implications of RBC dropping to critical levels and scenarios of highly leveraged entities are also explored.

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Interest Rate Risk & Duration Matching: A Regulatory Perspective

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  1. Interest Rate Risk & Duration Matching:A Regulatory Perspective Chet Szczepanski Chief Actuary Pennsylvania Insurance Department

  2. VFIC Study • Timely • Utilizes DFA • Important Conclusion

  3. Important Conclusion • Long duration strategies performed better than matched duration strategies. • A matched portfolio is not inherently superior to a longer one.

  4. One Regulator’s Conclusion • The VFIC paper demonstrates that it makes about as much sense to insist that a healthy P&C insurer adopt a duration matching investment strategy as it would to insist that the same insurer hold his assets in passbook savings accounts. • This conclusion is pretty much inescapable!

  5. BUT • Should duration analysis and matching be expelled from the regulator’s toolkit?

  6. One Regulator’s Opinion • Not yet!

  7. Key Observations • Most P&C insurers invest in portfolios of assets with durations longer than those of their liabilities. • Life insurers discount their liabilities bringing them closer to an economic presentation. • Two sided risk measures are elegant, but less likely to be relevant to a company’s actual long term success. • There is no consideration in this analysis of future cash flows.

  8. Net Duration

  9. What “Risk” Concerns the Regulator? • It is most definitely one sided! • It is that the entity will not be able to honor its obligations!

  10. What Happens When RBC Drops to Company Action Level and Below? • Reserves are effectively discounted! • Survival, rehabilitation or liquidation become critical question. • Duration matching becomes critical!

  11. Hypothetically, What Do We Do When An Entity Is: • Highly leveraged with regard to reinsurance, • Writes mostly rating sensitive business?

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