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ALM in Asset Management - Insurance Spring Meeting

Learn about the role of Asset Liability Management in insurance asset management, definitions, theory, and practice. Explore topics such as effective duration, liability duration, duration matching, bullet and barbell strategies, conditional immunization, liquidity reserves, yield rolldown, and risk analysis.

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ALM in Asset Management - Insurance Spring Meeting

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  1. I N S U R A N C E A S S E T M A N A G E M E N T ALM in Asset Management CAS Spring Meeting - 20 May 2002

  2. Outline • What is the role of ALM in asset management? • Definitions • Theory • Practice • New use

  3. Effective Duration without option with option Price - + 0 P P P Rate

  4. Liability Duration • Selection of discount rate • Reserves only or include future business • Years of future business • Rate of growth • Expected v. Variable

  5. Yield curve expectations • Duration matching assumes parallel shifts in yield curve • Companies should be indifferent, but … • Companies play directional guessing game • Higher yield  shorter duration • Lower yield longer duration

  6. Bullet • Concentrated around desired duration • Expectation of a flatter yield curve

  7. Barbell • Distributed around desired duration • Expectation for steeper yield curve

  8. Conditional Immunization • Decompose investment into components • Case Cash/Liquidity • IBNR Duration matched fixed income • Surplus Equity/longer fixed income/alternative • Optimal component allocation  sub-optimal overall allocation • Similar to securities on deposit • Transition inefficiencies Liquidity Reserve Surplus 1 Year 5-10 Years

  9. Yield Rolldown - Year 0

  10. Yield Rolldown - Year 1

  11. Yield Rolldown • Obvious extreme example • No credit exposure • Liability Duration decay smaller than Asset Duration decay • Yield curve has positive slope • Liability discount rate not constant

  12. From Theory to Practice • Theory of ALM not applied in practice • Markets aren’t efficient • Markets aren’t complete • Liabilities don’t behave • External restrictions

  13. Bond Price/Index • Bonds traded over the counter • No definite price • Liquidity not guaranteed • Securities not homogenous • Bond index defined by structure - not security • No published list • Broad criteria

  14. Risk Types

  15. Inter-Sector Excess Return Analysis As of 3/31/02

  16. Duration/Sector Allocation

  17. Security Selection

  18. Relative Municipal Yield Nominal vs. tax-equivalent percent yields at 3/31/02 Treasury AAA municipal bond

  19. Avoiding AMT • Determine % income from municipal securities • Expected underwriting • Invest based on BOY assumptions • Mid-year update • 6/30 data available 7/15 • Analysis complete mid-August • Rebalance allocation • Material differences in U/W results require massive rebalancing • Purchases may not be available • Sales might be unprofitable

  20. Conditional Asset Allocation • ALM models used for asset allocation • Expected basis • Catastrophes • Increase short term liquidity needs • Remove need for shielding • Possibly extend duration • Use ALM models to develop liability catastrophe scenarios • Model asset behavior in catastrophes • Develop post-catastrophe allocation • Develop transition plan

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