16 - Asset-Liability Management Flashcards
Give the factors that a provider of financial products should consider when selecting an investment?
Liability nature, term, currency and uncertainty.
The provider’s risk appetite.
Investments should aim to maximise the overall return on the assets.
What are the components of ‘overall return’?
Income + Capital
Liability outgo in a period depends on?
The monetary value of each of the constituents and the probability of it being received or paid out.
Give the categories of the nature of liabilities.
Guaranteed in money terms.
Guaranteed in terms of a prices index or similar.
Discretionary.
Investment-linked.
Why is it not suitable to ignore liability-asset matching with regards to discretionary benefits?
Policyholder expectations of a minimum return may create obligations to the provider to uphold reputation and trust with the client base.
Give the characteristics of cash flows to consider when analysing a scenario.
Positive or negative from the correct perspective.
Fixed or real.
Amounts are known or not.
Timing is known or not.
Under which circumstances may a firm aim for mismatching of assets and liabilities?
When there are free assets or a surplus that the provider can use to ensure the ability to cover liabilities as they fall due against adverse market movements.
How can a provider use improved overall return on its assets to benefit stakeholders?
Clients through higher benefits or lower premium/contribution rates.
Shareholders through higher dividends.
Describe when equities are a suitable investment.
A diverse portfolio of equities is a suitable matching strategy for long-dated liabilities that have no cash flow issues in the short term and so the short-term volatility of equity returns will not cause liquidity issues for the provider.
How are reserves usually found?
By statistically reducing the probability of not being able to meet liabilities as they fall due to a reasonably low level by increasing assets held to ensure against adverse market movements.
Give the controls that may be implemented in order to satisfy regulation around asset-liability management.
- Restrictions of the types of assets that a provider may invest in.
- Restrictions on the amount of any particular type of assets that can be taken into account for demonstrating solvency.
- A requirement to match assets and liabilities by currency.
- Restrictions on the maximum exposure to a single counter party.
- Custodianship of assets.
- A requirement to hold a certain proportion of total assets in a particular class.
- A requirement to hold a mismatching reserve.
- A limit on the extent to which mismatching is allowed at all.
Define: Pure Matching.
Structuring the flow of income and maturity proceeds from the assets so that they coincide precisely with the net outgo from the liabilities under all circumstances.
Why is it difficult to achieve pure matching in practice?
Reinvestment conditions are usually unknown and all cash flows have to be known in full: nature, term, currency, amount and timing.
Define: Liability Hedging.
Assets are chosen so as to perform in the same way as liabilities in all aspects.
Benefits of asset-liability models.
- Forces investors to stet objectives.
- can be used iteratively to set objectives.
- Useful for experience monitoring.
