Chapter 17 - Asset Liability Management

Question 1

What is asset liability matching?

Answer 1

It consists of ensuring there is adequate alignment between an insurer’s assets and liabilities

and that any mismatch between the characteristics of assets and liabilities is identified and quantified

to ensure that it is within the insurer’s acceptable level of risk.

It is used as a tool to make sure that enough money is available to meet liabilities (solvency requirement)

and that cashflows are of such a nature that money is available when needed (liquidity requirement)

Question 2

What is asset liability management (ALM):

Answer 2

Asset liability management is the practice of managing a business so that the decisions and actions that are taken with respect to assets and liabilities are coordinated

Question 3

What is asset liability modelling:

Answer 3

It is an analytical tool used to model and investigate the joint behaviour of an insurer’s assets and liabilities over time, using consistent assumptions about future scenarios and alternative strategic options

Question 4

Asset liability matching is useful for evaluating the following risks borne by a LI: (5)

Answer 4

1. Liquidity risk
2. Market risk
3. Underwriting risk
4. Reinvestment risk
5. Financial impact of options and guarantees that are embedded in contracts

Question 5

Risks falling under market risk: (6)

Answer 5

1. Interest rate risk
2. Credit spread risk
3. Equity and property risk
4. Foreign exchange risk
5. Concentration risk
6. Asset volatility

Question 6

What is credit spread risk:

Answer 6

It is the risk that the company is exposed to lower returns or losses as a direcr or indirect result of fluctuations in credit spreads above the risk free rate

Question 7

3 different methods of applying Asset Liability matching:

Answer 7

1. Do a valuation of a block, or even all, existing policies using a range of different deterministic assumptions for future conditions
2. Project annual CFs under different sets of scenarios to check that they are adequate in every year of the projection period
3. Project all cashflows using stochastic methods

Question 8

Derivatives are being used in asset liability matching in order to meet investment aims for the following purposes: (5)

Answer 8

1. To increase available capital/profit
2. Reduce tax or investment costs
3. To more effectively or efficiently acquire or dispose of positions in relation to assets (since some derivatives are more liquid than their underlying assets)
4. To hedge one or more aspects of the guarantees provided in with profits contracts
5. To provide exposure required to match the investment guarantees underlying some contracts, qw guaranteed equity bonds or variable annuities