Chapter 16: Asset liability management

Question 1

Match liabilities with assets on CANT C RRED

When matching assets and liabilities keep the following in mind

CNT CRRD

Answer 1

Certainty
Amount
Nature 
Term 
Currency
Return
Regulation/Risk appetite 
Diversification of assets

/
Currency 
Nature
Term
Certainty
Return
Regulation or Legislation
Diversification of assets

Question 2

Liability outgo

Answer 2

L = Benefits+ Expenses - Premiums/Contributions

Question 3

Types of benefit payments and asset strategy to match nature:
GIDI

Answer 3

Guaranteed in nominal terms

• Choose approximate matching assets (Fixed interest bonds)
• Larger amount of free assets needed when providing guaranteed benefits

Index linked

• Match with assets following the same index or equities
• real liabilities —> Inlfation linked bonds, equity or property

Discretionary (Highest expected return possible)

• Match PRE
• Stay within risk appetite
• Limited matching strategy followed
• Highest return assets classes —> Equity, property

Investment linked:

• liabilities linked to performance of underlying index
• lower investment risk
• PRE needs to be satisfied
• Can use CIS

Question 4

Regulatory limitations of investments

TECH SCAM CLS

Answer 4

• Types of assets that can be invested in
• Extent of mismatching allowed
• Currency
• Hold only certain assets
• Single counterparty maximum exposure
• Custodianship of assets (Not use other companies)
• Amount of any one asset used to demonstrate solvency
• Mismatching Reserve

Objectives:

Control
Limit
Set coherence in the industry

Question 5

Limitations of Redington’s immunisation theory

FAT DRY PI

Answer 5

Fixed nominal values assumed
Assets of long enough duration may not exist
Timing of asset proceeds/liability outgo unkown
Dealing costs ignored
Rebalancing after every change in interest rate
yield curve assumed to be flat
Profit from mismatching eliminated
Interest rate changes assumed to be small

Question 6

Steps required to perform a stochastic ALM modelling exercise:
OSNeP SAP

Answer 6

1. The Objectives of the strategy need to be defined clearly
2. Simulations of assets and liabilities over the full run off period of the liabilities produced
3. New business added or not, depending on the objectives
4. If NB is included, projected sales can be obtained from business plans and input from marketing and sales departments
5. Depending on the size of the book and computing power, it may be necessary to select model points
6. Appropriate input assumptions are required such as distribution parameters of assets, correlation between assets and liabilities
7. Projections should be based on best estimate assumptions
8. An initial strategy is tested by projecting the Assets and Liabilities under several thousand simulations to derive a probability distribution and to determine the suitability of the strategy

Question 7

Aspects of an Asset Liability model OPHACC:

Answer 7

Objectives of investment formulated
Performance target set
Horizon of performance set
Assumptions of model set
Confidence levels of performance determined
Continuously run and assess the model