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Liability driven investment asset liability management optimisation

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Liability driven investment asset liability management optimisation

  1. 1. LDIOpt:Asset – Liability ManagementSoftware Demo
  2. 2.  LDIOpt – An integrated solution Insurance ALM problem considered LDIOpt Demo Pre Analysis window Optimization window Post Analysis Window Performance Measure Window Chart Viewer Solver Options
  3. 3. • An integrated solution - considers Assets and Liabilitiestogether.• Advanced stochastic models with real world constraints.• Incorporates Uncertainties in decision models• Based on most recent and effective approach toovercome interest rate risk.– minimize the Present value (PV) deviation of asset andliability at each time step over the planning horizon.• Considers overlay strategies to make the results robust.
  4. 4. LDIOpt :From Historical data toOptimum ALM decisions
  5. 5. Platform and technical aspects• The LDIOpt is currently in development stage• It runs under windows, XP and Vista.• The optimization models are constructed using AMPLmodelling tool and the embedded application with GUI andsolver is constructed using AMPL NET.• LDIOpt uses FORTSP as solver engine which in turn isbuilt around CPLEX and FORTMP solvers which areembedded within the systems as an alternative
  6. 6. Insurance Product Considered forthis Prototype• Liabilities of one of the most popular and conventionallife insurance products, Annuity is considered.• The individual is supposed to pay a fixed amount, oncewhile buying the Annuity Policy.• The annuitant will get the coupon value at every sixmonth on the decided pay-out(Interest Rate).• Policy maturity is till death of the annuitant and on thedeath of the annuitant, the nominee receives the ‘sumassured and the pay-out’.
  7. 7. Getting Started With Prototype: LDIOptLDIOpt Prototype is in Development stageICON OF LDIOpt
  8. 8. Getting Started With Prototype: LDIOptLDIOpt Prototype is in Development stageICON OF LDIOptThe Introduction PageDefault page opens when you click on the LDIOpt icon
  9. 9. The Pre-Analysis window: LDIOptWindow to Analyze the Current Portfolio.Screen shot ofPre-Analysiswindow
  10. 10. The Pre-Analysis window: LDIOptWindow to Analyze the Current Portfolio.Browse toinsert the Asset, Liability andcurrent holdingdata
  11. 11. The Pre-Analysis window: LDIOptWindow to Analyze the Current Portfolio.Two TAB1.Universal Set: Shows all assets considered for theportfolio rebalancing.2.Portfolio Allocation: Shows the current holdings of theclient portfolio
  12. 12. The Pre-Analysis window: LDIOptWindow to Analyze the Current Portfolio.Shows the break-upbased on risk ratingof bonds availablefor rebalancing.
  13. 13. The Pre-Analysis window: LDIOptWindow to Analyze the Current Portfolio.Display clients current bond/fixedincome portfolio by
  14. 14. The Optimization window: LDIOpt• To fix the optimization model
  15. 15. The Optimization window: LDIOpt• To Input the Interest rate values for PV calculation
  16. 16. The Optimization window: LDIOpt• To Fix the Bond Rating and Sector constraints
  17. 17. The Optimization window: LDIOpt• To choose the asset classes/indices/swap
  18. 18. The Optimization window: LDIOpt• To solve the model click “Solve”To solve the model click “Solve”
  19. 19. The Optimization window: LDIOpt• To create the Efficient Frontier click “Solve”To create the Efficient Frontier click “Solve”
  20. 20. The Optimization window After fillingthe data: LDIOpt
  21. 21. The Optimization window After fillingthe data: LDIOpt
  22. 22. The Optimization window After fillingthe data: LDIOpt
  23. 23. The Optimization window After fillingthe data: LDIOpt
  24. 24. The Optimization window After fillingthe data: LDIOpt
  25. 25. The Optimization window After fillingthe data: LDIOpt
  26. 26. The Optimization window After fillingthe data: LDIOpt
  27. 27. The Optimization window After fillingthe data: LDIOpt
  28. 28. The Post- Analysis window : LDIOpt• Screen shot of Post Analysis window when you juststart
  29. 29. The Post- Analysis window : LDIOpt• Screen shot of Post Analysis window when you juststartEfficient Frontier:A graph showstradeoff betweenInitial Injected Cashand Total Deviation
  30. 30. The Post- Analysis window : LDIOpt• Screen shot of Post Analysis window when you juststartInitial Injected Cash:Additional cash requirement,at present, to buy Assets tomeet all liabilities in future.
  31. 31. The Post- Analysis window : LDIOpt• Screen shot of Post Analysis window when you juststartTotal Deviation:Sum ofdeviations of PV(Asset PV – Liability PV)at each time step.
  32. 32. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier point
  33. 33. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier pointSelected EfficientFrontier Point
  34. 34. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier pointThe value of total deviation forthat particular efficient frontierpoint
  35. 35. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier pointThe value of Initial Injected cashfor that particular efficient frontierpoint
  36. 36. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier pointFour Tabs1.Allocation Chart2.Allocation Data3.NPV Matching4.NPV Asset and NPVliabilities
  37. 37. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier point1. Allocation Chart:A. Allocation in variousassets by volume.B. Allocation in variousassets by value.
  38. 38. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier point
  39. 39. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier point2. Allocation Data:A.Allocation by volume( # of units perbond )B. Allocation by value( rupee valueinvestment per bond )
  40. 40. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier point
  41. 41. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier point3. NPV Matching:A Bar chart showsAsset PV and Liability PVon each time step
  42. 42. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier point
  43. 43. The Post- Analysis Page : LDIOpt• Screen shot of Post Analysis Page when you click onany efficient frontier point4. NPV Assets andNPV Liabilities:A.PV of Assets ateach time periodB. PV of Liabilities ateachtime period
  44. 44. The Performance Measure Page : LDIOpt• Screen shot of Performance Measure Page when youjust start
  45. 45. The Performance Measure Page : LDIOpt• Screen shot of Performance Measure Page when youjust startEfficientFrontierPerformanceMeasures fromIndustries &academia.
  46. 46. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier point
  47. 47. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier pointEfficient FrontierPoint SelectedPoint - 11PerformanceMeasure/RatioSelected
  48. 48. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier point
  49. 49. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier point and “Graph” tab.
  50. 50. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier point and “Graph” tab.Every insurancecompany is requiredto maintain solvencymargins based on itsvolume of businessand as per theguidelines stipulatedby the IRDA.
  51. 51. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier point and “Graph” tab.Ratio of Excess valueof Assets overinsurance liabilities(furnished by IRDA) byvalue of insuranceliabilities is calledSOLVENCY RATIO
  52. 52. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier point and “Graph” tab.The solvency of an insurancecompany corresponds to itsability to pay claims.An insurer is insolvent if itsassets are not adequate[over indebtedness] orcannot be disposed ofin time {illiquidity} to paythe claims arising.
  53. 53. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier point and DATA TABLE TAB
  54. 54. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier point and DATA TABLE TAB
  55. 55. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier point and DATA TABLE TABTIME STEPFRONTIERPOINT 11FRONTIERPOINT 11
  56. 56. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier point and DATA TABLE TABFRONTIERPOINT 11Solvency Ratio iscalculated usingAsset PV and LiabilityPV.= (Asset PV –LiabilityPV) / LiabilityPV
  57. 57. The Performance Measure Page : LDIOpt• Chosen Solvency Ratio and any of the efficientfrontier point and DATA TABLE TABFrom the shownsolvency ratio value itcan be concluded thatat any time period ofplanning horizon; if allthe liabilities come duesuddenly thaninsurance companycan easily pay back byliquidating its assetwithout any delay orloss.
  58. 58. The Performance Measure Page : LDIOpt• Chosen Funding Ratio and any of the efficient frontierpoint
  59. 59. The Performance Measure Page : LDIOpt• Chosen Funding Ratio and any of the efficient frontierpointEfficient FrontierPoint SelectedPoint - 11PerformanceMeasure/RatioSelected
  60. 60. The Performance Measure Page : LDIOpt• Chosen Funding Ratio and any of the efficient frontierpointEfficient FrontierPoint SelectedPoint - 11PerformanceMeasure/RatioSelected
  61. 61. The Performance Measure Page : LDIOpt• Chosen Funding Ratio and any of the efficient frontierpoint and GRAPH TAB
  62. 62. The Performance Measure Page : LDIOpt• Chosen Funding Ratio and any of the efficient frontierpoint and GRAPH TABRatio of value ofAssets and the valueof insurance liabilities(furnished in IRDA)called FUNDINGRATIO
  63. 63. The Performance Measure Page : LDIOpt• Chosen Funding Ratio and any of the efficient frontierpoint and GRAPH TABRatio of value ofAssets and the valueof insurance liabilities(furnished in IRDA)called FUNDINGRATIOThe Funding of anInsurance companycorresponds to itsability to pay claims.Funding ratio is similarto solvency ratio. Aninsurer is not enoughFunded if its assets arenot adequate or cannotbe disposed of in time{illiquidity} to paythe claims arising.
  64. 64. The Performance Measure Page : LDIOpt• Chosen Funding Ratio and any of the efficient frontierpoint and DATA TABLE TABFRONTIERPOINT 11
  65. 65. The Performance Measure Page : LDIOpt• Chosen Funding Ratio and any of the efficient frontierpoint and DATA TABLE TABTIME STEPFRONTIERPOINT 11FRONTIERPOINT 11
  66. 66. The Performance Measure Page : LDIOpt• Chosen Funding Ratio and any of the efficient frontierpoint and DATA TABLE TABFunding Ratio iscalculated usingAsset PV and Liability PV.= Asset PV / LiabilityPV
  67. 67. The Performance Measure Page : LDIOpt• Chosen Funding Ratio and any of the efficient frontierpoint and DATA TABLE TABFrom the shownFunding ratio value itcan be concluded thatat any time period ofplanning horizon; TheInsurance provider isfunded enough toovercome any liabilitythat comes at any timeperiod.
  68. 68. The Performance Measure Page : LDIOpt• Chosen Sharpe Ratio and any of the efficient frontierpoint
  69. 69. The Performance Measure Page : LDIOpt• Chosen Sharpe Ratio and any of the efficient frontierpointEfficient FrontierPoint SelectedPoint - 11PerformanceMeasure/RatioSelected
  70. 70. The Performance Measure Page : LDIOpt• Chosen Sharpe Ratio and any of the efficient frontierpoint
  71. 71. The Performance Measure Page : LDIOpt• Chosen Sharpe Ratio and any of the efficient frontierpoint and GRAPH TAB
  72. 72. The Performance Measure Page : LDIOpt• Chosen Sharpe Ratio and any of the efficient frontierpoint and GRAPH TAB Sharpe ratio wasderived in 1966 byWilliam Sharpe, it hasbeen one of the mostreferenced risk/return measures used infinance.
  73. 73. The Performance Measure Page : LDIOpt• Chosen Sharpe Ratio and any of the efficient frontierpoint and GRAPH TABThe ratio describes howmuch excess return (AssetPV return – LiabilityPVReturn)You are receiving for the extra volatility (SD of AssetPVreturn – LiabilityPV Return)that you endure for holding ariskier asset. 
  74. 74. The Performance Measure Page : LDIOpt• Chosen Sharpe Ratio and any of the efficient frontierpoint and DATA TABLE TAB
  75. 75. The Performance Measure Page : LDIOpt• Chosen Sharpe Ratio and any of the efficient frontierpoint and DATA TABLE TABTIME STEPFRONTIERPOINT 11FRONTIERPOINT 11
  76. 76. The Performance Measure Page : LDIOpt• Chosen Sharpe Ratio and any of the efficient frontierpoint and DATA TABLE TABSharpe Ratio is calculated using(Asset PV return and Liability PV return)
  77. 77. The Performance Measure Page : LDIOpt• Chosen Sharpe Ratio and any of the efficient frontierpoint and DATA TABLE TABIt is the measure of excessreturn you receive at eachtime period withunpredictability.
  78. 78. The Performance Measure Page : LDIOpt• Chosen Sharpe Ratio and any of the efficient frontierpoint and DATA TABLE TABFRONTIERPOINT 11An investor choose toinvest in a portfolio withhigher value of Sharpe ratio.A positive value and upward trendsof Sharpe ratio always attracts theinvestor.Here, we suggest clients to choosethe frontier point with maximumvalue of Sharpe ratio and do theinvestment as per that point.
  79. 79. The Performance Measure Page : LDIOpt• Chosen Sortino Ratio and any of the efficient frontierpoint and GRAPH TAB
  80. 80. The Performance Measure Page : LDIOpt• Chosen Sortino Ratio and any of the efficient frontierpoint and GRAPH TABA ratio developed by“Frank A. Sortino” todifferentiate betweengood and bad volatilityin the Sharpe ratio.
  81. 81. The Performance Measure Page : LDIOpt• Chosen Sortino Ratio and any of the efficient frontierpoint and GRAPH TABThe ratio describes howmuch excess return (Asset return – LiabilityReturn)You are receiving for thedownwards volatility(Downside Deviation of Assetreturn – Liability Return) thatyou endure for holding ariskier asset. 
  82. 82. The Performance Measure Page : LDIOpt• Chosen Sortino Ratio and any of the efficient frontierpoint and DATA TABLE TAB
  83. 83. The Performance Measure Page : LDIOpt• Chosen Sortino Ratio and any of the efficient frontierpoint and DATA TABLE TABTIME STEPFRONTIERPOINT 11FRONTIERPOINT 11
  84. 84. The Performance Measure Page : LDIOpt• Chosen Sortino Ratio and any of the efficient frontierpoint and DATA TABLE TAB• The Sortino ratio measures thereturn to "bad" volatility.• This ratioallows investors to assess risk ina better manner than simplylooking at excess returns to totalvolatility (Sharpe ratio),• Since such a measure doesnot consider how oftenthe price of the security rises asopposed to how often it falls. Alarge Sortino Ratio indicates a lowrisk of large losses occurring.
  85. 85. The Performance Measure Page : LDIOpt• Chosen Sortino Ratio and any of the efficient frontierpoint and DATA TABLE TABAn investor choose toinvest in a portfolio withhigher value of Sortino ratio.Here, we suggest clients tochoose the frontier pointwith maximum value ofSortino ratio and do theinvestment as per that point.
  86. 86. The Performance Measure Page : LDIOpt• Chosen Modigliani M2 ALPHA and any of theefficient frontier point and GRAPH TAB
  87. 87. The Performance Measure Page : LDIOpt• Chosen Modigliani M2 ALPHA and any of theefficient frontier point and GRAPH TABModigliani Risk-AdjustedPerformance(RAP) orM2 is a measure of therisk-adjusted return ofa investment portfolio.
  88. 88. The Performance Measure Page : LDIOpt• Chosen Modigliani M2 ALPHA and any of theefficient frontier point and GRAPH TABIt measures the return of theportfolio, adjusted for the riskof the portfolio, relative to thatof some benchmark (e.g., themarket). In our case, thebenchmark is the liabilityreturn. 
  89. 89. The Performance Measure Page : LDIOpt• Chosen Modigliani or M-Square Measure and anyof the efficient frontier point and DATA TABLE TAB
  90. 90. The Performance Measure Page : LDIOpt• Chosen Modigliani or M-Square Measure and anyof the efficient frontier point and DATA TABLE TABTIME STEPFRONTIERPOINT 11FRONTIERPOINT 11
  91. 91. The Performance Measure Page : LDIOpt• Chosen Modigliani or M-Square Measure and anyof the efficient frontier point and DATA TABLE TABThe Modigliani Risk-AdjustedPerformance measure is usedto characterize how well aALM Model rewards aninvestor for the amount of risktaken, relative to that ofLiability retrun.
  92. 92. The Performance Measure Page : LDIOpt• Chosen Modigliani or M-Square Measure and anyof the efficient frontier point and DATA TABLE TABThe Modigliani or M-SquareMeasure (see Modigliani andModigliani (1997))is given as the following:RAPA(F) = Sharpe ratio *standard deviation of liabilityreturn ( Benchmark portfolio)
  93. 93. The Performance Measure Page : LDIOpt• Chosen Jensen Index and any of the efficientfrontier point and GRAPH TAB
  94. 94. The Performance Measure Page : LDIOpt• Chosen Jensen Index and any of the efficientfrontier point and GRAPH TABThe Jensen Indexmeasures theperformance againstthe marketindex(Liability Return).A high Jensen Index isinterpreted as higherreturn given a risk levelon the portfolio.
  95. 95. The Performance Measure Page : LDIOpt• Chosen Jensen Index and any of the efficientfrontier point and GRAPH TABThe Jensen index usesthe capital asset pricingmodel(CAPM) as its basis fordetermining whether or nota ALM manager outperformeda market index (oroutperformed its liabilityPortfolio).
  96. 96. The Performance Measure Page : LDIOpt• Chosen Jensen Index and any of the efficient frontierpoint and DATA TABLE TAB
  97. 97. The Performance Measure Page : LDIOpt• Chosen Jensen Index and any of the efficient frontierpoint and DATA TABLE TABTIME STEPFRONTIERPOINT 11FRONTIERPOINT 11
  98. 98. The Performance Measure Page : LDIOpt• Chosen Jensen Index and any of the efficient frontierpoint and DATA TABLE TABThe CAPM determinesthe required rate of return, andthe Jensen index helpsinvestors see if the calculationyielded expected results.In our present case Jensen’salpha would beJensens alpha = AssetReturn − Asset Beta *(Liability Return)
  99. 99. The Performance Measure Page : LDIOpt• Chosen Jensen Index and any of the efficient frontierpoint and DATA TABLE TABA high Jensen indexsuggests a high level ofreturn given the level of risk(systematic or market) onthe investment. A lowJensen index, such as anegative number, indicatesinferior performance whencompared to the risk.
  100. 100. The Performance Measure Page : LDIOpt• Chosen Treynor Ratio and any of the efficientfrontier point and GRAPH TAB
  101. 101. The Performance Measure Page : LDIOpt• Chosen Treynor Ratio and any of the efficientfrontier point and GRAPH TABThe Treynor ratiorelates Asset PV return  tothe risk taken; however,systematic risk is usedinstead of total risk. Thehigher the Treynor ratio, thebetter the performance ofthe ALM implementation.
  102. 102. The Performance Measure Page : LDIOpt• Chosen Treynor Ratio and any of the efficientfrontier point and GRAPH TABAlso known as the"reward-to-volatility ratio".The Treynor ratio iscalculated as:Treynor ratio = AssetReturn / Asset Beta
  103. 103. The Performance Measure Page : LDIOpt• Chosen Information Ratio and any of the efficientfrontier point and GRAPH TAB
  104. 104. The Performance Measure Page : LDIOpt• Chosen Information Ratio and any of the efficientfrontier point and GRAPH TABA ratio of portfolio returns above the returns of abenchmark (presently Liabilityreturn) to the volatility of thosereturns. The information ratio(IR) measures a portfoliomanagers ability to generateexcess returns relative to abenchmark, but also attemptsto identify the consistency ofthe investor. In our casebenchmark is Liability Return.
  105. 105. The Performance Measure Page : LDIOpt• Chosen Information Ratio and any of the efficientfrontier point and GRAPH TABThis ratio will identifyif a manager hasbeaten the benchmarkby a lot in a few time bucketor a little every time bucket.The higher the InformationRatio the more consistent aManager is and consistencyis an ideal trait.
  106. 106. The Performance Measure Page : LDIOpt• Chosen Tracking Error or Standard deviation ofexcess return and any of the efficient frontier pointand GRAPH TAB
  107. 107. The Performance Measure Page : LDIOpt• Chosen Tracking Error or Standard deviation ofexcess return and any of the efficient frontier pointand GRAPH TABThe standard deviationof the difference betweenthe funds return(Asset PV return ) and abenchmark return(liability PV return) is alsocalled the tracking error.
  108. 108. The Performance Measure Page : LDIOpt• Chosen Tracking Error or Standard deviation ofexcess return and any of the efficient frontier pointand GRAPH TABThe Tracking errorrepresents the volatility inthe excess return andsuccessfulness of theoptimization function. Thevalue should be close tozero. The tracking errorplotted against planninghorizon represent themovement (upper or lower)of the total PV deviation.
  109. 109. This Page is to help user to comparedifferent models with their efficient frontiersThe Chart Viewer Page: LDIOpt
  110. 110. The Chart Viewer Page: LDIOpt
  111. 111. The Chart Viewer Page: LDIOpt
  112. 112. The Chart Viewer Page: LDIOpt
  113. 113. The Chart Viewer Page: LDIOpt
  114. 114. The Chart Viewer Page: LDIOptHere you cansee thecomparison ofEVLP model andSP model for twoconditions1.With bondsonly portfolio2. With all assetclass
  115. 115. The Chart Viewer Page: LDIOpt
  116. 116. The Chart Viewer Page: LDIOptWhereas when weinclude the marketindices it reducesthe initial inject cashsignificantly. Theefficient frontier isvery steep for thiscase which meansfor small reduction indeviation, fundmanager will requiremore cash incomparison to “BondOnly Portfolio”
  117. 117. This Page helps users to choose thesolver to solve the optimization modelThe Solver Option Page: LDIOpt
  118. 118. This Page helps users to choose thesolver to solve the optimization modelThe Solver Option Page: LDIOptLDIOpt has two solvers CPLEX and FortMPembedded into the solver options
  119. 119. This Page helps users to choose thesolver to solve the optimization modelThe Solver Option Page: LDIOptCPLEX is developed and marketed by IBM ILOGIt is very efficient and solve the problem very fastFor large scale problem we prefer the use of CPLEX
  120. 120. This Page helps users to choose thesolver to solve the optimization modelThe Solver Option Page: LDIOptFortMP is developed and marketed byOptiRisk Systems, UK and It is good for small scaleproblems and can be easily used for theSmall scale ALM problem.
  121. 121. LDIOpt: Tailoring as perclient requirement
  122. 122. Asia Pacific, Africa, Australia &Middle East:Europe & America:No 12, 25th Cross StreetThiruvalluvar Nagar ,Thiruvanmiyur,Chennai –600041, IndiaOptiRisk R&D House,One Oxford, Uxbridge,Middlesex, UB9 4DA,United KingdomContactBala. PadmakumarPh: +91 98406 18472 / +91 44 4501 8472Email: optimize@optiriskindia.comWeb: http://www.optiriskindia.com/Thank you

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