The document discusses asset liability management (ALM) in today's environment, outlining key ALM concepts, techniques, and processes. It explains that ALM establishes a framework for insurers to measure and manage risks from their asset and liability portfolios as well as the interaction between the two. The document also provides an overview of typical ALM techniques like duration matching, key rate duration matching, and cash flow matching along with important considerations around liquidity, capital, and regulatory risks.
1. Investment Symposium
March 2009
F4: ALM in Today's Environment
Pin Johnny Chung
Axel Andre
Moderator
Frank Zhang
2. ALM in Today’s Environment
Dr. Pin Chung, March 22nd, 2010
g,
Agenda
ALM and ERM in today’s environment
ERM defined, framework, definitions and key risks
More on ERM, modeling approaches, effective factors
ALM in ERM
ALM processes, workflow, tasks, analysis, and models
ALM enterprise partners and applications
Conclusions
2
1
3. ALM and ERM in today’s environment
ERM is the strategy that aligns the firm’s business with the risk factors
of its environment in the pursuit of strategic objectives
Tillinghast-Towers Perrin survey reveals 80% of survey participants
consider ERM useful in pursuing earnings growth, revenue growth,
return on capital, and expense control
ALM is the core activity of ERM for financial institution
3
ERM defined
Strategy
alignment of a firm with its environment
ERM
aligns business with risk factors of its environment in pursuit of business goals
A firm’s goal: to create economic value
A framework links strategy, process, organizational forms, human
resources, IT, and other areas to improve performance
The general ERM goal:
to identify drivers of performance;
to plan a path for managerial actions to improve performance metrics
4
2
4. ERM framework
Conceptual Organization
approaches
•Market risk
framework
•Credit risk
Firm’s
•Liquidity risk
Objectives
•Operational risk
•Business risk
•Other risks
Tools
5
Some definitions
Financial risk
Unpredictable event results in a financial loss
A firm will not meet some specified fi
fi ill t t ifi d financial goals
i l l
Risk
Risk is more of a choice than a chance
Risk Management
Provides tools to measure risks and techniques to make rational decisions
Business
Package and sell risks by designing pricing capitalizing funding and marketing
designing, pricing, capitalizing, funding,
financial products
Objective
Use cash flows generated from business activities, with leverage debt or equity capital
to enhance economic value through growth of earning, cash flow stability, and
reduced costs of financial distress
6
3
5. Key risks
Liquidity risk
Funding risk: when an institution is unable to raise cash to fund its activities
g
Trading risk: unable to execute a transaction at the prevailing market prices
Market risk
Risk arising from changes in financial market prices and rates
Credit risk
Risk of an un-kept payment promise when an obligor defaults, or rating changes
Operational risk
Losses due to human error, fraud, management failure, systems, data or legal actions
Business risk
Due to volatility of volumes, margins, or costs when engaging in the firm’s business
7
More on ERM
ERM takes a global view of the firm on the enterprise level
ERM takes a global view on the risks the firm is exposed to
ERM takes an integrated view of the business processes to achieve
the goal of alignment efficiency and adding value
For example, integrated financial product management of its product
design, pricing, capitalizing, funding and marketing
8
4
6. Two approaches
To manage the risk adjusted return across: product design, pricing,
and funding by looking at the following 3Ps of ERM (Lo’90):
1. Probability of extreme events
2. Process of asset risk and return profile
3. Preference towards risk
1. Single line business:
Repackage financial risks, price them, transfer to other market participants
or hold them in a portfolio
2. Multiple financial products:
Manage the business portfolio problem
Find appropriate product mix and allocate the firm’s capital, taking an
integrated view of risks and returns of competing lines of business
9
Single line business
Marketing
ALM Asset class 1
Pricing SAA
Product Optimal
Design Asset class 2
asset
allocation …
Asset class N
Liability Asset return
profile profile
ALM and Inforce
Management
10
5
7. Multiple financial products
Design, Pricing, Funding, and Inforce Management
Strategic
St t i management of business profile of multiple and di
t fb i fil f lti l d diverse
products
Strategic Objective:
allocate capital among LoBs; consistent with risk-adjusted ROE (or other metrics)
satisfying risk based capital and all other regulatory requirements
Integration of design, pricing and funding of each product will result into
a process that maximizes risk-adjusted return for each product
Note that risk-adjusted return of a product is not independent from the
composition of the overall portfolio which leads to “portfolio choice
problem”
11
Multiple line portfolio problem
Marketing
ALM
SAA
Pricing Asset class 1N
Optimal Asset class 2N
Product
asset
DesignN
allocationN …
Asset class NN
Enterprise level Markowitz solution
Liability Asset return
profiles profiles
ALM and Inforce
Management
12
6
8. Effective ERM factors
Risk Measurement
Metrics include: VaR, CTE, Duration, Convexity, Key Rate Duration
y y
Risk Management
Supports diversification, hedging, risk transfer
Provides portfolio compression, risk decomposition, what if analysis, hedging and
optimization of complex portfolios
Performance Measure
Estimate contribution of each risk factor to the firm’s overall risk profile
f f f ’ f
Corporate Governance
Make sure components of ERM are in place; function properly; and are aligned with
each other and with the objective of the enterprise risk management strategy
13
ALM in ERM
Management of firm’s balance sheet is at the core of ERM
The balance sheet reflects th risks of th environment from the asset
Th b l h t fl t the i k f the i tf th t
side and most of the business risks from the liability side
To align these risks is the goal of ALM
ALM provides tools for risk measurement and risk management
ALM takes a more focused view of risks than ERM
Asset side: market, credit and liquidity risks
, q y
Liability side: volatility of margins and cost
ALM: Markowitz’52, Asset Allocation; Sharpe and Tint’90, Liabilities
14
7
9. ALM processes and ALM charter
ALM processes:
1. Establish
1 E t bli h a comprehensive ALM policy
h i li
2. Define risk tolerances by integrating with the firm’s business strategies
3. Monitor risk metrics relative to defined tolerances
4. Initiate corrective actions when metrics break policy limits
5. Periodically
5 P i di ll review ALM policy and make adjustments when needed
i li d k dj t t h d d
ALM charter members:
CEO, CFO, CIO, Chief Actuary, CRO, Asset Manager, Hedging Head
15
ALM workflow
contractual obligations, scenarios, risk
Data Storage assumptions, new business, marketing
assumptions, b h i assumptions
i behavior i
Risk Measurement: market valuation, option
adjusted analysis, Value-at-risk, Scenario
Analytic Tools analysis
Risk Management: active dynamic analysis,
Hedging, Portfolio optimization
Results
Provide report to regulators, rating
Reporting agencies, and shareholders: earnings,
EaR, VaR, what if analysis
16
8
10. ALM tasks
ALM Tasks Align the asset and
Current and future valuation
liability sides of
balance sheet through
asset allocation or
Sensitivity and scenario analysis capital allocation
Earnings and balance sheet simulation When “neutralized”:
alignment of assets and
liabilities is achieved.
E.g., duration matching
Dynamic balance sheet modeling to neutralize market risk
due to parallel shifts of
the term structure
17
ALM analysis
Base economic environment:
Conduct cash flow analysis, duration and convexity calculations
Other Economic Environment:
Forecast or simulate of interest rates, exchange rates and credit spreads
Simulate the balance sheet by reporting the assets and liabilities under
assumed scenarios
Dynamic analysis:
Passive: time evolution of the current balance sheet
Active: focus on explicit ALM strategies
Simulation:
Future, dynamic across time
18
9
11. ALM example
10 Effective Duration Effective Convexity
1.5
15
8 1.0
6 0.5
Years
Liabilities (1)
Y e a rs
4 AssetsxMBS (2) 0.0
Assets (3)
-100 0 100 200
2 (0.5)
MBS (4)
0 (1.0)
(1 0) Liabilities (1)
AssetsxMBS (2)
-100 0 100 200
Parallel Shift in Yield Curve (BP) (1.5) Assets (3)
MBS (4)
Parallel Shift in Yield Curve (BP)
19
ALM models
Question is:
How to address risk measurement and risk management problems with
respect to time and uncertainty?
Time:
Single-period: static time model; t = 0, only one decision is made
Multiple-period: dynamic time model; portfolio decisions will be made at t =1,
2, …, T, and these decisions are explicitly modeled
Risk factors:
Static: the
St ti th economy environment, asset returns and volatilities, term
i t t t d l tiliti t
structure of interest rates will remain at their current state and change
with small shifts
Stochastic: evolve with time according to some probability distributions;
scenarios drawn from this distribution are explicitly incorporated in the
model
20
10
12. ALM model clarification table
Risk
Single period Multiple period
Stochastic Model Stochastic Model
Time
Single period Multiple period
Static Model Static Model
21
ALM enterprise partners
Senior Management
Finance Risk Management
Portfolio Managers,
Corporate Tax
Asset Managers
ALM
Investment Product
Accounting Management
Investment Product
Operations Development
Financial
Reporting
22
11
13. ALM applications
Corporate
function
Personal Wealth Equity analyst
Management and Investors
Real Estate
Asset Managers
Companies
ALM
Alternative
Pension Plans
Investments
Depository
Life and P&C
Institutions
Credit Unions
23
Conclusions
Risk is opportunity
ALM is the current and future cornerstone of an effective ERM
ALM is one of the best tools to implement a firm’s strategies
Thank you! Q&A!
Dr. Pin Chung, pin.chung@allianzlife.com, 763-765-7647
24
12
14. Appendix
Handbook of Fixed Income Securities, 7th edition, F.J. Fabozzi, McGraw Hill
Professional, 2008
Handbook of Asset and Liability Management, S.A. Zenios and W.T. Ziemba,
Elsevier, 2006
H.M. Markowitz, Portfolio Selection, Journal of Finance, 7, 77-91, 1952
W.F. Sharpe and L.G. Tint, Liabilities -- a new approach, Journal of Portfolio
Management, 5-10, Winter, 1990
A.W. Lo, The three P’s of total risk management, Financial Analyst Journal, 51-
57, January/February, 1999
Private conversation: Duane Gajewski, Steve Thiel, Darryl Johnson, Matt Gray,
Ross Bowen
25
13
15. SOA Investment Symposium
y p
ALM in Today’s Environment
Axel André, Goldman Sachs Asset Management
March 22, 2010
Goldman Sachs Asset Management
What is Asset Liability Management (ALM)?
Insurers face risks from various parts of their business
• Asset portfolio risks
• Liability risks
• Interaction between assets and liabilities
Asset portfolio risks include:
p
• interest rate
• credit spread
• credit downgrade
• credit default
• equity market
Liability risks include:
• mortality / morbidity
• longevity
• policyholder behavior
• catastrophe risk
Risks arising from interaction between assets and liabilities include
• disintermediation risk (e.g. disinvestment, reinvestment)
• liquidity risk
• surplus volatility
– must maintain adequate level of regulatory surplus to ensure solvency
– must maintain adequate level of rating agency capital to prevent downgrades
ALM establishes a framework for measuring and managing asset and liability risk exposures systematically
1
1
16. Goldman Sachs Asset Management
Why is ALM Important?
General ALM Risks
Typical ALM mismatch risks are:
• Disinvestment Risk arises when fixed-income assets must be sold prior to maturity to meet cash flow needs
– Exposes the insurer to the risk of rising interest rates / credit spreads, potentially triggering the realization of losses
when assets are sold
• Reinvestment Risk arises when cash flows have to be reinvested
– Exposes the insurer to the risk that available yields fall below the yield assumed / guaranteed for pricing of the
liability
Liability duration 5.2 / Asset duration 8.0 Liability duration 12.1 / Asset duration 8.0
140 140
Reinvestment
130 Risk 130
120 120
110 110
Disinvestment
100 Risk 100
90 90
80 80
70 70
-2.5% -2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% -2.5% -2.0% -1.5% -1.0% -0.5% 0.0% 0.5% 1.0% 1.5% 2.0% 2.5%
Change in Yield Change in Yield
MV of Assets MV of Liability MV of Assets MV of Liability
For illustrative purposes only. 2
Goldman Sachs Asset Management
Typical ALM Techniques & Considerations
Technique Description Considerations
Duration Matching Match duration of liabilities with asset portfolio May not eliminate liquidity risk + ignores
( t
(within reasonable to e a ce limits)
easo ab e tolerance ts) c ed t sp ead du at o
credit spread duration
Key Rate Duration Construct a portfolio that matches KRD of liability More effective than matching duration
Matching alone but ignores credit spread duration
Design an asset portfolio to replicate liability cash Typically costly strategy to implement +
Cash Flow flows (within some tolerance) may not be achievable
Matching Minimizes interest rate risk, but ignores
credit spread duration
Cash flow needs must be monitored closely to Insufficient liquidity may force insurer to
avoid liquidity issues sell assets and realize gains/losses
Liquidity Planning
Uncertainty in structured products cash
flows
Insurers need to be mindful of regulatory, rating Some regulatory capital methodologies
Capital agency, and economic capital penalize ALM mismatch
Considerations Economic capital is becoming more
important + Solvency II in EU
3
2
17. Goldman Sachs Asset Management
ALM Step by Step Process: Objectives & Constraints
Objectives & Constraints Objectives & Constraints Define objectives: total return, yield, capital efficiency, surplus
Target Investment Return 5.5% volatility
estment
Risk apetite / Volatility 4.5%
Determine insurance specific constraints:
Duration mismatch tolerance (yrs) 0.2
KRD mismatch tolerance (yrs) 0.1 • Tolerance for ALM mismatch
C
Step 1: Inve
• Exposure limits by asset class
Exposure Limits
Investment Grade Credit A & higher 80% • Regulatory / Statutory / Rating Agencies
Investment Grade Credit BBB 30% • Economic
High Yield Credit BB 10% Set risk appetite: portfolio volatility (asset-only), surplus volatility
MBS / ABS / CMBS 25%
(assets net of liability), earnings volatility…etc
9%
HY BB Long
8%
Step 2: Asset Universe
7% Cred Baa Long HY BB Int Choose from broad set of investible assets to maximize the risk-
tions
6% Cred A Long CMBS adjusted return
Cred Aa Long
U
Yie ld
• Asset classes’ risk-return profile are key to finding the most
classes
& Assumpt
5%
Cred Baa Int Govt Long
4% MBS
suitable solution
Cred A Int
3% ABS Correlations between asset classes and correlation of asset
Cred Aa Int
2% Govt Int
classes with liability profile are key to find risk-optimal solution
1%
0% 5% 10% 15% 20%
Total Return Volatility
For illustrative purposes only. Investment objectives and constraints may vary for each client.
4
Goldman Sachs Asset Management
ALM Step by Step Process: Liability Profile
160
Step 3: Liabilit Cash Flow
Liability Ca Flow ($mm)
Best estimate liability cash flows help construct portfolios
120
• Maturity profile of portfolio
80
ash
ile
• For products with embedded options, a dynamic approach
ty
Profi
should be used to reflect the variability of cash flows in different
40
market scenarios
-
2010 2015 2020 2025 2030 2035 2040
Year
2.5
Liability key rate durations (KRD) provide more granular view of
Step 4: Liability Key Rate
uration (yrs)
interest rate risk and help allocate the total duration risk to the
2.0
relevant maturity buckets
rofile
1.5
Asset portfolios that match liability KRD will minimize interest rate
Key Rate Du
Duration Pr
y
1.0 risk
0.5 • Better than duration match but not necessarily a cash flow
- match
6m 2y 5y 10y 20y 30y
Key Rate
For illustrative purposes only
5
3
18. Goldman Sachs Asset Management
ALM Step by Step Process: Strategic Asset Allocation
6.5%
Find portfolios that achieve target return and minimize the risk
Step 5: Surplu Efficient
6.0%
• Surplus volatility measures the volatility of assets net of
folio Yield
5.5% liabilities
tier
5.0% • Surplus volatility captures the impact of ALM (mis)match:
us
Front
Portf
4.5% – ALM mismatch more surplus volatility
4.0%
– Can be thought of as ALM mismatch tolerance on an
economic basis
3.5%
• Risk-return tradeoffs can be evaluated with and without
0.0% 1.0% 2.0% 3.0% 4.0%
constraints (duration mismatch tolerance, exposure limits…etc)
Surplus Volatility
Govt
5%
Securitized
Step 6: Strateg Asset
19% Cred AA Overall strategic asset allocation (SAA) decision should reflect
15% insurers’ objectives and constraints and incorporate ALM
objectives as well
gic
on
Allocatio
SAA can be used as benchmark for security-level portfolio
Cred BIG
construction
10%
Cred BBB Cred A
23% 28%
For illustrative purposes only. Portfolio construction will vary for each client based on constraints and objectives.
6
Goldman Sachs Asset Management
Risk of Rising Interest Rates, Steep Yield Curve and ALM
6.0%
5.0% 5.00% Current steep yield curve implies a forward rise
4.34% in interest rates
Treasury Yield
4.0%
3.75% • 10y Treasury yield implied to rise to 4.1%
Y
3.0% by 12/31/2010 (29bps yoy rise) and 4.6%
2.0% by 12/31/2011 (48bps yoy rise)
1.0% • 30y Treasury yield implied to rise to 4.9%
by YE2010 (21bps yoy rise) and 5.1% by
0.0%
YE2011 (24bps yoy rise)
0 5 10 15 20 25 30
WSJ economists forecasting survey forecasts
Term (yrs)
10y Treasury yield at 4.34% by YE2009
YE 2009 YE 2010
YE 2011 WSJ Forecasting survey - mean
WSJ Forecasting survey - 10th pctile WSJ Forecasting survey - 90th pctile
Historically low yields difficult to meet net investment income targets without investing longer than the liability
Risk of rising interest rates should one take a view and invest shorter than the liability ?
Source: Wall Street Journal Online Forecasting Survey, January 2010
For illustrative purposes only.
7
4
19. Goldman Sachs Asset Management
Case Study
SPIA Block 8.2 yrs Duration
Liability Cash Flows Liability Key Rate Durations
160
2.5
m)
Liability Cash Flow ($mm
Key Rate Duration (yrs)
120 2.0
1.5
80
1.0
40 0.5
-
-
6m 2y 5y 10y 20y 30y
2010 2015 2020 2025 2030 2035 2040
Key Rate
Year
Liability duration = 8.2 yrs
• KRD help construct portfolios that minimize interest rate risk need long duration (15y+ maturity), intermediate
duration (5-15y), and short duration assets
Liability discount rate for statutory reserving / pricing of product
• Target yield that matches liability discount rate / minimizes shortfall
For illustrative purposes only.
8
Goldman Sachs Asset Management
Case Study
Portfolio Construction – Economic View
6.5%
6.0%
Portfolio Yield
5.5%
5.0%
4.5%
4.0%
3.5%
0.0% 1.0% 2.0% 3.0% 4.0%
Surplus Volatility
At each target portfolio yield, minimize the surplus volatility, i.e. risk of assets net of liabilities
• Interest rate risk from liability is partially offset from asset portfolio duration
Interest rate duration
• Should Duration / KRD match be a constraint of optimization ?
• Should KRD (mis)match be a result of optimization (i.e. optimal net risk allocation may be slight long/short IR
duration + slight long credit risk)
For illustrative purposes only. Performance results vary depending on the client’s investment goals, objectives, and constraints. There can be no assurance that the same or similar
results to those presented above can or will be achieved. 9
5
20. Goldman Sachs Asset Management
Case Study
IR Duration Risk: Should KRD match be a Constraint?
6.5% 2.0
Net long
Asset - Liability Duration (yrs)
6.0% 1.5
duration
Portfolio Yield
d
5.5% 1.0
5.0% Less efficient
due to KRD 0.5
4.5% constraint
-
4.0% 3.5% 4.0% 4.5% 5.0% 5.5%
(0.5)
3.5% (1.0) Net short
0.0% 1.0% 2.0% 3.0% 4.0% duration
(1.5)
Surplus Volatility Portfolio Yield
KRD matched KRD constraint relaxed KRD matched KRD constraint relaxed
Imposing KRD match as a constraint implies that the only net risk between assets and liabilities is credit risk
• May result in less diversified results than allowing for some rate risk + some credit risk + diversification benefit
• Minimizing surplus volatility “naturally” results in approximately matched duration
• Unconstrained net duration gap may range from short ~ 1 yrs to long ~1.5 yrs
For illustrative purposes only. Performance results vary depending on the client’s investment goals, objectives, and constraints. There can be no assurance that the same or similar
results to those presented above can or will be achieved. 10
Goldman Sachs Asset Management
Case Study
KRD Matching Efficient Portfolios
6.5% 100% Securitized
90% HY BB Long
6.0%
80% HY BB Int
eld
5.5%
5 5%
Portfolio Yie
70%
Cred Baa
5.0% 60% Long
Cred Baa
50% Int
4.5% Cred A
40% Long
4.0% Cred A Int
30%
3.5% 20% Cred Aa
Long
0.0% 1.0% 2.0% 3.0% 4.0% 10% Cred Aa Int
Surplus Volatility 0% Govt Long
3.7%
3.8%
3.9%
4.0%
4.1%
4.2%
4.3%
4.4%
4.5%
4.6%
4.7%
4.8%
4.9%
5.0%
5.1%
5.2%
5.3%
5.4%
5.5%
5.6%
KRD matched KRD constraint relaxed Govt Int
All portfolios match liability KRD within 0.1 yrs tolerance (and 0.2 yrs for overall duration)
• Exposure limits set maximum exposures to e.g. Corp Credit BBB, below investment grade credit (BIG),
Securitized products (ABS/MBS/CMBS)
Is it “worth” taking some IR duration risk and increasing the available yield for a given level of surplus risk ?
For illustrative purposes only. Performance results vary depending on the client’s investment goals, objectives, and constraints. There can be no assurance that the same or similar
results to those presented above can or will be achieved. 11
6
21. Goldman Sachs Asset Management
Case Study
To Match or Not To Match ?
6.5% 100%
Impact of +50bps rise in rates B
6.0% 90%
Securitized
80%
ield
5.5% A HY BB Long
Portfolio Yi
70% HY BB Int
5.0%
60% Cred Baa Long
4.5% Cred Baa Int
50%
Cred A Long
4.0% 40%
Cred A Int
3.5% 30%
Cred Aa Long
0.0% 1.0% 2.0% 3.0% 4.0% 20% Cred Aa Int
Surplus Volatility 10% Govt Long
0% Govt Int
KRD matched KRD constraint relaxed
KRD matched +50bps impact KRD constraint relaxed + 50bps impact A B
Is it “worth” taking some IR duration risk and increasing the available yield for a given level of surplus risk ?
g g y g p
Taking interest rate duration risk by investing longer than the liability may result in higher or lower returns
• Not KRD matched = more risk = (much) wider range of potential outcomes
Insurer’s statutory balance sheet does not coincide with pure economic / mark-to-market view
C-3 Phase I and Cash Flow Testing will pick up ALM mismatch
Does the “economic” risk of being net long duration lead to any statutory balance sheet impact ?
Which portfolio is better: A or B?
For illustrative purposes only. Performance results vary depending on the client’s investment goals, objectives, and constraints. There can be no assurance that the same or similar 12
results to those presented above can or will be achieved.
Goldman Sachs Asset Management
Case Study
Portfolio A (KRD matched) vs. Portfolio B (mismatched)
Portfolio A: 8.2 yr duration / 5.7% yield Portfolio B: 9.7 yr duration / 6.2% yield
160 160
mm)
mm)
Cash Flows ($m
Cash Flows ($m
120 120
80 80
40 40
0 0
2010 2015 2020 2025 2030 2035 2010 2015 2020 2025 2030 2035
Year Year
Liability Assets (not default-adjusted) Liability Assets (not default-adjusted)
3.0 3.0
uration (yrs)
uration (yrs)
2.0 2.0
1.0 1.0
- 0.0
00
Key Rate Du
Key Rate Du
(1.0) 6m 2y 5y 10y 20y 30y (1.0) 6m 2y 5y 10y 20y 30y
(2.0) (2.0)
(3.0) (3.0)
Key Rate Key Rate
Liability Assets Net Liability Assets Net
Is the extra 50bps in yield worth the risk of running a 1.5 yrs duration mismatch ?
For illustrative purposes only. Performance results vary depending on the client’s investment goals, objectives, and constraints. There can be no assurance that the same or similar 13
results to those presented above can or will be achieved.
7
22. Goldman Sachs Asset Management
Case Study
Portfolio A vs. Portfolio B: Unrealized Gains & Losses
Portfolio A: 8.2 yr duration / 5.7% yield Portfolio B: 9.7 yr duration / 6.2% yield
4 4
mm)
mm)
Unrealized gain/loss ($m
Unrealized gain/loss ($m
2 2
- -
2010
2015
2020
2025
2030
2035
2040
2010
2015
2020
2025
2030
2035
2040
(2) (2)
(4) (4)
(6) (6)
(8) (8)
Maturity Year Maturity Year
Total URG/L URG/L non-Fin URG/L Fin Total URG/L URG/L non-Fin URG/L Fin
Assets and Liability cash flows, book value, market value are projected forward for Portfolio A & B
Disinvestment / R i
Di i t t Reinvestment assumptions used t d id which assets t sell / what t reinvest i
t t ti d to decide hi h t to ll h t to i t in
• Disinvestment: rank assets by maturity year, then inside of each maturity bucket rank by size of unrealized
gains / losses
• Sell short maturity assets with least unrealized losses (most gains) first
• Reinvestments: reinvest in 10y A corporate bond (shorter if final maturity of 2040 is < 10y away)
Liability statutory discount rate assumed to be 6% for calculating statutory reserves and surplus
For illustrative purposes only. Performance results vary depending on the client’s investment goals, objectives, and constraints. There can be no assurance that the same or similar 14
results to those presented above can or will be achieved.
Goldman Sachs Asset Management
Statutory Surplus Projection
Portfolio A vs. Portfolio B on Forward Rates Scenario
Portfolio A: 8.2 yr duration / 5.7% yield Portfolio B: 9.7 yr duration / 6.2% yield
20 20
PV Statutory Surplus ($ mm)
PV Statutory Surplus ($ mm)
10 10
- -
2009 2014 2019 2024 2029 2034 2039 2009 2014 2019 2024 2029 2034 2039
(10) (10)
(20) (20)
(30) (30)
(40) (40)
Forwards Forwards + 150bps steepness Forwards Forwards + 150bps steepness
Portfolio A closely KRD matched but not completely Portfolio B suffers cash flow shortfalls in early years
cash flow matched • Assets must be sold to meet liquidity needs
• Surplus initially dips: portfolio yield < liability • Realized gains and higher portfolio yield lead
discount rate to better result than A on the “Forwards”
• Portfolio yield eventually overtakes liability scenario
discount rate Rising rates reduce unrealized gains and forced
Rising rates lead to better statutory surplus asset sales to meet liquidity needs result in realized
losses much worse surplus result than A
• Reinvested (slight) excess cash flows earn
higher yield
For illustrative purposes only. Performance results vary depending on the client’s investment goals, objectives, and constraints. There can be no assurance that the same or similar 15
results to those presented above can or will be achieved.
8
23. Goldman Sachs Asset Management
Statutory Surplus Projection
Portfolio A vs. Portfolio B in Rising/Falling Rates
Portfolio A: 8.2 yr duration / 5.7% yield Portfolio B: 9.7 yr duration / 6.2% yield
100 100
$mm)
$mm)
PV Statutory Surplus ($
PV Statutory Surplus ($
50 50
- -
2009 2014 2019 2024 2029 2034 2039 2009 2014 2019 2024 2029 2034 2039
(50) (50)
(100) (100)
Dec 5y Inc 5y Forwards Dec 5y Inc 5y Forwards
Forwards + 150bps steepness Inc 5y Dec 5y Forwards + 150bps steepness Inc 5y Dec 5y
Level Pop Down Level Pop Down
Pop Up Unif. Dec 10y Pop Up Unif. Dec 10y
Unif. Inc 10y Unif. Inc 10y
Portfolio A very closely cash flow matched Portfolio B suffers cash flow shortfalls in early years
• No asset sales are required to meet cash flow • Assets must be sold to meet liquidity needs
needs • High sensitivity to interest rates scenarios
• Low sensitivity to interest rates scenarios • Great results in falling rates scenarios
• Lowest risk strategy • Painful results in rising rates scenarios
PV of ending surplus is $2mm on average with a PV of ending surplus is $8mm on average with a
range of +/- $4mm range of +/- $50mm
For illustrative purposes only. Performance results vary depending on the client’s investment goals, objectives, and constraints. There can be no assurance that the same or similar 16
results to those presented above can or will be achieved.
Goldman Sachs Asset Management
Case Study
Conclusions
Rebalancing from portfolio B (duration mismatched but higher yield) to portfolio A (matched but lower yield)
would result in (for $1bn book value):
• R d ti i portfolio yield f
Reduction in tf li i ld from 6 2% t 5 7%
6.2% to 5.7%
• Sale of $261mm book value of assets (25% of portfolio), purchase of $257mm of assets
• Realized losses of $11mm (1.1% of book value)
• Day one net impact to statutory surplus of $(18)mm (1.8% of book value) [may be less due to
IMR/AVR]
Resulting outcome of rebalancing from A to B is to lock-in a statutory loss of $(16)mm with a potential range
of +/- $4mm
• Portfolio B results in a PV expected statutory surplus of $8mm with a potential range of +/-$50mm
p y p $ p g $
Importance of defining / analyzing risk-return trade-offs and implications on economic, statutory, and
accounting basis
When deciding whether to take risk or not, risk-adjusted returns are key metric
For illustrative purposes only. Performance results vary depending on the client’s investment goals, objectives, and constraints. There can be no assurance that the same or similar 17
results to those presented above can or will be achieved.
9
