2. AGENDA
► Why is Assets and Liability Management (ALM) necessary in the life
insurance business for its financial health and what are the
implications?
► How assets and liability management is performed in the life
insurance business?
► What are the factors affecting the ALM?
► What are the issues and challenges in the Indian market in
managing the ALM risk?
► What are the simple measures used in managing the ALM risk?
3. To manage Change in interest rate risk?
Assets Liability
Longer in term
ShorterinTerm
Change in
Liability
Change in
Assets Change in Assets
minus Liability
Risk= Exposure*Duration Gap
Impact the bottom line
Delta “I”
(ALM)
4. Nature of Liability- types of Products
Unit Linked
Products
Non-Participating
Product in Profit
Participating
Product in Profit
Maturity depends
on Market Value
Guaranteed
Liability on
Maturity
Guaranteed +
Discretionary
Benefit
No ALM Risk High ALM Risk Medium ALM Risk
Increasing Guarantees
with term through bonus
additions
5. 2001-2010 2010 Post 2010
Pre-dominantly
ULIP were sold
IRDA-SEBI Spat on
ULIP products and
subsequent
restrictions on
charges by IRDA
Market moved to
Traditional
Products
Indian Product Market Scenario
Par
Non-Par
Many Players Selling Par
Many Players Selling
Term product with only
death benefit
Some players are selling
products with maturity
guarantee
X
6. Par Non-Par
Guaranteed Sum Assured
(GSA)- Small in Amount
Bonus (B) every year that
becomes guaranteed on
maturity and Death
Death Benefit = GSA + B
Bonus declared up to time of
death
Maturity = GSA+B+TB
TB= Terminal Bonus
Guaranteed Sum Assured (GSA)
Bonus = NIL
Death Benefit = GSA
Maturity = GSA
Total Pay out Rs.500,000/-
Total Bonus= 300,000
Similar to
fixed and
floating
interest rate
GSA = 200,000
8. Par Non-Par
Increasing Guarantee but has a
slow increasing Guarantee
Interest rate risk is medium/low
ALM is important
Maturity = GSA+B+TB
TB= Terminal Bonus
Has Guarantee at the on set
Interest rate risk is very high
ALM is very important
Current risk in the Indian Market is
from fall in future interest rate
Focus Point
9. Lets look at a simple example:
► An insurance company collects premium from customers and provides a guaranteed return
of 6% over the policy period (which is say 20 years);
► Further, the premium collected from customers is invested in Corporate Bonds/Govt
Securities at a return of 8%.
6 months later, the interest rate falls to 5%. What’s the impact on the insurance company:
► Insurance company faces the risk of reinvestment of future premium at lower interest
rates. Incase fall in interest rate is permanent, the company may have to pay from its
pocket as the returns are guaranteed for the customer.
In the above scenario, what would be the risk if interest rates were to fall to 7% in place of 5%?
► Profit Margins will get compressed as the Insurer will earn less return on the investment.
So an insurer has a risk of ‘falling’ interest rate.
10. Reinvestment
Risk
Liability
Duration at
times has
absurd value
Liquidity Risk
In the event of
fall in interest
rate future
premium will be
invested at
higher price
Due to the
nature of the
liability cash
flows, duration
value is assured
For a long term
products such as
whole life
product,
maximum term
of assets could
be around 30
years or so
Hedging
instrument
Shorter Asset
Term
Indian Regulator
has just allowed
using interest
rate derivatives
to hedge the
risk.
Initial days
In case of mass
surrender, risk
of liquidity
11. Assets Longer than Liability Liability Longer than Assets
Rise in Interest rate is a risk
Assets to be sold @ cheaper price
on liability maturity
Example- General Insurance and
Health Insurance Products
Shareholder’s Fund
Fall in interest rate is a risk
Reinvestment risk of future
premium
Typical Life Insurance long term
products
Maturity = GSA
Invest Short term Invest longer term
12. Duration
Matching
Cash flow
matching
Regulatory
minimum
requirement
Some players are
matching
duration of assets
and liability
Project Assets
and Liability cash
flow into future
and invest assets
based on the
visual gap
Calculate
exposure on
change in interest
rate by 1 bps
Strategic Assets
Allocation
It has its own
challenges
Simple, but lack
quantification
PVBP
Some may be
using
Allocate Assets
on criteria such
as profit, keeping
risk within
appetite and stay
within
constraints
?
14. Assets Liability Default
Assets are
Longer- Loans
Liabilities are
shorter-
Deposits
Liquidity risk
is more
prominent
ProductsLiquidity
What can be learnt ?
Assets are
Shorter
Liabilities are
Longer
Liquidity risk
is less
prominent
Par and Non-
Par
Floating and
Fixed Rates
Premium
Lapse
EMI Default
Banking
Life
Insurance
15. Level Premium
Increasing Benefits
in a probabilistic
sense
Shorter Tenure of
Assets
Liability are due to
the customer and
Cannot be
adjusted
ALM focus on
Optimizing assets
portfolio given
the liability
Match Assets by
“Nature”, “Term &
"Currency” of
Liability
20. Year 1 Reserves: INR 237,862
Purchase assets equal to the value of INR 237,862
Questions
How to purchase assets equivalent to INR 237,862:
► What will be the term of the Bonds?
► How much money you will be kept in short term assets to maintain liquidity ?
► What should be the optimal mix of assets?
Answers
Asset purchasing philosophy: Purchase assets in a manner that it matches the:
► Nature of Liability (Guaranteed, Discretionary, Linked),
► Term (Duration of assets = Duration of Liability), and;
► Currency of Liability (Invest in same currency as liability)
