Academic journal article Journal of Risk and Insurance

Asset/liability Management for the Life Insurer: Situation Analysis and Strategy Formulation

Academic journal article Journal of Risk and Insurance

Asset/liability Management for the Life Insurer: Situation Analysis and Strategy Formulation

Article excerpt

Asset/Liability Management for the Life Insurer: Situation Analysis and Strategy Formulation

ABSTRACT

Asset portfolios of life insurers support the performance of obligations to customers and contribute to the profitability of insurers. The obvious risks associated with these portfolios are magnified by the instability of financial markets. Insurers should have a heightened awareness of the simultaneous effects of unstable markets and changes in interest rates not only on the assets, but also on liabilities. This study examines the current operational status and planning procedures of seven asset/liability management processes appropriate for life insurers and offers recommendations.

Introduction

The concepts and techniques of asset/liability management (ALM) [see Babbel and Stricker (1987), Babbel and ,amm-Tennant (1987)] are of concern to both industry leaders and academicians. The simultaneous effects of unstable financial markets and changes in interest rates on both the assets and liabilities of insurers have resulted in the recognition of ALM as a necessary part of prudent portfolio management. Before implementing a comprehensive ALM process, a life insurer should complete a strategic planning process which includes three distinct phases: situation analysis, strategy formulation, and implementation. This study analyzes the planning, evaluation and use of ALM techniques appropriate for the life insurance industry. In addition, the advantages and disadvantages of each technique are identified. Guidelines for an investment management strategy are provided based on situation analysis. Further research is necessary for completion of the strategy formulation and implementation phases.

The article proceeds in the following manner: data source and respondents are described; the first phase of a strategic ALM plan--situation analysis--is addressed by analyzing the current operational status of seven ALM processes and the planning/evaluation procedures currently used by the industry regarding ALM; and conclusions and recommendations are given.

Data and Survey Method

A survey of management philosophy and utilization rates of seven ALM techniques was mailed to senior investment officers at a random sample of 250 life insurers, during late 1986 and early 1987. Seven ALM techniques were identified in the survey, nevertheless other techniques or variations may be appropriate for a particular product or circumstance. Respondents were invited to discuss these additional ALM techniques, such as dedication or contingent immunization. Ninety-four insurers responded; 102 were represented because, in some cases, the investment process was centrally performed for a group of insurers. Respondents were invited to submit a partially completed questionnaire whenever data were unavailable. As a result, all questions yielded fewer than 94 responses.

Respondents were profiled by six characteristics: organizational type, location, size, number of state licenses, product mix, and asset mix. The respondents are a fair representation of the industry. Forty-two percent of the firms are mutual insurers and 58 percent are stock insurers. Home offices of the firms are predominantly located in the northeast although all regions of the United States are represented. Seventy percent of the firms report net invested assets of $4 billion and less, whereas 30 percent report net invested assets greater than $4 billion. Forty-four percent of the firms are licensed to sell insurance products in 50 states with the remaining 56 percent licensed to sell in fewer states. The product mix of the firms include numerous interest sensitive products and the representation of these products as a percentage of net statutory liabilities is significant. Exposure to interest rate risk is evident among the firms due to a significant percentage of invested assets held in long-term bonds. …

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