Life Insurance IPS

CFA Level III
#1

A few q’s on life insurance IPS:

  1. So segmentation divides the assets and liab into ones that ‘match’ each other and you are left with a surplus portfolio (hopefully), is that correct?

  2. How do you know if the surplus portfolio is sufficiently covering any duration mismatches?

  3. If duration of assets are less than duration of liabilities then that’s not ideal (re-investment risk) but better than the other way round right?

  4. there is a lot of talk of spread management which is just where return from assets is greater than what you have to pay from liabilities however how does this fit into the surplus portfolio? Is the surplus portfolio just a result of spread managment?

  5. Let’s say we have a portfolio of bonds where we are receiving 300k semi-anually, we then have a load of liabilities where we are paying 200k semi-annually so we are net recieving 100k semi-anually which we put in a surplus portfolio in equities. Is this in practice what happens?

  6. it’s getting late and maybe i just can’t think striaght but why are life insurance companies sensitive to losses from increasing Interest rates? Is is just because the value of fixed income assets would decrease? Although that would only be realised if sold.

This stuff is really confusing me, any help on any of the above would be greatly appreciated.

cheers!

#2

  1. Segmentation helps insurance companies make different risk/return decisions depending on product lines. Nothing to do with surplus. Companies have surplus because you were told that it has surplus in question. A company could have accumulated surplus becuase of many reasons: previous years profits, equity, returns from invested assets etc.

  2. Surplus does not cover the duration liabilities. Your insurance product assets are supposed to cover liabilities duration. Where does the assets come from? From the insurance premiums.

  3. Either way it is risk. Duration of assets = Duration of liabilities is close to no risk. In general reinvestment risk is less when interest rates are going up as you can invest your coupons at higher rates.

  4. Yep, surplus could be result of addtional spread you made over the years, which is profit itself. Surplus portfolio is beyond any legal and regulatory coverage. So surplus portfolio could be invested with Asset Only approach for maximum return.

  5. Sure, if you say 100k is profit and you have met all your liabilities with the 200k. You could add it to surplus, you can distribute it as dividends, grow the company.

  6. Disintermediation. Life insurance policies have option that lets the insurance holders borrow money. So if interest rates are rising your insurance holders may borrow money from to invest at higher rates and profit . So if you have invested in long duration bonds, your bond values goes down due to interest rates rise and you are forced to sell of if the insurance holders start borrowing.

#3

thanks a lot! Really appreciate the help - a followup question if you may.

  1. fine, thanks.

  2. I see what you are saying but surely if there is an asset liab mismatch such that liab duration is less than asset duration then they can use the surplus to cover it no? Therefore my point being when you are looking at asset liablility mismatches of the portfolio, if you have a large surplus, is it fair to say that the risk is not extremely high as the surplus can be used to cusion any liablities that come due.

  3. ok thanks.

  4. thanks

  5. thanks

  6. makes sense - thanks.

#4

Large surplus ==> High risk tolerance. You can do what you want with surplus. Yes, use surplus, if you like, to bring assets duration to match liabilities.

#5

I can say the answers provided by janardhanc is solid, and i agree with them.

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