Introduction

Introduction - ACTSC 445: Asset-Liability Management...

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ACTSC 445: Asset-Liability Management Department of Statistics and Actuarial Science, University of Waterloo Unit 1 – Introduction What is Asset-Liability Management (ALM)? “ALM can be defined as managing a financial institution so as to earn an adequate return on funds invested, and to maintain a comfortable surplus of assets beyond liabilities” (from “Quantitative Risk Management”, by McNeil, Frey and Embrechts) “ALM is the practice of managing a business so that decisions and actions taken with respect to assets and liabilities are coordinated. (. . . ) It can be defined as the ongoing process of formulat- ing, implementing, monitoring and revising strategies related to assets and liabilities to achieve an organization’s financial objectives, given the organization’s risk tolerances and other constraints. ALM is relevant to, and critical for, the sound management of the finances of any organization that invests to meet its future cash flows needs and capital requirements.” (From SOA’s Professional Actuarial Specialty Guide on ALM) Why ALM? Was initially developed to deal with interest rate risk, which became a major concern in the 1970’s, when rates increased substantially and became quite volatile. For instance, insurance companies often sell products that are sensitive to interest rates: an obvious example is the option given to the policyowner to take a loan on the policy at a prespecified interest rate. Before the 1970’s, insurers did not expect this option to be exercised very often, except under special personal circumstances. However, when rates went up in the late 1970’s and early 1980’s, several policyowners decide to exercise this option and invest the loan at a much higher rate than the lending rate. Insurance companies thus needed cash on a much shorter term than anticipated, and often had to borrow money at a very high price to fulfill all the loan requests. Here are a two recent actual examples of what can happen when an insurance company does not properly manage its assets and liabilities: In 1997, Nissan Mutual Life , a major insurance company in Japan covering 1.2 million clients
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This note was uploaded on 06/27/2009 for the course ACTSC 445 taught by Professor Christianelemieux during the Spring '09 term at Waterloo.

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Introduction - ACTSC 445: Asset-Liability Management...

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