ALL - ACTSC 445 Asset-Liability Management Fall 2006...

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ACTSC 445: Asset-Liability Management – Fall 2006 Department of Statistics and Actuarial Science, University of Waterloo Unit 1 – Introduction What is Asset-Liability Management (ALM)? (From SOA’s Professional Actuarial Specialty Guide on ALM) “ALM is the practice of managing a business so that decisions and actions taken with respect to assets and liabilities are coordinated.” “ALM can be de±ned as the ongoing process of formulating, implementing, monitoring and revising strategies related to assets and liabilities to achieve an organization’s ±nancial objectives, given the organization’s risk tolerances and other constraints. ALM is relevant to, and critical for, the sound management of the ±nances of any organization that invests to meet its future cash ²ows needs and capital requirements.” 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 prespeci±ed 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 ful±ll all the loan requests. Here are a two recent actual examples of what can happen when a 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 and having about 17 billion US$ in assets, was o³ering individual annuities at a rate of 5 or even 5.5%. The company had a signi±cant portion of its assets invested in government bonds, and when the rates for those dropped to record (low) levels, the wide gap between the promised return on its liabilities and the one earned on its assets caused the company to go bankrupt (and was the ±rst japanese insurance company to do so in over 50 years). In 1999, General American Life in the US had issued for 6.8 billion US$ of short-term funding agreements at a quite interesting rate, and with the provision that the investors could ask to be reimbursed within 7 days. When Moody’s downgraded the credit rating of General American Life from A2 to A3, several investors asked to be reimbursed. In fact, a few days after the 1
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downgrading, a total of 4 billion dollars needed to be reimbursed, which made it impossible for the company to sell its assets quickly enough to satisfy all the reimbursement requests. The company eventually was sold to MetLife.
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ALL - ACTSC 445 Asset-Liability Management Fall 2006...

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