Asset Liability Management Best Practice in Insurance

Transcription

1 Asset Liability Management Best Practice in Insurance Joint Regional Seminar 2017

2 1 Investment Environment 2

3 Investment Strategy Impacting Factors Investment Strategy (SAA / ALM) 3

4 Assessment of Vulnerability In a Low for Long Scenario 4

5 Assessment of Vulnerability In a Low for Long Scenario 5

6 2 Economic Scenarios 6

7 There are many types of Economic Scenarios A broad range of tasks in risk and financial management are commonly addressed using scenarios describing potential future events for financial, economic and other variables Business planning and stress-testing Economic Valuation of complex lifeinsurance liabilities Deterministic Risk-based decision making Stochastic Market Consistent (MC) Solvency capital requirements Assetallocation and ALM? Stochastic Real World (RW) Nested Stochastic RW -> MC 7

8 3 ALM Framework 8

9 ALM modelling - a general scenario-based framework time=0 time=1 time=2 Scenario 1 Scenario 2 Scenario 3 Economic scenario (market & non-market risk factors) Business management model 9

10 ALM modelling Zoom in on the business management model Account for revenues and expenses Update liability portfolio Update asset portfolio Calculate Balance Sheet Account for shareholder cash flows Investment income Premiums Claims Mortality Lapses New business Investment of revenues Rebalancing Available capital Required capital Dividends Capital injections Maintenance expenses Tax (Dynamic) Asset/Liability management actions Stochastic / Factor Based? 10

11 4 Strategic Asset Allocation Approaches 11

12 Return Traditional Strategic Asset Allocation (SAA) Approach Mean Variance Optimisation (MVO) ASSUMPTIONS + HISTORICAL DATA T=0 T=1 (5y) ASSET 1 Return / Risk / Correlation Optimiser Risk Strategic Asset Allocation Formulate AVG EXPECTED RETURN AVG EXPECTED RISK CORRELATION ASSET 2 ASSET 3 Limitations Single period - constant risk & return over planning horizon Use historical data to calculate correlation, risk and return Risk is defined as volatility of returns Asset correlation defined as single linear relationship Assumes portfolio is instantly restructured to target Assumes portfolio remains at target allocation Cant capture dynamic strategies 12

13 More Effective SAA Construction Business Stakeholders Inc Management Risk based metrics Consider Liabilities Strategic Strategic Strategic Strategic Asset Asset Allocation Asset Allocation Asset Allocation Allocation Test SAA Full ALM Cash - Flow Model Liabilities Adjust SAA Policy Data / Scenarios Management Actions / Stress Scenarios 13

14 Return Stochastic Strategic Asset Allocation Approach Calibration Projection T=0 T=5 Initial Portfolio Selection Own Capital Market Views 5k+ Real World stochastic scenarios Asset Returns Current & Historical Market Data ASSET 1 Asset Returns Optimiser (MVO) Risk Select Candidate Portfolios Forward Looking Model calibrations ASSET 2 ASSET 3 Liability value / cash flows Market Risk factors (structural) Insurance Risks (statistical) Asset Returns Liability / Risk Factors Scenarios Policy Data Liabi lities Balance Sheet Projection Optimisation / Light ALM Full ALM Cash flow Model Stochastic Risk Measure Analyse & Select Optimal Portfolio (SAA) 14

15 Why are these advanced modelling capabilities Important? Multi time step Path dependency Reinvestment / rebalancing Dynamic management actions / trading strategies Changing risk over time is captured Full distribution of outcomes Economic structure & consistency Cash flows in and out, pay-outs, coupons Relevant risk metrics (SCR, EC, impairment) Capture A-L interaction Forward Looking, inc market expectations Incorporate own views Realistic dynamic features (stochastic vol, jumps) Regulation & Accounting Standards Dependency structure / joint behaviour 15

16 5 Case Study: Intro 16

17 Nature of ESG Economic structure & consistency Multi time step Full distribution of outcomes ESG is» Comprehensive mathematical model to project distribution over multiple time steps Economic factors Modelled assets ESG is NOT» Crystal Ball We Provide ESG, but there is no way to tell you the future deterministically» Simple Random Number Generator or Simple Mean-Variance Model It does contains random number generator More importantly, we bring in the realistic economic structure 17

18 ESG Economy Model Structure Equity Returns Property Returns Alternative Asset Returns (e.g. Commodities) Corporate Bond Returns Credit Risk Model Initial swap and government nominal bonds Nominal Short Rate Inflation Expectations (Nominal - Real) Exchange Rate (PPP or Interest Rate Parity) Index linked government bonds Real Short Rate Realised Inflation and Alternative Inflation Rates (e.g. Medical) Foreign Nominal Interest Rate Structural relationships and correlations ensure plausible dependencies between asset classes 18

19 ESG is Structural Economic Model» Simple statistical model (mean-variance model) does not have realistic economic structure Single period (either considering 1-year or considering 10-year) No dynamic strategies (reinvestment, HTM, tradable, etc) Correlation, volatility and return does not capture all economic structure (like fat-tail, skew, etc) Correlation in mean-variance model is linear (no tail-dependence) Risk is constant over time (but it should be time-dependent) Long term bond subject to interest rate risk Short term bond subject to reinvestment risk 19

20 6 Case Study: Asset & Liability 20

21 Case Studies on Participating Business For ring-fenced participating business, at least 70% of excess return over guarantees belong to customers, let s consider two cases» 1-year term participating business (guarantee rate same as Gov t bond of same tenor)» 10-year term participating business (guarantee rate same as Gov t bond of same tenor) Maturity benefits and maturity dividend are only considered components in cash flow (death benefits & surrender benefits are ignored) Available assets:» Equities» 1-year government bonds and corporate bonds with various ratings (HTM)» 10-year government bonds and corporate bonds with various ratings (HTM) Goal is to construct efficient frontier for asset allocation strategy 21

22 Methodologies» Economic Scenarios are adopted» Using light ALM methodologies here Only consider the profit realized at the end of policy period We don t consider liability valuation at each time step It s simple but brings impressive results» Using 1,000 sample allocation strategies (out of whole allocation space) to construct efficient frontier» We will try to compare Traditional MVO on asset side only versus Linking liability participation and outgo together and considering tail risk (VaR) 22

23 7 Case Study: Importance of Linking Liability 23

24 SAA for 1-Year Business (Only Asset Side) Based on ESG, applying MVO, considering 1,000 allocation strategies Return Metric: Mean return (Y-Axis), Risk Metric: Volatility (X-Axis) It s very common seen efficient frontier Higher equity allocation leads to higher return More risky investment leads to higher return 24

25 SAA for 10-Year Business (Only Asset Side) Based on ESG, applying MVO, considering 1,000 allocation strategies Return Metric: Mean return (Y-Axis), Risk Metric: Volatility (X-Axis) It s very common seen efficient frontier Higher equity allocation leads to higher return More risky investment leads to higher return 25

26 SAA for 1-Year Participating Business Based on ESG, applying stochastic asset and liability interaction model, considering 1,000 allocation strategies Return Metric: Mean profit of 1-year term (Y-Axis), Risk Metric: Worst 1 th percentile loss (X-Axis) 一年期分红险回报和风险 Return and Risk for 1-year Par Business 一年期分红险权益投资占比和回报 Return and Equity Ratio for 1-year Par Business (500.00) (1,000.00) (1,500.00) (500.00) 1, , , , , , , Why it s so different? Most efficient point is to hold 1-year high spread IG bonds» Invest in high-risk instrument (equity), all risk is borne by company (worst 1th percentile), but 70% of upside potential belongs to policyholders % 10% 20% 30% 40% 50% 60% It can be understood under binomial tree:» Investment return: 50% to get 42%, 50% to lose 20% (mean return is 11%)» Best scenario to earn 12.6% (only 30% of 42%), while worst case to lose 20% (100% of 20%). The mean profit is -3.7% (NOT 11%!) 26

27 SAA for 10-Year Participating Business Based on ESG, applying stochastic asset and liability interaction model, considering 1,000 allocation strategies Return Metric: Mean profit of 10-year term (Y-Axis), Risk Metric: Worst 1 th percentile loss (X-Axis) 10, , , , , , , , , , Return and 十年期分红险回报和风险 Risk for 10-year Par Business - (5,000) - 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 Risky investment benefit from longer horizon» Diversification» More chance to recover from loss» Redline is the capital market line Return 十年期分红险权益投资占比和回报 and Equity Ratio for 10-year Par Business 0 0% 10% 20% 30% 40% 50% 60% Higher allocation lower marginal return for risky investment» Every unit increase on equity investment brings out lower marginal return 27

28 8 Case Study: What Other Factors Matter? 28

29 Does the Participating Rule (Sharing Rule) Matter? Return and Risk 十年期分红险回报和风险 for 10-year Par Business (70/30) Return and Risk for 10-year Par Business (90/10) 10, , , , , , , , , , (5,000) - 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 Lower policyholder participation leads to more aggressive investment» Closer to shareholder own fund (return and risk are more aligned) Higher policyholder participation leads to more conservative investment» Insurers have to provide guarantees» Less alignment on return and risk 29

30 Does the Asset Position Matter? Guarantee at the money Asset = Guaranteed Liability Guarantee out of the money (Asset >> Guaranteed Liability) Return and Risk 十年期分红险回报和风险 for 10-year Par Business (70/30) Return and Risk for 10-year Par Business (70/30) 10, , , , , , , , , , (5,000) - 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 Lower asset position will make you less aggressive» When the investment performs well, majority of benefit goes to policyholders, but not the company Higher asset position will allow insurers to pursue higher return» Because guaranteed outgo has been met, very low probability for downside» Hence, return and risk are more aligned 30

31 Any Others?» Quite a Lot! Economic Environment (Interest Rate, Volatilities of Different Assets, etc) Other Features» Dividend / Bonus Options (Reversionary Bonus, Cash Dividend, Dividend on Deposit, Terminal Bonus, etc)» Surrender Benefits» Guarantee Annuitization Option Management Actions» The Actions Management is Willing and Able to Undertake (Cut Bonus / Increase Bonus, etc) Policyholder Behaviours» Dynamic Lapse / Surrender Based on Different Market Environment» It s important to bring liability and asset & realistic interaction together to make better decision 31

32 9 Summary 32

33 Key Point Summary» Internal business requirements & complicated economic environment are motivating Insurers to enhance their ALM framework» As emphasized by regulators» Operational disjoint between Asset and Liability sides of an Insurers business makes investment decisions inefficient (traditional MVO approach)» An integrated ALM framework using economic scenarios gives Insurers a more realistic Risk Adjusted view and results in efficient investment strategies 33

34 moodysanalytics.com Paul Manson Director, ERS Insurance Advisory Office: Ken Liang Assistant Director, Actuarial Modelling Service Office: HK Mobile: China Mobile:

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