Insight Session: Asset Liability Management in a Low Interest Rate Environment

It was a useful session that SKL consultants have attended yesterday. The speakers Anthony Carey (Head of Investments at CommInsure) and Chit Wai Wong (Data Analytics Manager at AIA) have discussed the challenges for the insurance industry that were caused by the low interest rate environment in the recent years. The session explored the considerations involved in developing an ALM framework and practical applications including the setting of liability assumptions for interest rate and inflation.

Hedging Objectives

Which is more important to your company?

1. Manage earnings volatility
2. Ability to remit planned dividends
3. Consideration of above depending on risk appetite

Low Interest rate environment

  • Discussions related to a low interest environment are typical related to product design and policyholder behaviours (annuities, GIMBs, etc.)
  • From a return on regulatory capital perspective: (Credit Risk capital charges ~6% & Equity/ Property/ Risk capital charges ~35%)


  • Stark differences in capital charges may limit the appetite for growth assets
  • In a low interest rate environment. The insurance industry may not perform as well relative to other unregulated industries
  • Industry concentration on credit risk

What could be done?

Limited options within the constraints of LAGIC

Influence APRA to consider an alternative approach in setting capital risk charges:

  • Start with a view of an ideal SAA that is appropriate for the industry with an appropriate weighing for growth assets
  • Reporting considerations to reduce noise from movement in credit spreads driven by market sentiment

Practical consideration for ALM

Liability side:

  • Accurate & appropriate granular interest rate and inflation rate
  • Dependent upon liability economic assumptions
  • Interest rate exposures to be managed with assumptions: Monthly, market rate & full curve
  • Inflation rate exposures to be managed with assumptions: Monthly, market index/ BEI & full curve

Asset side:

Strategy | “Matching” vs “Hedging”

Which one to use?

  • Size of exposures to be managed
  • Precision of outcomes ALM required
  • Swap or bond yield
  • Liability economic assumptions are set on curve or point of time

Mitigate but not element risk

  • Data timing risk
  • Liability estimation risk
  • Basis risk (2 curves: swap & govt. bond)
  • Curve Risk (Interest rate & inflation do not move parallel)

Costs vs Benefits

  • Interest rate futures are cheap but limited in scope
  • OTC derivatives are expensive but tailored outcome
  • OTC derivate are heavy in infrastructure

Some final thoughts…

  • How much is on the table in terms of risk?
  • How much is the business prepared to pay vs how much tolerance your Board has for volatility arising from the ALM approach?
  • Effective ALM strategy MUST follow how liability economic assumptions are set and these assumptions MUST be set on an ongoing, market related basis to enable an ALM strategy to be effective!
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