Liability-Driven Investing for Life Insurers

Abstract

Liability-driven investing (LDI) has recently emerged as a powerful paradigm in financial risk management. The basic idea behind LDI is to split the company's balance sheet into two separate balance sheets: one for the liabilities and the matching assets and one for the other (return) assets and the surplus. We show that constructing a proper liability-hedging portfolio (LHP) is very attractive for life insurers because the liability-driven risks can be suppressed without a negative impact on overall return. When these risks are covered by the LHP, the return assets can be optimised using well-known (Markowitz) optimisation techniques or (equity) hedge strategies. The LDI approach thus stimulates insurers to address all risks embedded in the insurance liabilities and facilitates the subsequent optimisation of the return assets.

Valuation of real-estate losses via Monte Carlo simulation

“…The Monte Carlo method has been used to set parameters in different market price models (Hardy, 2002), such as house prices, as well as interest rates to be used for the valuation of reverse mortgages (Huang et al, 2011;Yang, 2011). It is also used to contrast new paradigms, such as liability-driven investing, through dynamic financial analysis (Van Bragt & Kort, 2011).…”

Bond Portfolio Management Under Solvency II Regulation

“…We therefore identify a direct impact of the SCR regulation on insurance firms' demand for bonds of various maturities and ratings. 5 Our focus on assets (without liabilities) is also in line with core-satellite approach widely used by portfolio managers of insurance companies and pension funds (see Amenc et al, 2006;van Bragt and Kort, 2011;and Deguest et al, 2015). 6 It is worth mentioning that Solvency II allows asset-liabilities matching approach provided that certain conditions are met.…”