The Russell-Yasuda Kasai Model: An Asset/Liability Model for a Japanese Insurance Company Using Multistage Stochastic Programming

Abstract

Frank Russell Company and The Yasuda Fire and Marine Insurance Co., Ltd., developed an asset/liability management model using multistage stochastic programming. It determines an optimal investment strategy that incorporates a multiperiod approach and enables the decision makers to define risks in tangible operational terms. It also handles the complex regulations imposed by Japanese insurance laws and practices. The most important goal is to produce a high-income return to pay annual interest on savings-type insurance policies without sacrificing the goal of maximizing the long-term wealth of the firm. During the first two years of use, fiscal 1991 and 1992, the investment strategy devised by the model yielded extra income of 42 basis points (¥8.7 billion or US$79 million).

Discrete-Time Financial Planning Models Under Loss-Averse Preferences

“…Our model shares the basic characteristics of more elaborate empirical models such as that of Cariño et al (1994). Downside risk was used because of its widespread popularity in the financial industry and its use in related academic work.…”

“…(2) also resembles the objective function of Cariño et al (1994), albeit that they use a piecewise linear penalty function in terms of the expected loss, where we have a linear one. In addition, they argue that in the context of banks and insurance companies, risk measures as in (2) can easily be justified, as these companies are faced with specific costs if reserves fall below critical threshold levels.…”

“…ALM is foremost a practical science. Cariño et al (1994) describe an implemented ALM model where downside risk is incorporated as a stepped penalty function accommodating for the specific thresholds at which risks become effective. Boender (1997) describes the details of an ALM model that is used empirically for advising defined benefit pension funds.…”

“…Downside-risk measures are currently used extensively in the area of ALM. Recent research typically incorporates these risk measures in a multistage stochastic programming (MSP) approach, as in Consigli and Dempster (1998), Mulvey and Thorlacius (1998), Cariño et al (1994), Boender (1997), and Dert (1998). The main advantage of the MSP approach relative to the more traditional static meanvariance oriented approach is that the explicit dynamic nature of financial decisions can better be taken into account.…”

“…As a result, the MSP approach generally produces significant improvements over static mean-variance-based decisions. These improvements can be exploited when the MSP model is implemented in practice, as in Cariño et al (1994).…”