matching in UL funds

[phantom]

should the assets of a policyholder unit linked fund be chosen to "match" the liabilities w.r.t duration? of course, it depends on the disclosed investment policy, but should such a policy reflect a desire for matching?

 

[Lynn Birchall]

Hi

The link between assets and liabilities works the other way round really for UL business I think - ie the assets define the unit liabilities, rather than the liabilities being defined amounts with the assets then being chosen to match the liabilities.

So, the investment of the assets of the unit-linked fund should just follow the stated investment policy (eg UK equities).

Hope the studying is going well

 

[phantom]

thanks for the reply..

i really do understand that it is actually the assets that define liability.. my question is really this way:

consider for a moment a policyholder fund whose investment policy is very "open", and leaves almost everything to be decided by the insurer.. lets ignore regulations for a moment..

would it be beneficial, in these circumstances, for the insurer to select assets which match nature, term, currency etc of liabilities? i really do think the answer is yes, because it would help policyholders avoid unnecessary risk (e.g. why risk mismatching by duration? it may give rise to liquidity or reinvestment risk) and achieve a "disciplined" rate of return..

am i thinking correctly here?

 

[phantom]

and by liabilities of UL policyholder fund, i mean the payouts required at the time of death, surrender etc...

 

[jashworth]

thanks for the reply..

i really do understand that it is actually the assets that define liability.. my question is really this way:

consider for a moment a policyholder fund whose investment policy is very "open", and leaves almost everything to be decided by the insurer.. lets ignore regulations for a moment..

would it be beneficial, in these circumstances, for the insurer to select assets which match nature, term, currency etc of liabilities? i really do think the answer is yes, because it would help policyholders avoid unnecessary risk (e.g. why risk mismatching by duration? it may give rise to liquidity or reinvestment risk) and achieve a "disciplined" rate of return..

am i thinking correctly here?

You are missing the point. There are no liabilities to match. The investment risk is wholly borne by the policyholder. So if the policyholder choses a certain fund to invest in, say UK equities, then he bears the risk of not matching his liabilities or purpose in investing.

For example if the policyholder has a short term liability, say he wishes to save for retirement due in 5 years time but then chooses an equity fund to invest in, he runs the risk of the assets not matching his liabilities.

The liability for the insurance company is just the value of the units the policyholder has bought. This is determined by the value of the assets held by the particular fund the policyholder has chosen. To match this liability the company only needs to invest according to the published investment objectives of the fund.


If there are any policy benefits that are not unit-linked, say a guaranteed minimum death benefit then the company holds what are called sterling reserves to meet these payouts in excess of the unit value. In this case it is sensible to talk about matching the assets to the liabilities but these reserves are not held in the unit fund.
Does this help?

 

[phantom]

what should i say? other than that i do agree 100% with what you said.. my only concern, as you mentioned, is this:

The investment risk is wholly borne by the policyholder. So if the policyholder choses a certain fund to invest in, say UK equities, then he bears the risk of not matching his liabilities or purpose in investing.

in an "open" investment policy fund, i thought it would be good (although not required by any means) to make good decisions on behalf of the policyholders; decisions which would include addressing situations as posed by you, eg.

if the policyholder has a short term liability, say he wishes to save for retirement due in 5 years time but then chooses an equity fund to invest in, he runs the risk of the assets not matching his liabilities.

would it then not be appropriate to match UL "payouts" (lets not call them "liabilities") by duration in the situation above? we are considering an "open" investment policy fund ...

 

[jashworth]

Yes phantom you are nearly there. Many unit-linked personal pension plans offer the option of automatic switching to fixed interest/gilt funds as the the policyholder nears retirement. So some guidance is given to policyholders as to suitable funds. But the whole point of unit-linked policies is for the investment risk to be passed onto the policyholder. The problem with the insurance company making 'good' decisions for policyholders is that each policyholder will have his own, individual reasons for investing and his own attitude to risk. The policyholder must decide which fund best meets his objectives. The main considerations for the insurance company are marketing ones - is its fund performance and charging structure as good as the competition.

As for matching payouts (say on death) there are two parts to any payout. If there is a guaranteed minimum death benefit and this is greater than the unit value at death then the payout is the unit value - paid from the UL fund plus the extra needed to meet the GMDB. This extra amount is paid from the sterling (non-unit) reserves. The assets backing these reserves are matched to the non-unit liability by duration etc. For example the sterling reserves for unit-linked PHI policies will have a shorter duration than the sterling reserves backing pension plans. This is if there are any non-unit liabilities which there may not be if there are no guarantees.

Any help?

 

[phantom]

i have seen instances where a company offers one main unit linked policyholder fund for unit linked whole life and term assurance policies (long term, about 30 years) to the customers... (customers don't choose between funds, coz there is just one)..

the problem is that the policyholder fund is predominantly invested in short-term bonds (3 and 6 months) and equities.. although this is not problematic to the company because all investment risk is borne by the policyholders, i still think this is not good, because policyholders are taking on "unnecessary" risk, which could easily be avoided by investing the policyholder fund's assets in longer term bonds.. the policyholders are pretty unaware of their plight i think..

wat do u think? [i am not concerned about the sterling reserves (non-unit linked company fund).. ]

 

[jashworth]

Dear Phantom,

Where shall I begin?

Term assurances: There is no investment risk for the policyholder as no significant unit fund is built up. Death benefits are paid for on a pay as you go basis is by a monthly deduction of mortality charges from the policyholder's units. I do not know of a term assurance where the death benefit is just the unit value of the policy.

Whole of life: Here there is a savings element and a unit fund is built up. Again guaranteed death benefits in excess of the unit value are paid for by monthly mortality charges. There is an investment risk for the policyholder if the performance of the fund is poor. The job of the insurance company is then to maximise the returns. Equities may be the appropriate investment here. But policyholders can surrender their policies if they don't like the performance of the fund and they may judge the fund on its short term performance. Investing in short bonds may be a way of reducing the volatility of the fund. The problem is how to invest to maximise returns not whether the assets are of the same term as the policies.

The mortality charges deducted each month should be enough to pay for any death claims that arise each month. This pay as you go approach removes the need for matching of assets to long-term liabilities. If there are excess charges then these make up the non-unit reserves that are invested to match the term of the liabilities.

Have I convinced you yet?

 

[phantom]

Term assurances: There is no investment risk for the policyholder as no significant unit fund is built up. Death benefits are paid for on a pay as you go basis is by a monthly deduction of mortality charges from the policyholder's units. I do not know of a term assurance where the death benefit is just the unit value of the policy.

we do sell policies with low cover, in fact we do have savings products wrapped up as 30 year term assurance.

But policyholders can surrender their policies if they don't like the performance of the fund.

is that really a solution? i m assuming they don't get their original money back, rather just the surrender value, which is pretty pathetic in early years given the NBS.

The problem is how to invest to maximise returns not whether the assets are of the same term as the policies.

can u plz explain this? the first task is to determine the objectives of the saver, which includes time to disinvestment. Ignoring this basic consideration is unscientific.

The mortality charges deducted each month should be enough to pay for any death claims that arise each month. This pay as you go approach removes the need for matching of assets to long-term liabilities. If there are excess charges then these make up the non-unit reserves that are invested to match the term of the liabilities.

i m not talking about the non-unit (company) fund.

(plz forgive the brevity of my reply - i am overloaded at the momemt. c ya jashworth. will wait for your reply)

 

[jashworth]

Hello Phantom,

In reply,

Savings products with 30 year term assurance - death benefit = unit value.

These are rather like pension plans that just give ROF on death. Here there are no guarantees. The saver's and the company's objective is just to maximise returns.

Surrenders

I think my point here was that savers judge funds, whether saving for the long term or not, on their short-term performance. Savers dislike short-term volatility and can either not buy the product in the first place or (once surrender penalties are not too onerous) can switch to another provider.

Objectives of the saver

Are also to maximise returns. That is why they have chosen a unit-linked product. If their aim was to meet some fixed target amount in 30 years a fixed interest bond would meet their need. They are prepared to forego any guarantees to hopefully get higher returns than conventional products. Having no guarantees gives the company more freedom in its investment strategy, they can take on more risk.

Non-unit reserves

These are necessary for all unit-linked products. These reserves are used to pay the guaranteed benefits on the policies which being guaranteed need matching assets.

Matching is a strategy used by insurance companies to protect them from insolvency should investment conditions change. If the unit values of their unit-linked policies fall there is no risk to their solvency since (as stated earlier) their liabilities are the asset values. There is a small risk because the non-unit reserves will have to increase if there are guaranteed benefits as the shortfall between the unit value and the guaranteed benefit will increase as unit values fall.

If the fund you describe is heavily invested in short bonds it could be because of the uncertainty in the equity markets at the moment (though they are recovering). This may not be its long-term strategy. What more can I say? The company I work for are so nervous of making investment decisions that their policyholder fund (admittedly not a unit-linked fund) is almost 20% invested in cash. They have just decided to invest in some long bonds because the valuation interest rate we had to use at the year-end was much lower than the maximum allowed regulation rate.

I hope you are not 'overloaded' for too long!