Mismatching and impact on surplus

[newbie]

Hi,

This is probably super basic but I can't seem to get my head around it: if there is an investment return loss in the analysis of surplus for immediate annuities backed by fixed-interest bonds and we're told that the yields on the bonds have fallen, the explanation given is that the loss is as a result of mismatching of assets and liabilities and that the fixed-interest securities are likely to be of shorter duration than the liabilities.
How is that deduced?

Thanks

 

[Em Francis]

Hi,

This is probably super basic but I can't seem to get my head around it: if there is an investment return loss in the analysis of surplus for immediate annuities backed by fixed-interest bonds and we're told that the yields on the bonds have fallen, the explanation given is that the loss is as a result of mismatching of assets and liabilities and that the fixed-interest securities are likely to be of shorter duration than the liabilities.
How is that deduced?

Thanks

If assets and liabilities were 100% matched, then a fall in yields on the bonds would increase value of the liabilities but would also increase the value of the assets and so there would be no impact on the surplus. However if assets were shorter in length than the liabilities, then the increase in the value of the liabilities would have a greater impact than the increase in the value of the assets and so a loss would be recognised.

Does this make sense?

 

[newbie]

Is this because we are discounting the liabilities cashflows for longer?

 

[Em Francis]

Is this because we are discounting the liabilities cashflows for longer?

Yes and so the discounting will have a bigger impact