Ch17 - Asset liability matching

[mossie]

Hi,

Could someone please help with my queries below?

Q17.7 solution 2nd paragraph - “assets might have a slightly longer term than the liabilities on the grounds that the company will write some new business”.

Does this mean, say, if assets and liabilities are fully matched by term, then writing new business will increase asset’s mean term? Could someone kindly explain how this works (i.e. how the asset’s mean term increases) using a simple numerical example?

Many thanks!

M.

 

[Sarah Byrne]

This just means that if we are writing new business, we may have assets with a longer duration than our current liabilities as we expect the average term of our liabilities to be increasing as we write new business. As the solution goes on to say, we could use some premiums to meet current cashflows and leave assets invested. But we need to be careful if we do this as obviously new business is not guaranteed.

Sarah

 

[mossie]

This just means that if we are writing new business, we may have assets with a longer duration than our current liabilities as we expect the average term of our liabilities to be increasing as we write new business. As the solution goes on to say, we could use some premiums to meet current cashflows and leave assets invested. But we need to be careful if we do this as obviously new business is not guaranteed.

Sarah

Thanks Sarah. Why do we not expect the average term of the assets to be increasing as well when we write new business? or why do liabilities term increases more so than the assets? Is it because assets with a sufficiently long term to match those new liabilities are not usually available?

 

[Sarah Byrne]

The solution to this question is suggesting that rather than using premiums to invest we use them to match other short-term outgoing cashflows. So, if we have assets with a longer term than the liabilities, when we write new business and the liability duration increases, there is a margin in the assets duration to allow us to do this.

This is only suggested as this question asks about situations when an insurer might be OK with having a longer term for its assets than liabilities. Obviously this has issues with it so in practice might not be used. Or could be used in part, but with some investment still being made.