Immediate annuity ALM

[Jishnu Bhatia]

Hi

1. Could you please explain when we do ALM for annuities, do we allow for deduction in expected defaults in future asset cashflows?

If yes, then when calculating the BEL we use only MA in VIR. So I am already increasing my liability by reducing defaults in Valuation rate of interest.

Are these two things related or independent?


2. Do we apply stochastic modelling in annuity ALM?


Thanks.

 

[Em Francis]

Hi

1. Could you please explain when we do ALM for annuities, do we allow for deduction in expected defaults in future asset cashflows?


If yes, then when calculating the BEL we use only MA in VIR. So I am already increasing my liability by reducing defaults in Valuation rate of interest.

Are these two things related or independent?

Yes, you would allow for expected defaults on corporate bonds via a deduction in asset cashflows. You would then use those reduced asset proceed amounts to match against the liability cashflows. In other words, you would need a slightly higher holding of corporate bonds in order to match the liability cashflows than you would if you ignored future defaults. The liability cashflows used for the ALM exercise would be based on best estimates (of the annuity benefit payments and expenses).

This is basically the same as using the MA in the liability valuation rather than using the full corporate bond yield. This is because the ‘extra’ amount of corporate bonds that you would need to hold in order to allow for some of the coupons & redemption amounts not to be received (due to defaults) is equivalent to the ‘extra’ liability that you get if you discount at actual corporate bond yield minus allowance for default risk, rather than at actual corporate bond yield.

2. Do we apply stochastic modelling in annuity ALM?

I suppose it will depend on what you have invested in, if you have invested in fixed interest then you are unlikely to model investment return stochastically. However, you may want to model longevity stochastically on the liability side if there is a well-known sophisticated model to do so.


Thanks.