Mohamed El-Dishish

Chief Executive at insurance institute of Egypt

CPA from American Institute of Certified Public
Accountants
Cairo - EGYPT

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Asset Liability Management

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 Asset Liability Management definition:
ALM is the practice of managing a business so that decisions and actions taken with
respect to assets and liabilities are coordinated. ALM can be defined as “the
continuous management process that formulates, implements, monitors, and back
tests financial strategies related to assets and liabilities to achieve an organization’s
risk tolerances and other constraints.

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 Scope of risks covered under ALM
Traditionally, ALM has focused primarily on the risks associated
with changes in interest rates; currently, ALM considers a much
broader range of risks including equity risk, liquidity risk, currency
risk, reinvestment risk, and sovereign or country risk.

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 ALM is practiced in diverse settings :
• Bankers coordinate the re-pricing horizons of their assets and liabilities.

• Pension plans adjust their investment to mirror the characteristics of their

liabilities with respect to interest rates, equity returns, and expected changes in
wages.

• Insurers select investment strategies to ensure they can support competitive

pricing and interest crediting strategies.

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 The main objectives of the application of ALM:
• ALM helps in analyzing financial risks (mainly market risk), to produce studies providing
recommendations on business strategies and asset allocation, and to monitor the implementation
of those strategies.
• ALM helps in executing a strategic decision-making framework to run the company by
formulating, implementing and executing investment strategies related to the assets and liabilities
that achieve the financial objectives and setting this up as an optimization program.
• ALM aims in demonstrating to internal and external stakeholders that the company is being well
managed, and
• ALM minimizes capital requirements, especially Risk Based Capital (RBC), and determines how
much interest should be credited to policyholders.

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 Asset-liability matching requirements – nature
of liabilities
• In practice the actual liability outgo in any year, or month, depends on:
● the monetary value of each of the constituents, and
● the probability of it being received or paid out.
• The liability outgo may be split by nature into four categories:
1. guaranteed in money terms
2. guaranteed in terms of a prices index or similar
3. discretionary – eg with-profit discretionary benefits
4. investment-linked – eg unit-linked benefits.
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Asset-liability matching requirements – selecting assets
• Liabilities guaranteed in money terms
These consist of the benefit payments specified in money terms less the
premium/contribution income that is fixed in money terms.
Appropriate assets are those which achieve matching (pure or approximate) or
immunization.
Any free assets are not likely to be used to support a move away from the matched
position.

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Asset-liability matching requirements – selecting assets
• Liabilities guaranteed in terms of a prices index or similar
These consist of the benefit payments specified by reference to an index, plus
expense outgo, less the premium/contribution income that is linked to an index.
Appropriate assets are index-linked securities or real assets.
Any free assets are not likely to be used to support a move away from the matched
position.

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 Asset-liability matching requirements – selecting assets
• Discretionary benefit payments
Appropriate assets are real assets in order to maximize returns.
The presence of free assets may thus be irrelevant unless there is not full discretion
over the benefit payments, in which case they may be used to ensure that the
probability of not meeting a certain level of discretionary benefits falls within an
acceptable level.
• Investment-linked benefit payments
Appropriate assets are those which replicate, or closely approximate the index.
Any free assets may be used to maximize returns with any profit benefiting the
provider. However, regulation may disallow mismatching.
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• Currency
Liabilities denominated in a particular currency should be matched by assets in the
same currency, so as to reduce any currency risk.
• Regulation
The following controls affecting investment strategy may be implemented:
● restrictions on the types of assets that a provider can invest in
● restrictions on the amount of any particular type of asset that can be taken into account for
the purpose of demonstrating solvency
● a requirement to match assets and liabilities by currency
● restrictions on the maximum exposure to a single counterparty
● custodianship of assets
● a requirement to hold a certain proportion of total assets in a particular class, for example
government stock
● a requirement to hold a mismatching reserve
● a limit on the extent to which mismatching is allowed at all. 11
 Matching
➢ In its purest form matching of assets and liabilities involves structuring the flow
of income and maturity proceeds from the assets so that they will coincide
precisely with the outgo in respect of the liabilities under all circumstances.
➢ Fixed monetary liabilities can be matched by fixed monetary assets provided that:
● the timing and amounts for both assets and liabilities are certain
● assets of long enough term exist
● asset proceeds do not exceed liability outgo in the early years.

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Actuarial techniques – asset-liability models
• An asset-liability model can be used to help set an investment strategy in line with
a stated objective.
• The objectives should include:
● a quantifiable and measurable performance target
● defined performance horizons, and
● quantified confidence levels for achieving the target.
• A stochastic model allows for the random nature of some of the model
parameters. If the assumptions underlying the model are realistic, then a clearer
picture of the appropriateness of the assets is possible.
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 Immunization
• Immunization is the investment of the assets in such a way that the present value
of the assets minus the present value of the liabilities is immune to a general small
change in the rate of interest.
• There are three conditions that must apply, in order for classical immunization
theory (according to Redington) to apply:
1. The present values of the liability-outgo and asset-proceeds are equal.
2. The (discounted) mean term of the value of the asset-proceeds must
equal the mean term of the value of the liability-outgo.
3. The spread (or convexity) about the mean term of the value of the asset-
proceeds should be greater than the spread of the value of the liability-
outgo. 14