ASSET – LIABILITY MANAGEMENT IN LIFE INSURANCE

Abstract

Asset liability management (ALM) is a fundamental element of life insurance company strategy and operations. The importance of ALM to insurers’ results is driven by the need of matching the duration of assets and liabilities. The estimation of insurance obligation cash flows, which may be uncertain for various reasons such as policyholder options, with assets buy and sell policy in a risky environment, is the main goal of effective ALM. Life insurance companies with long liability durations, due to the nature of multi-year policy contracts, can be exposed to significant risk on interest rates and FX. Inadequate ALM, ignoring the economic risk exposure could resulted in insolvencies. Therefore, for life insurance companies with long liability durations, it is important to understand the multiple dimensions of the interest rate risk and FX exposure. Effective governance is a key part of ALM, one of the most vital functions related to many insurers’ long term financial health. Effective governance provides a clear objective for the ALM function and ensures there is a framework in place for making decisions. The insurance industry in N. Macedonia is dominated by the non-life sector, and life insurance plays a less significant role and is still fairly undeveloped in terms of penetration and density rate. The favorable economic developments, monetary and financial stability, improved living conditions, increased risk, and insurance awareness, and the entrance of foreign-owned insurance companies in the last two decades have significantly contributed to the growth of the Macedonian life insurance market. Furthermore, the implementation of European regulation and effective supervision was also crucial for further development. With the increase in the life insurance sector, the importance of ALM practices gains in their importance. Therefore, the aim of this paper is twofold. First, to provide a theoretical background about the ALM techniques and tools applied in the European context in the life insurers, with the particularity of the Solvency 2 regulatory regime. The second aim will be to present a methodology tool that could be used by local life insurers in the ALM content. Management of risk exposure involves executing ALM metrics such as duration and convexity to manage the interest risk and FX risk exposure, set risk limits, and rebalance the portfolio. The main contribution of the paper's findings and recommendations will lead to immunizing the interest rate and FX risk exposure of life insurance companies on an economic basis. By that, there is an opportunity for insurance companies to improve the risk efficiency of their portfolios. In some cases, it simultaneously increases portfolio yield, increases net income, and adds positive convexity to the portfolio while decreasing risk and maintaining the solvency capital at the appropriate level.