Reinsurance for Asset -Liability Management and watch, 1980s; Liquid-crystal display. Game boy,...
Transcript of Reinsurance for Asset -Liability Management and watch, 1980s; Liquid-crystal display. Game boy,...
Laser gun SP, 1970sSolar panel cell as light sensor
Game and watch, 1980sLiquid-crystal display
Game boy, 1990sCombination of Game & Watch and Family Com
Wii, 2006Infrared sensing
Pokemon Go, 2016GPS, map and camera
Reinsurance for ALM, 2010sHedging technique and insurance risk appetite
“Lateral Thinking with Withered Technology”- Yokoi Gunpei, Nintendo
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Problem 1: Forward starting swap embedded in regular premium products
0 1 2 3 4 5 6 7 8 9 10Cashflow 90 90 90 90 90 90 90 90 90 90 -1,000Net liability value @ 2% -0 91 184 279 376 475 576 679 784 891 1,000Net liability value @ 1% 49 140 232 324 418 513 608 705 802 901 1,000Implied duration 52.97 25.51 16.02 11.04 7.85 5.56 3.78 2.33 1.09
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10Y Regular Premium Endowment, no lapse, no mortality
Forward starting interest rate positions
Translate to a high liability duration
It is also reinvestment problem
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Problem 2: Swaption position if dynamic lapse is concerned
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20Shortfall between SV and MV 322 295 266 237 207 175 142 108 72 35 96 67 36 4 - - - - - - -Surrender value 1,0001,0001,0001,0001,0001,0001,0001,0001,0001,0001,1001,1111,1221,1331,1451,1561,1681,1791,1911,2031,215Asset value (Book value 2% yield) 1,0001,0201,0401,0611,0821,1041,1261,1491,1721,1951,2191,2431,2681,2941,3191,3461,3731,4001,4281,4571,486Asset value (Market value 4% yield) 678 705 734 763 793 825 858 892 928 965 1,0041,0441,0861,1291,1741,2211,2701,3211,3741,4291,486
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Single Premium Whole Life with Surrender Value guaranteed
Shortfall between SV and MV Surrender value Asset value (Book value 2% yield) Asset value (Market value 4% yield)
Assumptions•Single Premium Whole Life with surrender value jumps at the end of year 10
•Liability duration calculated based on flat lapse
•Asset is zero coupon bond with duration same as liability
Loss if interest rate rises; will lapse be higher at higher interest rate?New DST?
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Problem 3: Invest into cross currencies swap
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10Y AUD Government Bond yield JGB repackaged AUD yield
• Instead of investing directly into e.g. AUD bonds, it is possible to invest into bonds in a different currency e.g. JGB, and use cross currency swaps to generate the return in the required currency
• Under perfect world assumptions, the two returns are the same
• However, due to different credit risks of governments, demand and supply of derivatives for hedging etc, the two investment yields are not the same, and hence the possibilities of “pickup”
• Investing into cross currency swaps directly however causes accounting mismatchAsset: market valueLiability: book valueSource: Bloomberg 5
Underlying Economics of Modco (Coinsurance fund withheld)
Ceding Company Reinsurer
Premium
Increase in reserve
In very short: Coinsurance but assets remains at cedant
Claims
Release of reserve
Modco rate * reserve
Increase in reserve (Reserving interest
rate part)
This is economically an interest rate swap embedded in (re)insurance:• If modco rate = reserving
interest rate, no investment risk transfer
• If modco rate = actual investment yield, investment risk transfer to reinsurer 6
Reinsurance solution for problem 1
Ceding Company ReinsurerPolicyhol
ders
Capital market
Premium
Benefit
Cash Bonds Fixed forward interest rate
Unknown fixed interest rate
Premium
Benefit
Future yield
ΔReserve
TInt rate
1Int rate
2Int rate
3Int rate
4Int rate
5Int rate
6Int rate
7Int rate
8Int rate
9Int rate
10 Reserve PremiumInvestment
incomeChange in
reserve ClaimP&L before reinsurance RI CFs
P&L after reinsurance
0 0.00 1 2.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 91.33 89.54 1.79 91.33 0.00 0.00 -0.00 -0.00 2 2.0% 1.5% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 184.48 89.54 3.17 93.15 0.00 -0.45 0.45 -0.00 3 2.0% 1.5% 1.5% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 279.50 89.54 4.57 95.02 0.00 -0.91 0.91 -0.00 4 2.0% 1.5% 1.5% 3.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 376.41 89.54 7.33 96.92 0.00 -0.05 0.05 -0.00 5 2.0% 1.5% 1.5% 3.0% 1.0% 0.0% 0.0% 0.0% 0.0% 0.0% 475.27 89.54 8.39 98.85 0.00 -0.93 0.93 -0.00 6 2.0% 1.5% 1.5% 3.0% 1.0% 1.5% 0.0% 0.0% 0.0% 0.0% 576.10 89.54 9.90 100.83 0.00 -1.39 1.39 -0.00 7 2.0% 1.5% 1.5% 3.0% 1.0% 1.5% 1.8% 0.0% 0.0% 0.0% 678.95 89.54 11.71 102.85 0.00 -1.60 1.60 0.00 8 2.0% 1.5% 1.5% 3.0% 1.0% 1.5% 1.8% 2.2% 0.0% 0.0% 783.85 89.54 13.91 104.91 0.00 -1.46 1.46 0.00 9 2.0% 1.5% 1.5% 3.0% 1.0% 1.5% 1.8% 2.2% 2.0% 0.0% 890.86 89.54 15.98 107.00 0.00 -1.49 1.49 0.00 10 2.0% 1.5% 1.5% 3.0% 1.0% 1.5% 1.8% 2.2% 2.0% 3.0% 1,000.00 89.54 18.99 -890.86 1,000.00 -0.62 0.62 0.00
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Reinsurance solution for problem 2 and 3
Ceding Company Reinsurer
Premium
Benefit
Modco rate
ΔReserveSwaptions or
swaps
Problem Asset hold by Cedant
Return credited to Reinsurer
Investment risks transferred to reinsurer
Hedging instruments run by reinsuer
2 Bonds Coupon + capital loss of bonds on mass lapse
Asset loss at mass lapse
Swaption
3 JGB JGB coupon Cross currency risks
Cross currency swaps
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FAQ1: What is the difference between Reinsurance for ALM and Financial Reinsurance?
(Traditional) Financial Reinsurance involves transfer of insurance risks in order to achieve financial objectives, e.g. increase in capital; where Reinsurance for ALM involves transfer of investment risks in addition toinsurance risks.
Ceding Company
Reinsurer
Financial Reinsurance
Transfer of insurance risk but itself is not an objective
Achieve financial objectives through reinsurance
Ceding Company
Reinsurer
Reinsurance for ALM
Transfer of investment risks together with insurance risks
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FAQ2: Why should I use reinsurance rather than derivatives
Pros Cons
Reinsurance • Better accounting treatment if reinsurance accounting applies
• Can use insurance profit to subsidize hedge cost
• Less operational burden• Diversification of hedge
counterparty through reinsurance
• More holistic; can achieve multiple objectives at the same time
• Conceptually more complicated
• Scrutiny by auditors and regulators possible
• Need of transfer of insurance risks
Derivatives • More freedom in choosing risks to take or hedge
• Hedge accounting not easy or even not possible
• Heavy operational and compliance burden for running derivatives 10
FAQ3: Is reinsurance more expensive than derivatives?
• No, definitely not• If reinsurer uses derivatives for hedging, the cost of production for this part is
fully market consistent• Insurance risk transfer has a cost but reinsurer can be a more efficient risk
taker due to global diversification
Diversifiable risks
Hedge-able risks
Systemic non-
hedgeable
Risk chargeMarket con-sistent cost Exclude
Reinsurance cost11
Hugo Choi, FSA, FRM, CFAHead of Financial Solutions Asia
Business Development DepartmentMunich Re Tokyo Life Branch
+81 (0)3 [email protected]
Thank you!Now your questions!
Appendix – summary of ALM issues and the corresponding reinsurance solutions
Problem ALM issues Reinsurance solution1 Interest rate is guaranteed in
future coming regular premium which creates leveraged interest rate exposure
Locking in future investment return by reinsurance, ie future investment risks are transferred to reinsurer
2 Guaranteed cash surrender value embeds swaptionpositions which will be materialized by rational policyholder behaviour
“Double trigger” lapse-interest rate risks are transferred within reinsurance scheme
3 Derivatives inside synthetic bonds cause accounting problems though economically matching liabilities
Derivative parts are loaded on reinsurer’s balance sheet and return credited to insurer
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