alm / market risk working group

2008

Sem

inar

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né 2

008

2008

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ALM / Market Risk Working Group

AA MeetingSeptember 2008

2008 Seminar for the Appointed Actuary

Colloque pour l’actuaire désigné 2008

2008 Seminar for the Appointed Actuary

Colloque pour l’actuaire désigné 2008

2008

Sem

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for

the

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né 2

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2008

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Scope of work

• Investigation of impact of several different capital

methodologies on simple product designs

• Risk free interest rate ALM risk analysed so far

• Equity risk to be covered in next stage (including

segregated funds)

• May move on to look at

• credit spread risk

• real estate price risk

• inflation risk

• FX risk

2008

Sem

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the

App

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né 2

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2008

Sem

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Summary of products investigated

• GIC – short / medium / long strategies

• Payout annuity – dynamic / static strategies

• Universal Life – complex product

• T100 – long term ALM risk (focus of following slides)

• Renewable Term – best estimate vs Padded cashflows

2008

Sem

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the

App

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né 2

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2008

Sem

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Methodologies tested

• One year projection period

• Real world terminal provision at various CTE levels

• Risk neutral terminal provision

• Term-to–maturity

• MCCSR

2008

Sem

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for

the

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né 2

008

2008

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One year projection period

Stochastic calculation of terminal value

t = 0

t = 1

t = maturity

Real world scenarios

Terminal Provision scenarios

2008

Sem

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né 2

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2008

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Risk neutral terminal provision

(simple product)

t = 1

t = 0

t = maturity

Real world scenarios

Deterministic projection – discount along yield

curve

2008

Sem

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2008

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Example of Yield Curve Extension for

1-Yr Risk NeutralSpot discount rates

1%

2%

3%

4%

5%

6%

7%

8%

9%

10%

3-mo 6-mo 1-yr 2-yr 3-yr 5-yr 7-yr 10-yr 20-yr 30-yr 40-yr 50-yr 60-yr

377-Spot

377-Fwd

550-Spot

550-Fwd

2008

Sem

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for

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2008

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2) The remaining 30-yr bond will be

sold & reinvested in a new 30-yr bond

1) Part of the 30-yr bond is allowed to

age to back liab CFs

Principles-based risk reduction strategyMaturity Values @ Dec 31, 2006 Maturity Values @ Dec 31, 2007

Maturity

Assets Liab

2007 -$150 -$150

2008 -$90 -$90

… … …

2035 $1,633 $1,633

2036 $1,638 $1,638

$13,752

2037 $1,633

… … …

2065 $5

2066 $2

Maturity

Assets Liab

2008 -$90 -$90

… … …

2035 $1,633 $1,633

2036 $1,638 $1,638

2037 $1,633 $1,633

$12,725

2038 $1,616

… … …

2065 $5

2066 $2

This process repeats for the next 30 years until all liab CFs are eventually matched

2008

Sem

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2008

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Results (BE Liab = CTE0 of Runoff)• Capital is expressed as (TBSR – Best Estimate liability) / Best

estimate liability

Time Horizon

Terminal Provision

CTE Level

Perfect Match

CFM up to 30yr (FWD)

CFM up to 30yr (Spot)

Run Time (812

Policies)

1 year RW - CTE50

99 0.0% 1.5% 1.5% 18 hrs / 8 processors

1 year RW - CTE80

99 0.0% 2.0% 2.0% 18 hrs / 8 processors

1 year RN 99 0.0% 13.5% 9.5% 15 hrs / 1 processor

Run-off N/A 95 0.0% 1.9% 1.9% 15 hrs / 1 processor

MCCSR regime* N/A 4.5% 5.9% 5.9%

2008

Sem

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2008

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Alternative strategy (TBSR)

• Alternative strategy assumes that cashflows in years 31+ are matched by 1-year bonds

2008

Sem

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2008

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Distribution of real world interest rates• The ESG assumes the long term interest rates mean revert to

7.27%

2008

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2008

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Comparison between strategies (TBSR)

• The TBSR of the alternative reinvestment strategy is higher in all approaches under the new ESG, reflecting the higher risk inherent in the strategy

2008

Sem

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2008

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Findings so far

• Investment strategies can be complex to model• Risk neutral approach may be difficult to apply when

markets are not liquid• Results sensitive to yield curve extension

methodology• More work still needed to set risk margins

methodology• Calibration of ESG is critical to a modelled capital

methodology