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ALM / Market Risk Working Group

ALM / Market Risk Working Group. AA Meeting September 2008. 2008 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2008. Scope of work Investigation of impact of several different capital methodologies on simple product designs

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ALM / Market Risk Working Group

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  1. ALM / Market Risk Working Group AA Meeting September 2008 2008 Seminar for the Appointed Actuary Colloque pour l’actuaire désigné 2008

  2. 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

  3. 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

  4. Methodologies tested • One year projection period • Real world terminal provision at various CTE levels • Risk neutral terminal provision • Term-to–maturity • MCCSR

  5. Terminal Provision scenarios Stochastic calculation of terminal value t = 0 Real world scenarios t = 1 t = maturity • One year projection period

  6. Deterministic projection – discount along yield curve Risk neutral terminal provision (simple product) t = 0 Real world scenarios t = 1 t = maturity

  7. Example of Yield Curve Extension for 1-Yr Risk Neutral

  8. 1) Part of the 30-yr bond is allowed to age to back liab CFs • Principles-based risk reduction strategy • Maturity Values @ Dec 31, 2006 Maturity Values @ Dec 31, 2007 2) The remaining 30-yr bond will be sold & reinvested in a new 30-yr bond This process repeats for the next 30 years until all liab CFs are eventually matched

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

  10. Alternative strategy (TBSR) • Alternative strategy assumes that cashflows in years 31+ are matched by 1-year bonds

  11. Distribution of real world interest rates • The ESG assumes the long term interest rates mean revert to 7.27%

  12. 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

  13. 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

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