Asset and Liability Management for Banks and Insurance Companies

171 Pages·2015·2.25 MB·English

by  William Gehin

Asset and Liability Management for
Banks and Insurance Companies

Series Editor
Jacques Janssen
Asset and Liability
Management for Banks and
Insurance Companies

Marine Corlosquet-Habart
William Gehin
Jacques Janssen
Raimondo Manca
First published 2015 in Great Britain and the United States by ISTE Ltd and John Wiley & Sons, Inc.
Apart from any fair dealing for the purposes of research or private study, or criticism or review, as
permitted under the Copyright, Designs and Patents Act 1988, this publication may only be reproduced,
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ISTE Ltd John Wiley & Sons, Inc.
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UK USA
www.iste.co.uk www.wiley.com

© ISTE Ltd 2015
The rights of Marine Corlosquet-Habart, William Gehin, Jacques Janssen and Raimondo Manca to be
identified as the authors of this work have been asserted by them in accordance with the Copyright,
Designs and Patents Act 1988.
Library of Congress Control Number: 2015942726

British Library Cataloguing-in-Publication Data
A CIP record for this book is available from the British Library
ISBN 978-1-84821-883-3
Contents
INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ix
CHAPTER 1. DEFINITION OF ALM IN THE BANKING AND
INSURANCE AREAS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1.2. Brief history of ALM for banks and insurance companies . . . . . . . . 2
1.3. Missions of the ALM department . . . . . . . . . . . . . . . . . . . . . . . 3
1.3.1. Missions of the ALM department for banks . . . . . . . . . . . . . . 3
1.3.2. Missions of the ALM department for insurance companies . . . . . 5
1.4. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
CHAPTER 2. RISKS STUDIED IN ALM . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.2. Risks studied in a bank in the framework of Basel II and III . . . . . . . 9
2.2.1. Main risks for banks . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
2.2.2. From Basel I to Basel III . . . . . . . . . . . . . . . . . . . . . . . . . 11
2.3. Stress tests . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
2.3.1. What is a stress test? . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
2.3.2. The stress tests of 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . 16
2.4. Risks studied in an insurance company in the
framework of Solvency II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
2.4.1. Solvency II in a nutshell . . . . . . . . . . . . . . . . . . . . . . . . . . 17
2.4.2. Focus on the risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
2.5. Commonalities and differences between banks
and insurance companies’ problems . . . . . . . . . . . . . . . . . . . . . . . . 25
2.5.1. Commonalities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
2.5.2. Differences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
2.6. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
vi Asset and Liability Management for Banks and Insurance Companies
CHAPTER 3. DURATIONS (REVISITED) AND SCENARIOS FOR ALM . . . . . . . 27
3.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
3.2. Duration and convexity risk indicators . . . . . . . . . . . . . . . . . . . . 28
3.3. Scenario on the cash amounts of the flow . . . . . . . . . . . . . . . . . . 32
3.4. Scenario on the time maturities of the flow . . . . . . . . . . . . . . . . . 34
3.5. Matching asset and liability . . . . . . . . . . . . . . . . . . . . . . . . . . 36
3.6. Matching with flow scenarios . . . . . . . . . . . . . . . . . . . . . . . . . 40
3.7. ALM with the yield curve . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
3.7.1. Yield curve . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43
3.7.2. ALM with the equivalent constant rate . . . . . . . . . . . . . . . . . 44
3.8. Matching with two rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
3.9. Equity sensitivity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47
3.9.1. Presentation of the problem . . . . . . . . . . . . . . . . . . . . . . . . 47
3.9.2. Formalization of the problem . . . . . . . . . . . . . . . . . . . . . . . 48
3.9.3. Time dynamic of asset and liability flows . . . . . . . . . . . . . . . 49
3.9.4. Sensitivity of equities and VaR indicator . . . . . . . . . . . . . . . . 51
3.9.5. Duration of equities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52
3.9.6. Special case of the aggregated balance sheet . . . . . . . . . . . . . . 52
3.9.7. A VaR approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54
3.10. ALM and management of the bank . . . . . . . . . . . . . . . . . . . . . 58
3.10.1. Basic principles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
3.10.2. ALM and shares . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58
3.10.3. Stochastic duration . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66
3.11. Duration of a portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70
3.12. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71
CHAPTER 4. BUILDING AND USE OF AN ALM INTERNAL MODEL
IN INSURANCE COMPANIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
4.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73
4.2. Asset model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
4.2.1. Equity portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74
4.2.2. Bond portfolio . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76
4.2.3. Real estate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82
4.2.4. Central scenario and simulated scenarios . . . . . . . . . . . . . . . . 83
4.3. Liability model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
4.3.1. Model points . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85
4.3.2. Mathematical reserves and annual policyholder benefits . . . . . . . 87
4.3.3. Annual policyholder benefits and crediting rate . . . . . . . . . . . . 87
4.3.4. Profit sharing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
4.3.5. Policyholder demography and behavior . . . . . . . . . . . . . . . . . 91
4.3.6. Other reserves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
4.3.7. Future new business . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
Contents vii
4.3.8. Fees and business costs . . . . . . . . . . . . . . . . . . . . . . . . . . 97
4.4. Structure of an ALM study . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
4.4.1. Determinist study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99
4.4.2. Stochastic study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
4.5. Case study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
4.5.1. Goal of the study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
4.5.2. Business plan and other liability inputs . . . . . . . . . . . . . . . . . 105
4.5.3. Central scenario and other asset inputs . . . . . . . . . . . . . . . . . 106
4.5.4. Fee and cost hypotheses . . . . . . . . . . . . . . . . . . . . . . . . . . 107
4.5.5. Step-by-step model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107
4.5.6. The ALM study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109
4.6. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 114
CHAPTER 5. BUILDING AND USE OF ALM INTERNAL
MODELS IN BANKS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
5.1. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
5.2. Case 1: Reduction of gaps . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
5.2.1. Basic numerical data . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115
5.2.2. Basic ALM indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . 118
5.2.3. Scenario for loss reduction . . . . . . . . . . . . . . . . . . . . . . . . 119
5.3. Case 2: A stochastic internal model . . . . . . . . . . . . . . . . . . . . . 121
5.3.1. Probability of bankruptcy . . . . . . . . . . . . . . . . . . . . . . . . . 121
5.3.2. Presentation of the first model (Model I) . . . . . . . . . . . . . . . . 122
5.3.3. Presentation of the model with correlations
(Model Ibis) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124
5.3.4. Presentation of the model with
correlations and non-negative values for
assets and liabilities (Model II). . . . . . . . . . . . . . . . . . . . . . . . . . 126
5.3.5. Consequences for ALM . . . . . . . . . . . . . . . . . . . . . . . . . . 131
5.4. Calibration of the models . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135
5.4.1. Historical method . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 135
5.4.2. Scenario generator . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
5.5. Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
5.5.1. Model Ibis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 139
5.5.2. ALM II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142
5.6. Key points for building internal models . . . . . . . . . . . . . . . . . . . 146
5.6.1. How to present an internal model? . . . . . . . . . . . . . . . . . . . . 146
5.6.2. Validation of the model . . . . . . . . . . . . . . . . . . . . . . . . . . 147
5.6.3. Partial and global internal models . . . . . . . . . . . . . . . . . . . . 147
5.7. Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148
viii Asset and Liability Management for Banks and Insurance Companies
CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149
BIBLIOGRAPHY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151
INDEX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 153