Hemant FRP Final

8/6/2019 Hemant FRP Final

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Introduction



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BACKGROUND

Asset Liability Management is ³the practice of managing a business so that decisions on assets

and liabilities are coordinated or more broadly it is the ongoing process of formulating

implementing monitoring and revisiting strategies related to assets and liabilities in an attempt to

achieve financial objectives for a given set of risk tolerance and constraints´.

In this Project I have made an attempt to study the management of assets & liabilities of the life

insurance companies. For the purpose of study two life insurance company Life Insurance

Corporation of India & Bajaj Allianz has been taken into consideration. Comparison has been

done among the two companies to know how these two companies use to cover their liabilities

over their assets.

The scope for ALM (asset-liability management) is essentially limited to the ³asset´ side1. If the long-term interest rate drops significantly below the guaranteed (technical) interest ratethe buyback liability can be affected to some extent through speculation ³prevention´ clauses inlife insurance contracts.3. Changes to bonus schemes (bonus liability) in the form of so-called conditional bonus could be used for ALM purposes, but there are certain legal problems here.

Asset Liability Management is ³the practice of managing a business so that decisions on assets

and liabilities are coordinated or more broadly it is the ongoing process of formulating

implementing monitoring and revisiting strategies related to assets and liabilities in an attempt to

achieve financial objectives for a given set of risk tolerance and constraints´.

The Life Insurance Corporation of India (LIC) is the largest state-owned life insurance

company in India, and also the country's largest investor. It is fully owned by the Government of India. It also funds close to 24.6% of the Indian Government's expenses. It has assets estimatedof 9.31 trillion (US$ 202.03 billion). It was founded in 1956 with the merger of more than 200insurance companies and provident societies.



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Headquartered in Mumbai, financial and commercial capital of India, the Life InsuranceCorporation of India currently has 8 zonal Offices and 101 divisional offices located in different parts of India, at least 2048 branches located in different cities and towns of India along withsatellite Offices attached to about some 50 Branches, and has a network of around 1.2 millionagents for soliciting life insurance business from the public.



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LITERATURE REVIEW



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Brief History Of Insurance

The story of insurance is probably as old as the story of mankind. The same instinct that prompts

modern businessmen today to secure themselves against loss and disaster existed in primitive

men also. They too sought to avert the evil consequences of fire and flood and loss of life and

were willing to make some sort of sacrifice in order to achieve security. Though the concept of

insurance is largely a development of the recent past, particularly after the industrial era ± past

few centuries ± yet its beginnings date back almost 6000 years.

Life Insurance in its modern form came to India from England in the year 1818. Oriental Life

Insurance Company started by Europeans in Calcutta was the first life insurance company on

Indian Soil. All the insurance companies established during that period were brought up with the

purpose of looking after the needs of European community and Indian natives were not being

insured by these companies.H

owever, later with the efforts of eminent people like BabuMuttylalSeal, the foreign life insurance companies started insuring Indian lives. But Indian lives were

being treated as sub-standard lives and heavy extra premiums were being charged on them.

Bombay Mutual Life Assurance Society heralded the birth of first Indian life insurance company

in the year 1870, and covered Indian lives at normal rates. Starting as Indian enterprise with

highly patriotic motives, insurance companies came into existence to carry the message of

insurance and social security through insurance to various sectors of society. Bharat Insurance

Company (1896) was also one of such companies inspired by nationalism. The Swadeshi

movement of 1905-1907 gave rise to more insurance companies. The United India in Madras,

National Indian and National Insurance in Calcutta and the Co-operative Assurance at Lahore

were established in 1906. In 1907, Hindustan Co-operative Insurance Company took its birth in

one of the rooms of the Jorasanko, house of the great poet Rabindranath Tagore, in Calcutta. The



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Indian Mercantile, General Assurance and Swadeshi Life (later Bombay Life) were some of the

companies established during the same period. Prior to 1912 India had no legislation to regulate

insurance business. In the year 1912, the Life Insurance Companies Act, and the Provident Fund

Act were passed. The Life Insurance Companies Act, 1912 made it necessary that the premium

rate tables and periodical valuations of companies should be certified by an actuary. But the Act

discriminated between foreign and Indian companies on many accounts, putting the Indian

companies at a disadvantage.

The first two decades of the twentieth century saw lot of growth in insurance business. From 44

companies with total business-in-force as Rs.22.44 crore, it rose to 176 companies with total

business-in-force as Rs.298 crore in 1938. During the mushrooming of insurance companies

many financially unsound concerns were also floated which failed miserably. The Insurance Act

1938 was the first legislation governing not only life insurance but also non-life insurance to

provide strict state control over insurance business. The demand for nationalization of life

insurance industry was made repeatedly in the past but it gathered momentum in 1944 when a

bill to amend the Life Insurance Act 1938 was introduced in the Legislative Assembly. However,

it was much later on the 19th of January, 1956, that life insurance in India was nationalized.

About 154 Indian insurance companies, 16 non-Indian companies and 75 provident were

operating in India at the time of nationalization. Nationalization was accomplished in two stages;

initially the management of the companies was taken over by means of an Ordinance, and later,

the ownership too by means of a comprehensive bill. The Parliament of India passed the Life

Insurance Corporation Act on the 19th of June 1956, and the Life Insurance Corporation of India



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was created on 1st September, 1956, with the objective of spreading life insurance much more

widely and in particular to the rural areas with a view to reach all insurable persons in the

country, providing them adequate financial cover at a reasonable cost.

LIC had 5 zonal offices, 33 divisional offices and 212 branch offices, apart from its corporate

office in the year 1956. Since life insurance contracts are long term contracts and during the

currency of the policy it requires a variety of services need was felt in the later years to expand

the operations and place a branch office at each district headquarter. Re-organization of LIC took

place and large numbers of new branch offices were opened. As a result of re-organisation

servicing functions were transferred to the branches, and branches were made accounting units.

It worked wonders with the performance of the corporation. It may be seen that from about

200.00 crores of New Business in 1957 the corporation crossed 1000.00 crores only in the year 1969-70, and it took another 10 years for LIC to cross 2000.00 crore mark of new business. But

with re-organization happening in the early eighties, by 1985-86 LIC had already crossed

7000.00 crore Sum Assured on new policies.

Today LIC functions with 2048 fully computerized branch offices, 109 divisional offices, 8

zonal offices, 992 satellite offices and the Corporate office. LIC¶s Wide Area Network covers

109 divisional offices and connects all the branches through a Metro Area Network. LIC has tied

up with some Banks and Service providers to offer on-line premium collection facility in

selected cities. LIC¶s ECS and ATM premium payment facility is an addition to customer

convenience. Apart from on-line Kiosks and IVRS, Info Centers have been commissioned at

Mumbai, Ahmedabad, Bangalore, Chennai, Hyderabad, Kolkata, New Delhi, Pune and many



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other cities. With a vision of providing easy access to its policyholders, LIC has launched its

SATELLITE SAMPARK offices. The satellite offices are smaller, leaner and closer to the

customer. The digitalized records of the satellite offices will facilitate anywhere servicing and

many other conveniences in the future.

LIC continues to be the dominant life insurer even in the liberalized scenario of Indian insurance

and is moving fast on a new growth trajectory surpassing its own past records. LIC has issued

over one crore policies during the current year. It has crossed the milestone of issuing

1,01,32,955 new policies by 15th Oct, 2005, posting a healthy growth rate of 16.67% over the

corresponding period of the previous year.

From then to now, LIC has crossed many milestones and has set unprecedented performance

records in various aspects of life insurance business. The same motives which inspired our

forefathers to bring insurance into existence in this country inspire us at LIC to take this message

of protection to light the lamps of security in as many homes as possible and to help the people

in providing security to their families.

Some of the important milestones in the life insurance business in India are:

1818: Oriental Life Insurance Company, the first life insurance company on Indian soil started

functioning.

1870: Bombay Mutual Life Assurance Society, the first Indian life insurance company started its

business.



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1912: The Indian Life Assurance Companies Act enacted as the first statute to regulate the life

insurance business.

1928: The Indian Insurance Companies Act enacted to enable the government to collect

statistical information about both life and non-life insurance businesses.

1938: Earlier legislation consolidated and amended to by the Insurance Act with the objective of

protecting the interests of the insuring public.

1956: 245 Indian and foreign insurers and provident societies are taken over by the central

government and nationalized. LIC formed by an Act of Parliament, viz. LIC Act, 1956, with a

capital contribution of Rs. 5 crore from the Government of India.

The General insurance business in India, on the other hand, can trace its roots to the Triton

Insurance Company Ltd., the first general insurance company established in the year 1850 in

Calcutta by the British.

Some of the important milestones in the general insurance business in India are:

1907: The Indian Mercantile Insurance Ltd. set up, the first company to transact all classes of

general insurance business.

1957: General Insurance Council, a wing of the Insurance Association of India, frames a code of

conduct for ensuring fair conduct and sound business practices.



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1968: The Insurance Act amended to regulate investments and set minimum solvency margins

and the Tariff Advisory Committee set up.

1972: The General Insurance Business (Nationalization) Act, 1972 nationalized the

general insurance business in India with effect from 1st January 1973.

107 insurers amalgamated and grouped into four companies viz. the National

Insurance Company Ltd., the New India Assurance Company Ltd., the

Oriental Insurance Company Ltd. and the

Life insurance Corporation of India

The Life Insurance Corporation of India (LIC) (Hindi:ê÷íâùì Úùðæ éùë÷ æÕë ) is the largest

owned life insurance company inIndia, and also the country's largest investor. It is fully owned

by the Government of India. It also funds close to 24.6% of the Indian Government's expenses. It

has assets estimated of 9.31 trillion (US$206.68 billion) It was founded in 1956 with the merger

of more than 200 insurance companies and provident societies

Headquartered in Mumbai, financial and commercial capital of India, the Life Insurance

Corporation of India currently has 8 zonal Offices and 101 divisional offices located in different

parts of India, at least 2048 branches located in different cities and towns of India along with

satellite Offices attached to about some 50 Branches, and has a network of around 1.2 million

agents for soliciting life insurance business from the public.



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Over its existence of around 50 years, Life Insurance Corporation of India, which commanded a

monopoly of soliciting and selling life insurance in India, created huge surpluses, and

contributed around 7 % of India'sGDP in 2006.

The Corporation, which started its business with around 300 offices, 5.6 million policies and a

corpus of INR 459 million (US$ 92 million as per the 1959 exchange rate of roughly Rs. 5 for a

US $, has grown to 25000 servicing around 180 million policies and a corpusof over 8 trillion

(US$177.6 billion).

The recent Economic Times Brand Equity Survey rated LIC as the No. 1 Service Brand of the

Country. The slogan of LIC is "Zindagikesaathbhi,Zindagikebaadbhi"inHindi. In English it

means "with life also, after life also.

According to The Brand Trust Report 2011, LIC is the 8th most trusted brand of India



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Bajaj Allianz Life Insur ance Company Limited

Bajaj Allianz Life Insurance is a union between Allianz SE, one of the largest Insurance

Company and Bajaj Finserv.

Allianz SE is a leading insurance conglomerate globally and one of the largest asset managers

in the world, managing assets worth over a Trillion (Over INR. 55, 00,000 Crores). Allianz SE

has over 119 years of financial experience and is present in over 70 countries around the world.

At Bajaj Allianz Life Insurance, customer delight is our guiding principle. Our business

philosophy is to ensure excellent insurance and investment solutions by offering customized

products, supported by the best technology.



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Some Risks faced by Life Insurance Companies:

Asset Depreciation Risk: Risk of Losses due to decline in market value, which has

inverse relationship with interest rates.

Pricing Risk: Risk of occurrence of expenses higher than expected.

Interest Rate Risk: Risk arising due to fluctuating interest rates, which is different for

asset and liabilities.

Business Risk: It covers Risks like Legal risk, regulatory changes and tax changes,

venturing new business etc.

ASSET AND LIABILITY MANAGEMENT (ALM)

Asset/ liability management (ALM) is a tool that enables insurance companies¶ to take business

decisions in a more informed framework. The ALM function informs the manager whatis the

current market risk profile of the company and the impact that various alternative business

decisions would have on the future risk profile. The manager can then choose the best course of

action depending on his board's risk appetite.

Asset-liability management (ALM) is a term whose meaning has evolved. It is used in slightly

different ways in different contexts. ALM was pioneered by financial institutions, but

corporations now also apply ALM techniques.

Traditionally, banks and insurance companies used accrual accounting for essentially all their

assets and liabilities. They would take on liabilities, such as deposits, life insurance policies or

annuities. They would invest the proceeds from these liabilities in assets such as loans, bondsor





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performance²the rates at which new business would be acquired for various products. Based

upon these assumptions, the performance of the firm's balance sheet could be projected under

each scenario. If projected performance was poor under specific scenarios, the ALM committee

might adjust assets or liabilities to address the indicated exposure. A shortcoming of scenario

analysis is the fact that it is highly dependent on the choice of scenarios. It also requires that

many assumptions be made about how specific assets or liabilities will perform under specific

scenarios.In a sense, ALM was a substitute for market-value accounting in a context of accrual

accounting. It was a necessary substitute because many of the assets and liabilities of financial

institutions could not²and still cannot²be marked to market. This spirit of market-value

accounting was not a complete solution. A firm can earn significant mark-to-market profits but

go bankrupt due to inadequate cash flow. Some techniques of ALM²such as duration

analysis²do not address liquidityissues at all. Others are compatible with cash-flow analysis.

With minimal modification, a gap analysis can be used for cash flow analysis. Scenario analysis

can easily be used to assess liquidity risk.

Firms recognized a potential for liquidity risks to be overlooked in ALM analyses. They also

recognized that many of the tools used by ALM departments could easily be applied to assess

liquidity risk. Accordingly, the assessment and management of liquidity risk became a second

function of ALM departments and ALM committees. Today, liquidity risk management is

generally considered a part of ALM.

ALM has evolved since the early 1980's. Today, financial firms are increasingly using market-

value accounting for certain business lines. This is true of universal banks that have trading



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operations. For trading books, techniques of market risk management²value-at-risk (VaR),

market risk limits, etc.²are more appropriate than techniques of ALM. In financial firms, ALM

is associated with those assets and liabilities²those business lines²that are accounted for on an

accrual basis. This includes bank lending and deposit taking. It includes essentially all traditional

insurance activities.

Techniques of ALM have also evolved. The growth of OTCderivatives markets have facilitated

a variety of hedging strategies. A significant development has been securitization, which allows

firms to directly address asset-liability risk by removing assets or liabilities from their balance

sheets. This not only reduces asset-liability risk; it also frees up the balance sheet for new

business.

The scope of ALM activities has widened. Today, ALM departments are addressing (non-

trading) foreign exchange risks and other risks. Also, ALM has extended to non-financial firms.

Corporations have adopted techniques of ALM to address interest-rate exposures, liquidity risk

and foreign exchange risk. They are using related techniques to address commodities risks. For

example, airlines' hedging of fuel prices or manufacturers' hedging of steel prices are often

presented as ALM.

Why we must consider ALM?

y Mismatching could have serious implications for the financial viability, as evidenced by

collapse of many life insurers

y Prudent management of ALM accounts for a good reward in RBC



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y ALM answers the strategic questions, viz.,

availability of adequate capital for solvency in stressed scenario;

how to make a tradeoff between risk and return;

what is the optimal growth of premium, given the risk appetite;

adequacy of reinsurance arrangements;

Optimal use of risk mapping and evaluation of alternative strategy.

STRATEGIC APPROACHES TO ALM

Spread Management : This focuses on maintaining an adequate spread between

abank¶s interest expense on liabilities and its interest income on assets.

G ap Management : This focuses on identifying and matching rate sensitive assetsand

liabilities to achieve maximum profits over the course of interest rate cycles.

I nterest Sensitivity Analysis: This focuses on improving interest spread by testing

theeffects of possible changes in the rates, volume, and mix of assets and liabilities, given

alternative movements in interest rates.

These strategies attempt to closely co-ordinate organisationsassets and liability

management sothat bank¶s earnings are less vulnerable to changes in interest rates.



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Relationship of Maturity Period, Market Price & Interest

y A rise in the required yield to maturity reduces the price of the fixed income security²

hence a downward sloping curve exists between market value and yield to maturity

y The longer the maturity of a fixed income security, the greater its fall in price and market

value due to an increase in the interest rate.

y The decrease in the value of the security increases at a diminishing rate for any given

increase in interest rate.

Maturity Period of Assets & Liabilities

Maturity Method: If the maturity of assets is greater than maturity of liabilities, any change in

the interest rate will affect the value of assets more than liabilities. Hence maturity method

considers only direction and magnitude of the maturity and does not consider cash flows.

Macaulay Duration:The weighted average term to maturity of the cash flows from a bond.

The weight of each cash flow is determined by dividing the present value of the cash flow by

the price, and is a measure of bond price volatility with respect to interest rates.

Modified Duration:The modified duration of financial instruments is a measure of price

sensitivity of a fixed set of cash flows to small changes in the single interest rate. The higher

the measure of duration, the more sensitive (elastic) is the value of the financial instrument to

changes in interest rates.



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Option Adjusted Duration: The option-adjusted duration is a measure of price sensitivity.

The difference is that option±adjusted duration is a much more accurate measure of price

sensitivity if the cash flows depend upon the path that interest rates take.This expresses how

much the price will change as a result of small changes in interest rates, and is expressed in

terms of a ratio by dividing by the beginning price.

Convexity:Convexity is defined as the second derivative of price with respect to interest rates

divided by the price, and is a measure of how the duration changes as interest rates change.

ISSUES:

1. First, risk management is closely related to ALM. Any mismatch between assets

andLiabilities increase risks, whether it is interest rate risk, credit risk or liquidity risk.

Accurate risk identification and classification of past losses into expected and

unexpectedlosses would help in positioning comprehensive internal controls. Not a

simple proposition, it requires in depth study and analysis of financial and other markets.

2. Secondly, the evaluation of credit rating continues to be an imprecise process. Overtime

one should expect that the banks rating procedures should be compatible with rating

systems elsewhere in the capital market and have the same degree of objectivity.3. A third area where improvements seem warranted is the analysis of ex-post outcomes

from lending. Credit losses are, currently not preciously related to credit rating. They

need to be more closely tracked by the banks than they currently are. In short, credit



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pricing, credit rating and expected losses ought to be demonstrably linked.

4. Fourthly, interest rate risk approaches include both the trading systems; there has been a

considerable improvement. The VaR methodology has converted a rather subjective

hand-on process of risk control to more quantitative one.

5. Finally, as banks move more towards off-balance sheet activities must be

betterintegrated into overall risk management and strategic decision making. Currently,

theyare ignored when bank risk management is considered or are at a fairly primitive

stage. Ifreasonable exposure estimates are to be obtained, much more need to be done

includingbuilding up of a strong Management Information System (MIS) backed up by a

sound database.

Asset liability management

Asset management Liability management



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Asset Liability Management (ALM) defines management of all assets and liabilities (both

off and on balance sheet items) of a insurance company. It requires assessment of various types

of risks and altering the asset liability portfolio to manage risk.

NEED FOR ASSET LIABILITY MANAGEMENT

Risk is inherent in insurance sector and is unavoidable. Asset Liability Management is not to

avoid but to manage risks (mismatch) at the same time sustaining the profitability. This requires

periodic monitoring of risk exposures which involves arrangements for collecting and analyzing

information. It involves ability to anticipate, forecasts and to act so as to structure the banks

business to profit from it.

Asset liability management seeks to contain risk while pursuing profit at the same time. The

risks are not independent from each other. They are in practice inter-linked and hence do not

offer specific solution easily. Therefore, techniques do not give solutions straight away. Asset

management like all management depends ultimately on judgment and decision making. Asset

liability management is concerning with all aspects of business involving financial decisions.

Thus there is a considerable technicality to make policy, to ensure consistent implementation and

to monitor the results. Generally large insurance company constituted a committee with

representatives drawn from all main functions of the bank, called Asset Liability Committee

(ALCO) for the management. This committee operates typically just below the board. In smaller

banks the responsibilities is vested with the board of management.

ALM involves both long term and short term policy decisions. While the long term policies need



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to be approved by the highest level, the short term policy needs delegation of both responsibility

and authority. There is a need to develop accounting and supervisory system to ensure smoother

implementations of ALM function.

Decisions would also involve the geographical dispersal of dealing markets, the dealing parties

and dealing offices/personnel. Also the institutionalizing of ALM requires certain investments in

training, information and communication system, developing new types of business products,

etc.

To conclude, the doctrine of return versus risk suggests that no institution should avoid

Taking risk. However, the question of scales, dimension and magnitude of risk as well as

return to be defined, in implemented and monitored. The ALM techniques provide a framework

for same in effective manner.

Importance of ALM: there are several reasons for the growing importance of

ALMfunction. More important are the exposure of the institution directly or indirectly to the risk

situation & the need to safeguard the position proactively .the following recent trends also

necessitate the ALM functions in banks.

1. Financial volatility

2. Explosion of new financial products

3. Regulatory initiatives4. Heightened awareness of top management



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Financial volatility: during the past decade we have witnessed heightened volatility in the

financial market in India & rest of the world .Increased volatility results in greater in greater

uncertainties in profitability, portfolio value & solvency.

When there is a risk, there is aneed for risk management, which is effective .ALM has become

critical in the volatile financial environment of the recent past.

New financial product innovation: the second reason for growing importance of ALM is the

explosive growth of new financial products. These products are innovated by the market player

in India& abroad & the agencies like RBI, SEBIetc. have introduced several new products during

the last decade. While analyzing new product, we need to understand:

1. product mechanics

2. pricing

3. applications

4. potential risks

Regulatory initiatives: the regulatory agencies throughout the world have taken several measures

to enhance sophistication & regulation of ALM .the Basel committee on bank supervision issued

an amendment in January 1996.to the capital accord 1988.to incorporate market risk in in the

supervisory norms. the supervisory authorities were asked to implement the same by year

end1997.accordingly RBI issued guidelines in February 1999 issued guidelines in



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february1999;the ALM system was to cover at least 60% of the asset liabilities of the banks

effective from 1 April 1999 &100% from April 2000

Management Recognition: the high profile head-line making derivatives disasters, losses related

to market risks, the effect of interest rate movements on the income of banks, have enhanced the

level of awareness of top management. They have begun to take greater interest, ask more

questions &want to improve the oversight of the risk management system in the banks.

Need of Asset Liability Management:

y Availability of adequate capital for solvency in stressed scenario;

y How to make a trade-off between risk and return;

y What is the optimal growth of premium, given the risk appetite;

y Adequacy of reinsurance arrangements;

y Optimal use of risk mapping and evaluation of alternative strategy

Various steps in the Asset Liability Management

y Portfolio segmentation by product line

y Cash-flow management

y Portfolio gap analysis, including maturity analysis and interest rate sensitivity analysis

y Simulation analysis, including cash flow testing and dynamic solvency testing



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y Optimization analysis

y Hedging strategies for investing

Research objective

1. What is asset liability management & how it is implied in insurance sector?

2. To study the portfolio matching behaviors of insurance sector In terms of nature &

relationship between asset & liability

3. To study the impact of ALM on profitability of insurance company



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s

Research methodology

Nature of Research: The research approach for this project is descriptive and analytical in

nature that based on analysis of asset liability management of selected insurance companies.

Further the project is based upon quantitative analysis of selected data.

Nature of Data: The data collected for the study is secondary in nature.

Sources of Data: The data has been collected though annual reports of concerned companies.

Sampling Procedure: For the purpose of the study by adopting simple random sampling two life

insurance companies have been selected namely:

1. Life Insurance Corporation of India

2. Bajaj Allianz

Research Instruments



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Research Instrument used for this study is based on Percentage.

Percentage is a way of expressing a number as a fraction of 100. Percentages are used to express

how large/small one quantity is, relative to another quantity.

Percentage in this study is being used to compare the investments done by the Life Insurance

Corporation of India&Bajaj Allianz in Assets held to cover the Linked Liabilities. Since there

is a large amount of difference in the amount of investment done by them, so a viable

comparison is not possible until figures of both the companies must be converted into common

size. Therefore, for the sake of comparison, percentage has been applied to convert absolute

figures into comparative one.

Limitations

y In this study only two insurance companies are taken for comparison.

y Data compared is only for one year.

y Due to the difference in the amount of investment done by the insurance companies there

comparison is done by deriving their percentage.



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DATA ANALYSIS& INTERPRETATION

Comparison on % Share of Assets Held to Cover Linked Liabilities



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Long Term Investments: Long term investment done by both the companies in the table given below shows that the investment done by Bajaj Allianz is in a very aggressive manner ascompared to LIC which can be seen through its investment in equity shares. LICs investment inGovernment securities and guaranteed bonds indicates that the LIC also used to invest in thesecure sectors more as compared to Bajaj Allianz



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ParticularsLIC

Bajaj

Allianz

Long Term Investments

Govt. Securities & Guaranteed Bonds 17.50% 9.91%

Other Approved securities 3.09% 0%

Equity Shares 64.90% 68.92%

Debentures/Bonds 2.75% 2.17%

Other Securities 0.00% 0.32%

Investment in Infrastructure & Social Sector 3.12% 5.36%

Other than Approved Investments 7.05% 6.75%

Short Term InvestmentsGovt. Securities & Guaranteed Bonds 0.00% 0.28%

Mutual Funds 4.61% 0.76%

Debentures/Bonds 0.00% 9.99%

Other Securities 3.03% 1.50%

Investment in Infrastructure & Social Sector 0.00% 0.31%

Net Current Assets -6.05% 2.63%Investment in India 99.99% 100%

Investment Outside India 0.01% 0%

% Share of Assets Held to Cover Linked Liabilities



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Short Term Investments: Short term investment done by both the companies in the table shownabove indicates that the investment done by Bajaj Allianz is more as compared to investmentdone by Life Insurance Corporation of India.

Net Investment: Net Investments done by both the companies shown in the table givenabove shows that Bajaj Allianz has invested 100% in India whereas, Life InsuranceCorporation of India has invested 99.99% in India & 0.01% outside India.

-0.2

0

0.2

0.4

0.6

0.8

1

1.2



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What about buying other assets?

y The guaranteed payments must be hedged with options (put options on stock, call options

on bonds when investing in shorter-maturity bonds).

y Options may also be needed to hedge the buyback liability?

Discussion of some option investment strategies

y Floating-rate note (coupon reset to one-year rate R), combined with an interest-rate floor

which has the following payoff: max (K- R, 0), where K is the strike rate. Here, the

buyback liability is fully hedged.

y Instead of buying 30-year bonds, the insurance company can buy 10-year bonds

combined with an option to buy 20-year bonds in 10 years (for example, a 10x20

receiver swaption). The purpose of the option is to hedge the reinvestment risk in 10

years.LIC does not adopt this Strategy.

y An investment in stocks should be combined with a put option on the stocks. The strike

price of the put option must match the future guaranteed payments (i.e., an annual return

equal to the technical interest rate).

Asset-liability management with options

y The company does not need to buy the options directly. They can replicate the options

through delta-hedging strategies. Instead of stocks + put options, they can switch from

stocks to bonds if stock prices drop (as the delta" on the put options approach -1).

y Main problem: reserves must be sufficient to cover the option exposure.



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Some Issues to be Looked Upon

Single premium products²what difference between A and L on economic basis?

Participating liability²proportionate change in assets is slightly more than that of

liabilities?

ULIPs²no duration match required for unit reserves?

Assets valued at book value ± liabilities at consistent basis are it appropriate?

Contradiction with GN2²´ if changes would result in a change in the aggregate liability

that is not matched by a change in market value of corresponding assets, the actuary

should consider as to what provision is required as contingency margin, having regard to

the consequences should the provision prove insufficient´

Need for a quasi-regulatory balance sheet ±taking assets at market value with due

allowance for MAD?

What kind of stress tests be used ±99th percentile with one year horizon?

Monitor the movement of free assets?

Projection of capital requirement²working out of resilience capital for the future?

Sensitivity of the company¶s financial strength to the following:

New business volume

Business mix

Expense control



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Process Flow Diagr am

Setting the objective of the project i.e.comparison of Asset

Liability Management of Life Insurance Companies

Collection of data and information from various sources

Extraction of relevant information

Analysis of the information

Observations

Compilation and presentation of report



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Findings & recommendations



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Findings

y LIC used to make more secure investments as compared to Bajaj Allianz by investing in

Government Securities & Guaranteed Bonds.

y LIC use to invest other approved securities whereas; Bajaj Allianz¶s investment is Nil in

it.

y LIC use to make more short term investments in Mutual Funds as Compared to Bajaj

Allianz.

y Bajaj Allianz has made more investment in short term Debentures/Bonds. On the other

hand LIC¶s investment in this sector is Nil.

y Net Current Assets of Bajaj Allianz is good as compared to LIC where LIC¶s net current

assets are going negative.

y LIC use to make investment outside India also whereas; Bajaj Allianz investment outside

India is Nil.

Recommendations

y Investing 100% in long-term bonds is not the ideal solution.

y Organizations should maintain adequate assets to meet liabilities.

y Investment in outside India companies is better option to avoid risk.

y The best hedge is to match the future outgoing payments with incoming payments from

long-term bonds.

y Bonds have standardized amortization profiles, typically bullet structures. However,

matching the duration (interest rate sensitivity) of the bond port-folio and the guaranteed

payments should suffice for practical purposes.



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y Long-dates bonds are needed here. The duration of the liabilities (guaranteed payments)

has been estimated at 16 years (in 1998). This corresponds to the duration of a 30-year

bullet bond.

y The technical interest rate should be set below the market interest rate at the beginning of

the contract, which leaves some reserves for buying other assets such as options.

y If the guaranteed payments are not hedged with long-term bonds, the insurance

companies must buy options to ensure the necessary payoff on the liability side.

y The annual rate of return to the policy holders cannot exceed the technical interest rate.

Difficult to attract new customers.

y The case with LIC is that it uses to invest only 2.75% in Long term Debentures/Bonds.

Investing 100% in long-term bonds is not the ideal solution

y What about the buyback liability? If interest rates increase, the value of the bond

portfolio is below par, but unless the buyback liability can be constrained somehow, the

liabilities cannot be valued below par.

y Only if the speculation prevention clause is fully effective (buyback with a discount

corresponding to the market value of assets), can we ignore this problem.

y The optimal (utility-maximizing) portfolio for the policy holders is unlikely to consist of

100% bonds.



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Conclusion:



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Conclusion

Asset-liability management is an essential improvement in insurance sector & banking sector

that allows private bankers to provide their clients with investment solutions and asset allocation

advice that truly meet their needs. I have also provided a series of illustrations that show that

some of the most sophisticated ALM techniques used in institutional money management can

satisfactorily be implemented In insurance sector as wellUltimately, I found that it is not the

performance of a particular fund nor that of a given asset class (including commodities or hedge

funds) that will be the determining factor in the ability of insurance sector to meet investors¶

expectations. What will prove to be the decisive factor is the wealth manager¶s ability to designan asset allocation solution that is a function of the kinds of particular risks to which the investor

is exposed, as opposed to the market as a whole. Hence, an absolute return fund, often perceived

as a natural choice in the context of wealth management, shall not be a satisfactory response to

the needs of a client facing long-term inflation risk, where the concern is capital preservation in

real, as opposed to nominal, terms... In other words, the success or failure of the satisfaction of

the client¶s long-term objectives is fundamentally dependent on an ALM exercise that aims to

determine the proper strategic inter-classes allocation as a function of the client¶s specific

objectives and constraints. Asset management should only come next as response to the

implementation constraints ofthe ALM decisions. On the one hand, it is meant to deliver/enhance

the risk and return parameters supporting the ALM analysis for each asset class. On the other

hand, it can also allow for the management of short-term constraints, such as capital preservation



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at a given confidence level, which are not necessarily taken into account by an ALM

optimization exercise, which by naturefocuses on long-term objectives.

Bibliogr aphy

y www.lichfi.com

y www.licindia.com

y www.bajajallianz.com

y www.actuariesindia.org

y www.jesperlund.com

y http://en.wikipedia.org/wiki/Asset_liability_management

y http://www.iimb.ernet.in/~vaidya/Asset-liability.pdf

Books: 1. K umar Ravi, edition 2010, Asset Liability Management

2. K umar Ravi Edition 2000 Indian Banking in Transition: Issues and Challenges



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Annexures



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Documents

Hemant FRP Final