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Insurance life : how to properly match assets and liabilities


Alain Thériault

March 15, 2019 11:30

Matching asset-liability may be appropriate for plans who want to cut the pear in two : only cover a portion of the risk, but pay less.

At the other end of the spectrum, the regime can ensure and maintain its assets, paying a slight premium to the insurer. It is the assurance of durability, or longevity swaps.

When a plan purchases an annuity, it provides a guarantee of protection very high. The company, however, must sacrifice a lot of capital to take advantage of this.

“There is a certain cost to this guarantee, according to Michel St-Germain, a member of the partnership of Mercer Canada. There is an alternative at a lower cost. The pension fund may invest in high yield bonds, from maturities staggered to match the payments of annuities provided for “, he explains.

Mr. St-Germain reports, however, that this option does not disappear neither longevity risk nor the credit risk. The credit risk may occur when the fund invests in bonds of companies to obtain a larger yield. The risk of default is higher in this category.

This option entails a risk of pairing, also explains Mr. St-Germain. The investments may not in fact match perfectly to the obligations of the plan, for example for the duration of the annuities to be paid. The pairing remains as a method of risk management approximate, he argued.

Better than doing nothing

Anyway, Michel St-Germain, believes that the pairing allows you to create a portfolio that is immunized, which represents a liability that is lower than that transferred to the insurer in the case of an annuity. “The transaction is done at a lower cost, without any transfer to the insurer, but it reduces the risk enormously,” said the actuary.

Louis-Bernard Désilets, senior adviser, pension and savings of Normandin Beaudry, was observed a gradation of a solution of risk management to the other. “For the past few years, we have accompanied many of our customers in measures to better match their retirement fund with the liabilities of their plan. It started this way : hold assets that behave in a similar way to the liabilities of the plan. If the scheme has more pensioners, the assets will consist more bonds. The interest rate risk of the plan is thus reduced, since in the case of rate changes, plan assets will tend to react in a way similar to his passive, ” he explains.

Risk management has also evolved with the introduction, in pension funds, longer-term bonds, said Mr. Désilets. “Other no more, our customers are buying more annuity, to transfer to the insurer not only the interest rate risk, but also all the others, including that of longevity – that is the risk of incorrectly assessing the life expectancy of the pensioners “, he said.

Another advanced widespread in Britain : the longevity swaps, better known in Canada under the name of insurance longevity. “This approach is especially offered to very large plans for the time being “, said Mr. Désilets.

According to the insurance longevity, the system does not transfer the longevity risk to an insurer. The plan sponsor retains the risk linked to equity markets and interest rates, since it keeps the assets in its pension fund. “This solution is suitable for schemes that believe they are able to invest way to beat the returns of the market for group annuities, but want to cover themselves against the risk of longevity,” says the actuary.

How does it work?

To purchase an annuity, the plan sponsor pays to the insurer a lump sum, ” says Mr. Désilets. It is a premium in a single payment, which essentially represents the total value of annuities expected from the pensioners insured, including any death benefits that are attached to it.

If he buys a swap (agreement to exchange), continues Mr. Désilets, the premium is broken into small pieces. For the duration of the contract, the promoter agrees to pay to the insurer a small annual premium, which is roughly the value of the payment of expected pensions of retirees insured for the year in question.

Unlike the purchase of annuities, the promoter keeps most of its assets, and its commitment becomes a series of fixed payments-determined (the annual premiums), rather than an annuity, the payment of which is uncertain and variable, as it depends on the survival of the pensioners and, in some cases, their spouse.

The insurers analyze the statistics of the scheme to determine the series of fixed payments to be paid by the promoter. According to the most common of these products, the insurer pays to the plan the pension real retirees according to the results, and the plan continues to pay these annuities directly to retirees. If the pensioner exceeds the life expectancy expected, the insurer must continue to pay his pension to the plan. For its part, the regime continues to pay the periodic premium under the contract. In practice, a net payment is often made annually between the insurer and the plan.

For the plan sponsor, the swap replaces the pension with a series of fixed payments-determined. He knows, as well his commitment, since his obligation becomes predictable.

For example, a retiree whose annuity has an annual $ 100 will pay the insurer a premium which decreases annually. The annual amount includes a risk premium and profit for the insurer. This amount decreases until it becomes zero according to the probabilities of death that are increasing in time. Without the swap, the insurer would have paid $ 100 per year until the death of that retiree.

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