In financial risk management investments are increasingly being viewed from a liability perspective. Constructing an investment portfolio that covers the financial risks stemming from the liabilities, the basic idea behind Liability-Driven Investing (LDI) is therefore very appealing for insurance companies.

A closely-related approach is the so-called liability benchmark method. Here existing insurance products are replicated by liquid financial instruments. To achieve this goal, it is important to mirror all cash flows of a product (premiums, costs, guaranteed benefits, profit sharing) as neatly as possible with available financial instruments (bonds, interest derivatives, etc.). This will make it possible to convert an insurance product (or insurance portfolio) into a similar portfolio of financial instruments.

Replicating portfolios has several great advantages. First of all, it is a good benchmark to compare investments. In addition, it is a practical tool for product development, pricing and risk management objectives. An embedded option in an insurance product can for example often be replicated by a derivate with an actual market value e.g. swaption. This information can then be used to determine a good hedge for the embedded option and the associated costs. Finally, the replicating of portfolios can speed up ALM calculations or optimizations of the investment portfolio.

The required information for liability benchmark calculations (such as market valuation of the liabilities and economic scenarios) are standard features of Ortec Finance’s ALM model for insurers. Our experts will assist you in applying these advanced techniques.