Asset-liability matching and duration
Management aimed at aligning the interest-rate sensitivity of an insurer's assets and liabilities to limit interest-rate risk.
Asset-liability matching designates the management by which an insurer aligns the characteristics of its investments with those of its liabilities, in order to control the risk that interest-rate movements affect assets and liabilities differently. Duration, the measure of a financial flow's sensitivity to rate changes, is the central tool: by bringing the duration of assets close to that of liabilities, the insurer reduces the sensitivity gap and thus interest-rate risk. Life insurers are the most exposed, since their liabilities can extend over several decades, sometimes beyond the maturity of bonds available on the market, creating reinvestment risk. Poor matching management has historically caused insurer failures during marked rate movements. For the analyst, the quality of matching and the residual duration gap are key indicators of a life insurer's financial robustness through rate cycles.
Textbook case: a life insurer whose liabilities have a duration of twenty years seeks to hold assets of comparable duration to neutralize the effect of a rate change on its solvency.
duration matching, asset-liability matching, ALM, asset-liability management
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