Duration gap
Difference between asset duration and liability duration weighted by their values, measuring in one figure an insurer's net value exposure to a rate move.
The duration gap equals asset duration minus liability duration weighted by the ratio of the two sides' values. Its sign says everything. A positive gap means assets are longer than liabilities: net value falls when rates rise. That is the classic position of a non-life insurer, whose liabilities are short. A negative gap means the reverse, and it is the structural position of life insurers and pension funds: their annuities run further out than the bonds available, so falling rates make them poorer. That asymmetry is why the negative rate years hurt the European life sector so badly, and why the return of higher rates from 2022 brought the same balance sheets relief. Two limits to keep in mind. The gap assumes a parallel shift of the curve, so it says nothing about twist risk. It also ignores embedded options, surrenders and minimum rate guarantees, which lengthen liabilities when rates fall and shorten them when rates rise: the real gap is worse than the reported one, in both directions.
European life insurer as of December 31, 2021, at the end of the very low rate period: asset duration 7.9 years, liability duration 13.2 years, a strongly negative gap. The several hundred basis point rate rise through 2022 cut the present value of obligations faster than that of assets, improving the sector's solvency ratios even as unrealized bond gains vanished.
Follow the research
One letter a week. First, the week's underwriting note, when one is published: a dated, argued decision, signed by Paul Bernardski. Then what the observatory published on cyber risk, political risk and insurance. No account, no tracking.
No spam, one-click unsubscribe, no data ever sold.