Important Points for IC 99 - Asset Management Exam
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Global Depository Receipts (GDRs) are long term capital market instruments and not money market instruments.
Role of ALM in Insurance Business : Insurance is characterized by the inversion of the cash flows, compared to other businesses : Insurance companies collect premium before they calculate the costs of the service they provide. They collect premium on the basis of estimated the cost of insurance (i.e. claim cost). Insurance companies always face the problems of liquidity, solvency and profitability. In non-life insurance, the underwriting cost generally exceeds the premium income resulting into underwriting loss. So the insurance companies have to depend largely on investment income for their survival, solvency and liquidity. Hence ALM plays vital role in insurance business.
Matching of the assets and liabilities : Without practice of ALM, it is difficult for insurance companies to match the value of asset with the amount of liabilities to policyholders in respect of payment of claims. ALM process applies a more refined concept of duration of asset (financial) with reference to related liability to ensure solvency and liquidity. It gives due consideration for the weighted-average life-span for the asset and the cash inflows to meet the outflows (i.e. payment of claims). ALM attempts to match the duration of the in-flows with the duration of out-flows. In practice, an insurance company cannot know exactly the timing of the out-flows especially in case of term insurance policy in life insurance business and in all policies in P&C insurance companies. There is always some variation that can be estimated somewhat with statistical analysis.
Prudential Norms : As principle of prudence insurance companies are required to have more cash at hand than expected, implying keeping idle cash in hand in worries and uncertainties. In absence of perfect ALM, insurers typically keep their assets with a shorter duration to meet unexpected shorter out-flows implying loss of investment income. Too short a gap means having more cash at hand in case of an unexpected large out-flow. ALM process and practice makes proper analysis of cash inflows and cash-outflows and enable the investment department to decide on a target sequence for the money flows applying more defined and data-based duration concept and to earn adequate investment income to set off and manage underwriting loss which is mounting today in non-life sector in India.
IRDA circular on Asset Liability Management and Stress testing for life Insurers : The challenge for insurance investment management is to manage the potential mismatch in value of its assets and liabilities and to ensure that such a mismatch will not cause any danger or damage to the financial stability or capacity of the insurance company as a going concern and endanger the policyholders interests.
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