Académique Documents
Professionnel Documents
Culture Documents
Callable assets
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ALM Tools
Financial statistics
Duration
Convexity
Benchmark Portfolios
Replicating Portfolios
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Liabilities
Single premium deferred annuities
Issued
Assets
$216 million corporate bonds
$64 million mortgage passthroughs
$174 million CMOs (Sequentials and PACs)
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Behavior Assumptions
Callable Bonds
Firms make irrational decisions
Commercial mortgages
Yield maintenance or make-whole provisions
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Behavior Assumptions
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Mult = 2.0
70%
Exp = 2.5
60%
50%
40%
30%
20%
Mult = 5.0
10%
Exp = 1.5
0%
0%
1%
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2%
3%
4%
5%
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Assets
Coupon
Calls/Prepayments
Adjusted for defaults
Liabilities
Premium
Benefits
Expenses
Taxes
Shareholder dividends?
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2010
2011
2012
2013
2014
2015
2016
2017
2018
Year
Asset Cash Flows
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2010
2011
2012
2013
2014
2015
2016
2017
2018
Year
Asset Cash Flows
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10
2010
2011
2012
2013
2014
2015
2016
2017
2018
Year
Asset Cash Flows
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200
150
100
50
0
-50
-100
2010
2011
2012
2013
2014
Projection Year
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Duration
Where
P0 = Bond price.
P- = Bond price when interest rate is incremented
P+ = Bond price when interest rate is decremented
y = change in interest rate in decimal form
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Convexity
Where
P0 = Bond price.
P- = Bond price when interest rate is incremented
P+ = Bond price when interest rate is decremented
y = change in interest rate in decimal form
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Liabilities
Use either spot rates or spot rates plus asset OAS to discount cash flows
Issues:
Future premiums (especially on flexible premium products) can lead to unusual
results
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15
165
160
155
150
145
140
135
130
-150
-100
-50
50
100
150
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Liabilities
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16
Duration
Convexity
Plus 100 bp
144.3
5.7
3.9
Plus 50 bp
148.5
5.4
-58.2
Base Line
152.4
5.0
-65.9
Minus 50 bp
156.1
4.2
-198.9
Minus 100 bp
159.0
3.4
-95.4
Scenario
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Duration
Convexity
Plus 100 bp
143.8
2.2
-66.9
Plus 50 bp
145.3
1.8
-93.7
Base Line
146.5
1.3
-117.8
Minus 50 bp
147.2
0.9
-12.7
Minus 100 bp
147.8
1.0
33.0
Scenario
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Extension of the efficient frontier from the capital asset pricing model
(CAPM)
CAPM uses the rates of return on assets and the volatility of those
returns to determine optimal portfolios
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10
Methodology
Volatility
Number of scenarios with negative present values
Number of periods where surplus is negative
Return
Average present value of distributable profits
Number of scenarios where assets under management exceed x dollars
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Methodology
Investment
Crediting
Product design
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11
Sample
100% Passthroughs
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Sample
Return
Risk
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12
PV Distributable Profits
16
14
12
G
B
10
8
6
4
2
0
0.0%
H
F
0.5%
1.0%
1.5%
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towerswatson.com
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13
Benchmark Portfolios
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Quality target
Sector allocation
Option risk
Liquidity
Regulatory constraints
Duration targets
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14
Duration
Yield
U.S. Treasury
5.32
2.01
Short Treasury
0.41
0.15
4.23
3.02
U.S. Credit
6.32
4.29
1-3 Yr Credit
2.03
2.28
4.38
3.70
12.5
6.01
2.92
3.49
4.44
9.48
Municipal Bond
8.24
3.48
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15
Replicating Portfolios
Definition
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Performance management
Solvency II
Economic Capital
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16
Process
Cash flows
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ALM Assumptions
Asset Options
Liability Options
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Callable Bonds
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Empirical Research
Three groups:
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18
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The more calls in are the money, the more likely the bond is to get
called
The longer a bond is in the money, the more likely it is to get called
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19
Calls and prepayments are the exercise of a call options, usually in a down
interest rate environment
Interest rate driven surrenders are the exercise of put options, usually in an
up interest rate environment
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Surrenders
Partial withdrawals
Higher or lower
Other
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20
Typical Formulas
CDs
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21
Since the early 80s, interest rates have exhibited a downward or level
trend
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22
Example:
Refinance opportunity
5%, 30 year, $1,610 monthly payment
Cost: $2,000
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Market conditions
Tax impacts
Surrender charges
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24
Final Thoughts
The world is always changing and we only have a rear view mirror
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Contact Information
Greg Roemelt
Towers Watson
71 S. Wacker Drive
Chicago, IL 60606
312.201.6317
Greg.Roemelt@TowersWatson.com
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