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Analysts: Knowing Products Key To Knowing Risk

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NU Online News Service, Oct. 17, 2003, 10:15 a.m. EDT – Options embedded in insurance contracts will make asset liability management more vital for companies and will make it more important for investors to understand how interest rates and product offerings affect risks, according to industry analysts.

Asset liability management is more important than ever, given that options within insurers’ product portfolios are among the biggest risks companies face today, says Michael Barry, managing director of Fitch Ratings, New York.

He made his remarks during a recent joint educational session sponsored by Fitch Ratings and Lehman Brothers, both of New York.

One way to understand a company’s risk is to understand the products that it offers and the options available within those products, said Julie Burke, a managing director in Fitch’s Chicago office. And the best way to do that is to review actuarial memorandums it files with state insurance departments.
But that resource is not readily available to many, Burke said, so it is disappointing that there is not more disclosure and not more information provided in 10Ks and 10Qs.

Another factor that should be considered is who sold the contract: a company producer or a wirehouse, she added. A contract sold through a wirehouse might be more susceptible to surrender, Burke said.

The current risk-based capital system is somewhat weak in measuring asset and liability management, Barry said.

The good news is that a new regulatory tool, the C-3, Phase I reserving guidelines, can require additional charges of up to two times regular C-3 requirements for certain companies. The requirement is designed to account for the risk of a company’s investment returns. At this point, however, only 10% of companies are implementing C-3, Phase I reserving, he added.

In general, the interest rate trend cited as the best for the industry would be a slowly declining environment.

The reason is that if necessary, a company could sell bonds at a gain, according to Burke. Moreover, if crediting rates were lowered, contract holders would be less likely to move because there would not be attractive alternative products available. And the company’s investment yield would not be affected, at least in the short and medium term, she said.

The worst case for the industry would be a pop-up scenario of quickly rising interest rates, Barry added.

The reason is the loss a company would suffer if it faced surrenders and had to liquidate bonds that had declined in value to meet those surrenders. The longer the duration of the bond, the bigger the loss, he added.