Life Insurance Company Asset-Liability Management
This domain tests whether assets are managed to meet liability cash flows and risk characteristics, not merely to maximise return.
ALM framework
Life liabilities are long-tailed and sensitive to interest rates, inflation and longevity. ALM uses cash-flow matching, duration matching, immunization and convexity analysis, supported by stress testing. Indian insurers invest under the IRDAI (Investment) Regulations, 2016 and an approved investment policy, with limits by asset class. ALM committees monitor duration gaps, liquidity and concentration. ULIP funds require separate matching within each segregated fund, consistent with the fund's objective.
Worked example
A pension liability has a duration of 9 years, while the backing assets have a duration of 6 years. If interest rates fall by 1%, the liability rises by roughly 9%, but assets rise by only about 6%, widening the deficit. The insurer can buy longer-dated government securities or use derivatives to lengthen duration, then re-test the gap under a 2% shock.
Traps
Matching book values rather than cash flows; ignoring embedded guarantees and policyholder options; treating ULIP assets as freely substitutable across funds; assuming duration matching removes all interest-rate risk; ignoring liquidity in stressed markets.