Introduction

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BACKGROUND
Asset Liability Management is the practice of managing a business so that decisions on assets and liabilities are coordinated or more broadly it is the ongoing process of formulating implementing monitoring and revisiting strategies related to assets and liabilities in an attempt to achieve financial objectives for a given set of risk tolerance and constraints. In this Project I have made an attempt to study the management of assets & liabilities of the life insurance companies. For the purpose of study two life insurance company Life Insurance Corporation of India & Bajaj Allianz has been taken into consideration. Comparison has been done among the two companies to know how these two companies use to cover their liabilities over their assets. The scope for ALM (asset-liability management) is essentially limited to the asset side 1. If the long-term interest rate drops significantly below the guaranteed (technical) interest rate the buyback liability can be affected to some extent through speculation prevention clauses in life insurance contracts. 3. Changes to bonus schemes (bonus liability) in the form of so-called conditional bonus could be used for ALM purposes, but there are certain legal problems here. Asset Liability Management is the practice of managing a business so that decisions on assets and liabilities are coordinated or more broadly it is the ongoing process of formulating implementing monitoring and revisiting strategies related to assets and liabilities in an attempt to achieve financial objectives for a given set of risk tolerance and constraints. The Life Insurance Corporation of India (LIC) is the largest state-owned life insurance company in India, and also the country's largest investor. It is fully owned by the Government of India. It also funds close to 24.6% of the Indian Government's expenses. It has assets estimated of 9.31 trillion (US$ 202.03 billion). It was founded in 1956 with the merger of more than 200 insurance companies and provident societies.

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Headquartered in Mumbai, financial and commercial capital of India, the Life Insurance Corporation of India currently has 8 zonal Offices and 101 divisional offices located in different parts of India, at least 2048 branches located in different cities and towns of India along with satellite Offices attached to about some 50 Branches, and has a network of around 1.2 million agents for soliciting life insurance business from the public.

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LITERATURE REVIEW

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Brief History Of Insurance

The story of insurance is probably as old as the story of mankind. The same instinct that prompts modern businessmen today to secure themselves against loss and disaster existed in primitive men also. They too sought to avert the evil consequences of fire and flood and loss of life and were willing to make some sort of sacrifice in order to achieve security. Though the concept of insurance is largely a development of the recent past, particularly after the industrial era past few centuries yet its beginnings date back almost 6000 years. Life Insurance in its modern form came to India from England in the year 1818. Oriental Life Insurance Company started by Europeans in Calcutta was the first life insurance company on Indian Soil. All the insurance companies established during that period were brought up with the purpose of looking after the needs of European community and Indian natives were not being insured by these companies. However, later with the efforts of eminent people like BabuMuttylal Seal, the foreign life insurance companies started insuring Indian lives. But Indian lives were being treated as sub-standard lives and heavy extra premiums were being charged on them. Bombay Mutual Life Assurance Society heralded the birth of first Indian life insurance company in the year 1870, and covered Indian lives at normal rates. Starting as Indian enterprise with highly patriotic motives, insurance companies came into existence to carry the message of insurance and social security through insurance to various sectors of society. Bharat Insurance Company (1896) was also one of such companies inspired by nationalism. The Swadeshi movement of 1905-1907 gave rise to more insurance companies. The United India in Madras, National Indian and National Insurance in Calcutta and the Co-operative Assurance at Lahore were established in 1906. In 1907, Hindustan Co-operative Insurance Company took its birth in one of the rooms of the Jorasanko, house of the great poet Rabindranath Tagore, in Calcutta. The

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Indian Mercantile, General Assurance and Swadeshi Life (later Bombay Life) were some of the companies established during the same period. Prior to 1912 India had no legislation to regulate insurance business. In the year 1912, the Life Insurance Companies Act, and the Provident Fund Act were passed. The Life Insurance Companies Act, 1912 made it necessary that the premium rate tables and periodical valuations of companies should be certified by an actuary. But the Act discriminated between foreign and Indian companies on many accounts, putting the Indian companies at a disadvantage.

The first two decades of the twentieth century saw lot of growth in insurance business. From 44 companies with total business-in-force as Rs.22.44 crore, it rose to 176 companies with total business-in-force as Rs.298 crore in 1938. During the mushrooming of insurance companies many financially unsound concerns were also floated which failed miserably. The Insurance Act 1938 was the first legislation governing not only life insurance but also non-life insurance to provide strict state control over insurance business. The demand for nationalization of life insurance industry was made repeatedly in the past but it gathered momentum in 1944 when a bill to amend the Life Insurance Act 1938 was introduced in the Legislative Assembly. However, it was much later on the 19th of January, 1956, that life insurance in India was nationalized. About 154 Indian insurance companies, 16 non-Indian companies and 75 provident were operating in India at the time of nationalization. Nationalization was accomplished in two stages; initially the management of the companies was taken over by means of an Ordinance, and later, the ownership too by means of a comprehensive bill. The Parliament of India passed the Life Insurance Corporation Act on the 19th of June 1956, and the Life Insurance Corporation of India

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was created on 1st September, 1956, with the objective of spreading life insurance much more widely and in particular to the rural areas with a view to reach all insurable persons in the country, providing them adequate financial cover at a reasonable cost. LIC had 5 zonal offices, 33 divisional offices and 212 branch offices, apart from its corporate office in the year 1956. Since life insurance contracts are long term contracts and during the currency of the policy it requires a variety of services need was felt in the later years to expand the operations and place a branch office at each district headquarter. Re-organization of LIC took place and large numbers of new branch offices were opened. As a result of re-organisation servicing functions were transferred to the branches, and branches were made accounting units. It worked wonders with the performance of the corporation. It may be seen that from about 200.00 crores of New Business in 1957 the corporation crossed 1000.00 crores only in the year 1969-70, and it took another 10 years for LIC to cross 2000.00 crore mark of new business. But with re-organization happening in the early eighties, by 1985-86 LIC had already crossed 7000.00 crore Sum Assured on new policies. Today LIC functions with 2048 fully computerized branch offices, 109 divisional offices, 8 zonal offices, 992 satellite offices and the Corporate office. LICs Wide Area Network covers 109 divisional offices and connects all the branches through a Metro Area Network. LIC has tied up with some Banks and Service providers to offer on-line premium collection facility in selected cities. LICs ECS and ATM premium payment facility is an addition to customer convenience. Apart from on-line Kiosks and IVRS, Info Centers have been commissioned at Mumbai, Ahmedabad, Bangalore, Chennai, Hyderabad, Kolkata, New Delhi, Pune and many

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other cities. With a vision of providing easy access to its policyholders, LIC has launched its SATELLITE SAMPARK offices. The satellite offices are smaller, leaner and closer to the customer. The digitalized records of the satellite offices will facilitate anywhere servicing and many other conveniences in the future. LIC continues to be the dominant life insurer even in the liberalized scenario of Indian insurance and is moving fast on a new growth trajectory surpassing its own past records. LIC has issued over one crore policies during the current year. It has crossed the milestone of issuing 1,01,32,955 new policies by 15th Oct, 2005, posting a healthy growth rate of 16.67% over the corresponding period of the previous year. From then to now, LIC has crossed many milestones and has set unprecedented performance records in various aspects of life insurance business. The same motives which inspired our forefathers to bring insurance into existence in this country inspire us at LIC to take this message of protection to light the lamps of security in as many homes as possible and to help the people in providing security to their families. Some of the important milestones in the life insurance business in India are: 1818: Oriental Life Insurance Company, the first life insurance company on Indian soil started functioning. 1870: Bombay Mutual Life Assurance Society, the first Indian life insurance company started its business.

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1912: The Indian Life Assurance Companies Act enacted as the first statute to regulate the life insurance business. 1928: The Indian Insurance Companies Act enacted to enable the government to collect statistical information about both life and non-life insurance businesses. 1938: Earlier legislation consolidated and amended to by the Insurance Act with the objective of protecting the interests of the insuring public. 1956: 245 Indian and foreign insurers and provident societies are taken over by the central government and nationalized. LIC formed by an Act of Parliament, viz. LIC Act, 1956, with a capital contribution of Rs. 5 crore from the Government of India. The General insurance business in India, on the other hand, can trace its roots to the Triton Insurance Company Ltd., the first general insurance company established in the year 1850 in Calcutta by the British. Some of the important milestones in the general insurance business in India are: 1907: The Indian Mercantile Insurance Ltd. set up, the first company to transact all classes of general insurance business. 1957: General Insurance Council, a wing of the Insurance Association of India, frames a code of conduct for ensuring fair conduct and sound business practices.

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1968: The Insurance Act amended to regulate investments and set minimum solvency margins and the Tariff Advisory Committee set up. 1972: The General Insurance Business (Nationalization) Act, 1972 nationalized the general insurance business in India with effect from 1st January 1973. 107 insurers amalgamated Ltd., and the grouped New into India four companies viz. the National the

Insurance

Company

Assurance

Company

Ltd.,

Oriental Insurance Company Ltd. and the

Life insurance Corporation of India

The Life Insurance Corporation of India (LIC) (Hindi: ) is the largest owned life insurance company inIndia, and also the country's largest investor. It is fully owned by the Government of India. It also funds close to 24.6% of the Indian Government's expenses. It has assets estimated of 9.31 trillion (US$206.68 billion) It was founded in 1956 with the merger of more than 200 insurance companies and provident societies Headquartered in Mumbai, financial and commercial capital of India, the Life Insurance Corporation of India currently has 8 zonal Offices and 101 divisional offices located in different parts of India, at least 2048 branches located in different cities and towns of India along with satellite Offices attached to about some 50 Branches, and has a network of around 1.2 million agents for soliciting life insurance business from the public.

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Over its existence of around 50 years, Life Insurance Corporation of India, which commanded a monopoly of soliciting and selling life insurance in India, created huge surpluses, and contributed around 7 % of India'sGDP in 2006. The Corporation, which started its business with around 300 offices, 5.6 million policies and a corpus of INR 459 million (US$ 92 million as per the 1959 exchange rate of roughly Rs. 5 for a US $, has grown to 25000 servicing around 180 million policies and a corpusof over 8 trillion (US$177.6 billion). The recent Economic Times Brand Equity Survey rated LIC as the No. 1 Service Brand of the Country. The slogan of LIC is "Zindagikesaathbhi,Zindagikebaadbhi"inHindi. In English it means "with life also, after life also. According to The Brand Trust Report 2011, LIC is the 8th most trusted brand of India

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Bajaj Allianz Life Insurance Company Limited

Bajaj Allianz Life Insurance is a union between Allianz SE, one of the largest Insurance Company and Bajaj Finserv.

Allianz SE is a leading insurance conglomerate globally and one of the largest asset managers in the world, managing assets worth over a Trillion (Over INR. 55, 00,000 Crores). Allianz SE has over 119 years of financial experience and is present in over 70 countries around the world.

At Bajaj Allianz Life Insurance, customer delight is our guiding principle. Our business philosophy is to ensure excellent insurance and investment solutions by offering customized products, supported by the best technology.

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Some Risks faced by Life Insurance Companies:  Asset Depreciation Risk: Risk of Losses due to decline in market value, which has inverse relationship with interest rates.  Pricing Risk: Risk of occurrence of expenses higher than expected.  Interest Rate Risk: Risk arising due to fluctuating interest rates, which is different for asset and liabilities.  Business Risk: It covers Risks like Legal risk, regulatory changes and tax changes, venturing new business etc. ASSET AND LIABILITY MANAGEMENT (ALM) Asset/ liability management (ALM) is a tool that enables insurance companies to take business decisions in a more informed framework. The ALM function informs the manager whatis the current market risk profile of the company and the impact that various alternative business decisions would have on the future risk profile. The manager can then choose the best course of action depending on his board's risk appetite. Asset-liability management (ALM) is a term whose meaning has evolved. It is used in slightly different ways in different contexts. ALM was pioneered by financial institutions, but corporations now also apply ALM techniques. Traditionally, banks and insurance companies used accrual accounting for essentially all their assets and liabilities. They would take on liabilities, such as deposits, life insurance policies or annuities. They would invest the proceeds from these liabilities in assets such as loans, bondsor

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real estate. All assets and liabilities were held atbook value. Doing so disguised possible risks arising from how the assets and liabilities were structured. Accrual accounting could disguise the problem by deferring losses into the future, but it could not solve the problem. Firms responded by forming asset-liability management (ALM) departments to assess asset-liability risk. They established ALM committees comprised of senior managers to address the risk. Techniques for assessing asset-liability risk came to include gap analysis and duration analysis. These facilitated techniques of gap management and duration matching of assets and liabilities. Both approaches worked well if assets and liabilities comprised fixed cash flows. Options, such as those embedded in mortgages or callable debt, posed problems that gap analysis could not address. Duration analysis could address these in theory, but implementing sufficiently sophisticated duration measures was problematic. Accordingly, banks and insurance companies also performed scenario analysis. With scenario analysis, several interest rate scenarios would be specified for the next 5 or 10 years. These might assume declining rates, rising rate's, a gradual decrease in rates followed by a sudden rise, etc. Scenarios might specify the behavior of the entire yield curve, so there could be scenarios with flattening yield curves, inverted yield curves, etc. Ten or twenty scenarios might be specified in all. Next, assumptions would be made about the performance of assets and liabilities under each scenario. Assumptions might include prepayment rates on mortgages or surrender rates on insurance products. Assumptions might also be made about the firm's

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performancethe rates at which new business would be acquired for various products. Based upon these assumptions, the performance of the firm's balance sheet could be projected under each scenario. If projected performance was poor under specific scenarios, the ALM committee might adjust assets or liabilities to address the indicated exposure. A shortcoming of scenario analysis is the fact that it is highly dependent on the choice of scenarios. It also requires that many assumptions be made about how specific assets or liabilities will perform under specific scenarios.In a sense, ALM was a substitute for market-value accounting in a context of accrual accounting. It was a necessary substitute because many of the assets and liabilities of financial institutions could notand still cannotbe marked to market. This spirit of market-value accounting was not a complete solution. A firm can earn significant mark-to-market profits but go bankrupt due to inadequate cash flow. Some techniques of ALMsuch as duration analysisdo not address liquidityissues at all. Others are compatible with cash-flow analysis. With minimal modification, a gap analysis can be used for cash flow analysis. Scenario analysis can easily be used to assess liquidity risk. Firms recognized a potential for liquidity risks to be overlooked in ALM analyses. They also recognized that many of the tools used by ALM departments could easily be applied to assess liquidity risk. Accordingly, the assessment and management of liquidity risk became a second function of ALM departments and ALM committees. Today, liquidity risk management is generally considered a part of ALM. ALM has evolved since the early 1980's. Today, financial firms are increasingly using marketvalue accounting for certain business lines. This is true of universal banks that have trading

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operations. For trading books, techniques of market risk managementvalue-at-risk (VaR), market risk limits, etc.are more appropriate than techniques of ALM. In financial firms, ALM is associated with those assets and liabilitiesthose business linesthat are accounted for on an accrual basis. This includes bank lending and deposit taking. It includes essentially all traditional insurance activities. Techniques of ALM have also evolved. The growth of OTCderivatives markets have facilitated a variety of hedging strategies. A significant development has been securitization, which allows firms to directly address asset-liability risk by removing assets or liabilities from their balance sheets. This not only reduces asset-liability risk; it also frees up the balance sheet for new business. The scope of ALM activities has widened. Today, ALM departments are addressing (nontrading) foreign exchange risks and other risks. Also, ALM has extended to non-financial firms. Corporations have adopted techniques of ALM to address interest-rate exposures, liquidity risk and foreign exchange risk. They are using related techniques to address commodities risks. For example, airlines' hedging of fuel prices or manufacturers' hedging of steel prices are often presented as ALM. Why we must consider ALM? y Mismatching could have serious implications for the financial viability, as evidenced by collapse of many life insurers Prudent management of ALM accounts for a good reward in RBC

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ALM answers the strategic questions, viz.,

 availability of adequate capital for solvency in stressed scenario;  how to make a tradeoff between risk and return;  what is the optimal growth of premium, given the risk appetite;  adequacy of reinsurance arrangements;  Optimal use of risk mapping and evaluation of alternative strategy.  STRATEGIC APPROACHES TO ALM  Spread Management: This focuses on maintaining an adequate spread between abanks interest expense on liabilities and its interest income on assets.   Gap Management: This focuses on identifying and matching rate sensitive assetsand liabilities to achieve maximum profits over the course of interest rate cycles. Interest Sensitivity Analysis: This focuses on improving interest spread by testing theeffects of possible changes in the rates, volume, and mix of assets and liabilities, given alternative movements in interest rates.  These strategies attempt to closely co-ordinate organisationsassets and liability management sothat banks earnings are less vulnerable to changes in interest rates.

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Relationship of Maturity Period, Market Price & Interest y A rise in the required yield to maturity reduces the price of the fixed income security hence a downward sloping curve exists between market value and yield to maturity y The longer the maturity of a fixed income security, the greater its fall in price and market value due to an increase in the interest rate. y The decrease in the value of the security increases at a diminishing rate for any given increase in interest rate.

Maturity Period of Assets & Liabilities

 Maturity Method: If the maturity of assets is greater than maturity of liabilities, any change in the interest rate will affect the value of assets more than liabilities. Hence maturity method considers only direction and magnitude of the maturity and does not consider cash flows.  Macaulay Duration:The weighted average term to maturity of the cash flows from a bond. The weight of each cash flow is determined by dividing the present value of the cash flow by the price, and is a measure of bond price volatility with respect to interest rates.  Modified Duration:The modified duration of financial instruments is a measure of price sensitivity of a fixed set of cash flows to small changes in the single interest rate. The higher the measure of duration, the more sensitive (elastic) is the value of the financial instrument to changes in interest rates.

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 Option Adjusted Duration: The option-adjusted duration is a measure of price sensitivity. The difference is that optionadjusted duration is a much more accurate measure of price sensitivity if the cash flows depend upon the path that interest rates take.This expresses how much the price will change as a result of small changes in interest rates, and is expressed in terms of a ratio by dividing by the beginning price.  Convexity:Convexity is defined as the second derivative of price with respect to interest rates divided by the price, and is a measure of how the duration changes as interest rates change.

ISSUES: 1. First, risk management is closely related to ALM. Any mismatch between assets andLiabilities increase risks, whether it is interest rate risk, credit risk or liquidity risk. Accurate risk identification and classification of past losses into expected and unexpectedlosses would help in positioning comprehensive internal controls. Not a simple proposition, it requires in depth study and analysis of financial and other markets. 2. Secondly, the evaluation of credit rating continues to be an imprecise process. Overtime one should expect that the banks rating procedures should be compatible with rating systems elsewhere in the capital market and have the same degree of objectivity. 3. A third area where improvements seem warranted is the analysis of ex-post outcomes from lending. Credit losses are, currently not preciously related to credit rating. They need to be more closely tracked by the banks than they currently are. In short, credit

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pricing, credit rating and expected losses ought to be demonstrably linked. 4. Fourthly, interest rate risk approaches include both the trading systems; there has been a considerable improvement. The VaR methodology has converted a rather subjective hand-on process of risk control to more quantitative one. 5. Finally, as banks move more towards off-balance sheet activities must be betterintegrated into overall risk management and strategic decision making. Currently, theyare ignored when bank risk management is considered or are at a fairly primitive stage. Ifreasonable exposure estimates are to be obtained, much more need to be done includingbuilding up of a strong Management Information System (MIS) backed up by a sound database.

Asset liability management

Asset management

Liability management

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Asset Liability Management (ALM) defines management of all assets and liabilities (both off and on balance sheet items) of a insurance company. It requires assessment of various types of risks and altering the asset liability portfolio to manage risk.

NEED FOR ASSET LIABILITY MANAGEMENT

Risk is inherent in insurance sector and is unavoidable. Asset Liability Management is not to avoid but to manage risks (mismatch) at the same time sustaining the profitability. This requires periodic monitoring of risk exposures which involves arrangements for collecting and analyzing information. It involves ability to anticipate, forecasts and to act so as to structure the banks business to profit from it. Asset liability management seeks to contain risk while pursuing profit at the same time. The risks are not independent from each other. They are in practice inter-linked and hence do not offer specific solution easily. Therefore, techniques do not give solutions straight away. Asset management like all management depends ultimately on judgment and decision making. Asset liability management is concerning with all aspects of business involving financial decisions. Thus there is a considerable technicality to make policy, to ensure consistent implementation and to monitor the results. Generally large insurance company constituted a committee with representatives drawn from all main functions of the bank, called Asset Liability Committee (ALCO) for the management. This committee operates typically just below the board. In smaller banks the responsibilities is vested with the board of management. ALM involves both long term and short term policy decisions. While the long term policies need

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to be approved by the highest level, the short term policy needs delegation of both responsibility and authority. There is a need to develop accounting and supervisory system to ensure smoother implementations of ALM function. Decisions would also involve the geographical dispersal of dealing markets, the dealing parties and dealing offices/personnel. Also the institutionalizing of ALM requires certain investments in training, information and communication system, developing new types of business products, etc. To conclude, the doctrine of return versus risk suggests that no institution should avoid Taking risk. However, the question of scales, dimension and magnitude of risk as well as return to be defined, in implemented and monitored. The ALM techniques provide a framework for same in effective manner.

Importance of ALM: there are several reasons for the growing importance of
ALMfunction. More important are the exposure of the institution directly or indirectly to the risk situation & the need to safeguard the position proactively .the following recent trends also necessitate the ALM functions in banks. 1. Financial volatility 2. Explosion of new financial products 3. Regulatory initiatives 4. Heightened awareness of top management

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Financial volatility: during the past decade we have witnessed heightened volatility in the financial market in India & rest of the world .Increased volatility results in greater in greater uncertainties in profitability, portfolio value & solvency. When there is a risk, there is aneed for risk management, which is effective .ALM has become critical in the volatile financial environment of the recent past.

New financial product innovation: the second reason for growing importance of ALM is the explosive growth of new financial products. These products are innovated by the market player in India& abroad & the agencies like RBI, SEBIetc. have introduced several new products during the last decade. While analyzing new product, we need to understand: 1. product mechanics 2. pricing 3. applications 4. potential risks Regulatory initiatives: the regulatory agencies throughout the world have taken several measures to enhance sophistication & regulation of ALM .the Basel committee on bank supervision issued an amendment in January 1996.to the capital accord 1988.to incorporate market risk in in the supervisory norms. the supervisory authorities were asked to implement the same by year end1997.accordingly RBI issued guidelines in February 1999 issued guidelines in

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february1999;the ALM system was to cover at least 60% of the asset liabilities of the banks effective from 1 April 1999 &100% from April 2000 Management Recognition: the high profile head-line making derivatives disasters, losses related to market risks, the effect of interest rate movements on the income of banks, have enhanced the level of awareness of top management. They have begun to take greater interest, ask more questions &want to improve the oversight of the risk management system in the banks. Need of Asset Liability Management: y y y y y Availability of adequate capital for solvency in stressed scenario; How to make a trade-off between risk and return; What is the optimal growth of premium, given the risk appetite; Adequacy of reinsurance arrangements; Optimal use of risk mapping and evaluation of alternative strategy

Various steps in the Asset Liability Management y y y y Portfolio segmentation by product line Cash-flow management Portfolio gap analysis, including maturity analysis and interest rate sensitivity analysis Simulation analysis, including cash flow testing and dynamic solvency testing

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y y

Optimization analysis Hedging strategies for investing

Research objective
1. What is asset liability management & how it is implied in insurance sector? 2. To study the portfolio matching behaviors of insurance sector In terms of nature & relationship between asset & liability 3. To study the impact of ALM on profitability of insurance company

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Research methodology
Nature of Research: The research approach for this project is descriptive and analytical in nature that based on analysis of asset liability management of selected insurance companies. Further the project is based upon quantitative analysis of selected data. Nature of Data: The data collected for the study is secondary in nature. Sources of Data: The data has been collected though annual reports of concerned companies. Sampling Procedure: For the purpose of the study by adopting simple random sampling two life insurance companies have been selected namely: 1. Life Insurance Corporation of India 2. Bajaj Allianz Research Instruments

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Research Instrument used for this study is based on Percentage. Percentage is a way of expressing a number as a fraction of 100. Percentages are used to express how large/small one quantity is, relative to another quantity. Percentage in this study is being used to compare the investments done by the Life Insurance Corporation of India&Bajaj Allianz in Assets held to cover the Linked Liabilities. Since there is a large amount of difference in the amount of investment done by them, so a viable comparison is not possible until figures of both the companies must be converted into common size. Therefore, for the sake of comparison, percentage has been applied to convert absolute figures into comparative one.

Limitations
y y y In this study only two insurance companies are taken for comparison. Data compared is only for one year. Due to the difference in the amount of investment done by the insurance companies there comparison is done by deriving their percentage.

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DATA ANALYSIS& INTERPRETATION

Comparison on % Share of Assets Held to Cover Linked Liabilities

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Long Term Investments: Long term investment done by both the companies in the table given below shows that the investment done by Bajaj Allianz is in a very aggressive manner as compared to LIC which can be seen through its investment in equity shares. LICs investment in Government securities and guaranteed bonds indicates that the LIC also used to invest in the secure sectors more as compared to Bajaj Allianz

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% Share of Assets Held to Cover Linked Liabilities Bajaj Particulars LIC Allianz Long Term Investments Govt. Securities & Guaranteed Bonds 17.50% 9.91% Other Approved securities 3.09% 0% Equity Shares 64.90% 68.92% Debentures/Bonds 2.75% 2.17% Other Securities 0.00% 0.32% Investment in Infrastructure & Social Sector 3.12% 5.36% Other than Approved Investments 7.05% 6.75% Short Term Investments Govt. Securities & Guaranteed Bonds 0.00% 0.28% Mutual Funds 4.61% 0.76% Debentures/Bonds 0.00% 9.99% Other Securities 3.03% 1.50% Investment in Infrastructure & Social Sector 0.00% 0.31% Net Current Assets -6.05% 2.63% Investment in India 99.99% 100% Investment Outside India 0.01% 0%

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Short Term Investments: Short term investment done by both the companies in the table shown above indicates that the investment done by Bajaj Allianz is more as compared to investment done by Life Insurance Corporation of India.

1.2 1 0.8 0.6 0.4 0.2 0 -0.2

Net Investment:Net Investments done by both the companies shown in the table given above shows that Bajaj Allianz has invested 100% in India whereas, Life Insurance Corporation of India has invested 99.99% in India & 0.01% outside India.

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What about buying other assets?

y y The guaranteed payments must be hedged with options (put options on stock, call options on bonds when investing in shorter-maturity bonds). Options may also be needed to hedge the buyback liability?

Discussion of some option investment strategies

y Floating-rate note (coupon reset to one-year rate R), combined with an interest-rate floor which has the following payoff: max (K- R, 0), where K is the strike rate. Here, the buyback liability is fully hedged. Instead of buying 30-year bonds, the insurance company can buy 10-year bonds combined with an option to buy 20-year bonds in 10 years (for example, a 10x20 receiver swaption). The purpose of the option is to hedge the reinvestment risk in 10 years.LIC does not adopt this Strategy. An investment in stocks should be combined with a put option on the stocks. The strike price of the put option must match the future guaranteed payments (i.e., an annual return equal to the technical interest rate).

Asset-liability management with options y The company does not need to buy the options directly. They can replicate the options through delta-hedging strategies. Instead of stocks + put options, they can switch from stocks to bonds if stock prices drop (as the delta" on the put options approach -1). Main problem: reserves must be sufficient to cover the option exposure.

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Some Issues to be Looked Upon  Single premium productswhat difference between A and L on economic basis?  Participating liabilityproportionate change in assets is slightly more than that of liabilities?  ULIPsno duration match required for unit reserves?  Assets valued at book value liabilities at consistent basis are it appropriate?  Contradiction with GN2 if changes would result in a change in the aggregate liability that is not matched by a change in market value of corresponding assets, the actuary should consider as to what provision is required as contingency margin, having regard to the consequences should the provision prove insufficient  Need for a quasi-regulatory balance sheet taking assets at market value with due allowance for MAD?  What kind of stress tests be used 99th percentile with one year horizon?  Monitor the movement of free assets?  Projection of capital requirementworking out of resilience capital for the future?  Sensitivity of the companys financial strength to the following:  New business volume  Business mix  Expense control

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Process Flow Diagram

Setting the objective of the project i.e.comparison of Asset Liability Management of Life Insurance Companies

Collection of data and information from various sources

Extraction of relevant information

Analysis of the information

Observations

Compilation and presentation of report

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Findings & recommendations

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Findings
y y y y y y LIC used to make more secure investments as compared to Bajaj Allianz by investing in Government Securities & Guaranteed Bonds. LIC use to invest other approved securities whereas; Bajaj Allianzs investment is Nil in it. LIC use to make more short term investments in Mutual Funds as Compared to Bajaj Allianz. Bajaj Allianz has made more investment in short term Debentures/Bonds. On the other hand LICs investment in this sector is Nil. Net Current Assets of Bajaj Allianz is good as compared to LIC where LICs net current assets are going negative. LIC use to make investment outside India also whereas; Bajaj Allianz investment outside India is Nil.

Recommendations
y y y y y Investing 100% in long-term bonds is not the ideal solution. Organizations should maintain adequate assets to meet liabilities. Investment in outside India companies is better option to avoid risk. The best hedge is to match the future outgoing payments with incoming payments from long-term bonds. Bonds have standardized amortization profiles, typically bullet structures. However, matching the duration (interest rate sensitivity) of the bond port-folio and the guaranteed payments should suffice for practical purposes.

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Long-dates bonds are needed here. The duration of the liabilities (guaranteed payments) has been estimated at 16 years (in 1998). This corresponds to the duration of a 30-year bullet bond.

The technical interest rate should be set below the market interest rate at the beginning of the contract, which leaves some reserves for buying other assets such as options.

If the guaranteed payments are not hedged with long-term bonds, the insurance companies must buy options to ensure the necessary payoff on the liability side.

The annual rate of return to the policy holders cannot exceed the technical interest rate. Difficult to attract new customers.

The case with LIC is that it uses to invest only 2.75% in Long term Debentures/Bonds.

Investing 100% in long-term bonds is not the ideal solution y What about the buyback liability? If interest rates increase, the value of the bond portfolio is below par, but unless the buyback liability can be constrained somehow, the liabilities cannot be valued below par. y Only if the speculation prevention clause is fully effective (buyback with a discount corresponding to the market value of assets), can we ignore this problem. y The optimal (utility-maximizing) portfolio for the policy holders is unlikely to consist of 100% bonds.

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Conclusion:

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Conclusion
Asset-liability management is an essential improvement in insurance sector & banking sector that allows private bankers to provide their clients with investment solutions and asset allocation advice that truly meet their needs. I have also provided a series of illustrations that show that some of the most sophisticated ALM techniques used in institutional money management can satisfactorily be implemented In insurance sector as wellUltimately, I found that it is not the performance of a particular fund nor that of a given asset class (including commodities or hedge funds) that will be the determining factor in the ability of insurance sector to meet investors expectations. What will prove to be the decisive factor is the wealth managers ability to design an asset allocation solution that is a function of the kinds of particular risks to which the investor is exposed, as opposed to the market as a whole. Hence, an absolute return fund, often perceived as a natural choice in the context of wealth management, shall not be a satisfactory response to the needs of a client facing long-term inflation risk, where the concern is capital preservation in real, as opposed to nominal, terms... In other words, the success or failure of the satisfaction of the clients long-term objectives is fundamentally dependent on an ALM exercise that aims to determine the proper strategic inter-classes allocation as a function of the clients specific objectives and constraints. Asset management should only come next as response to the implementation constraints ofthe ALM decisions. On the one hand, it is meant to deliver/enhance the risk and return parameters supporting the ALM analysis for each asset class. On the other hand, it can also allow for the management of short-term constraints, such as capital preservation

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at a given confidence level, which are not necessarily taken into account by an ALM optimization exercise, which by naturefocuses on long-term objectives.

Bibliography

y y y y y y y

www.lichfi.com www.licindia.com www.bajajallianz.com www.actuariesindia.org www.jesperlund.com http://en.wikipedia.org/wiki/Asset_liability_management http://www.iimb.ernet.in/~vaidya/Asset-liability.pdf

Books: 1. Kumar Ravi, edition 2010, Asset Liability Management

2. Kumar Ravi Edition 2000 Indian Banking in Transition: Issues and Challenges

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Annexures

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Assets Held To Cover Linked Liabilities LIC Bajaj Particulars (in Lakhs) Allianz
Long Term Investments:
Govt. Securities & Guaranteed Bonds Other Approved Securities Equity Shares Debentures/Bonds Other Securities Investment in Infrastructure & Social Sector Other than Approved Investments 2980283.16 526263.07 11054027.52 468568.81 15.59 531547.02 1200056.35 0 785688.85 0 515856.58 0 -1029789.32 28160.2 0 1958389.31 61747.13 9084 152436.7 191753.37 7968.34 21542 284000.2 42541 8930 74909.29

Short Term Investments:

Govt. Securities & Guaranteed Bonds Mutual Funds Debentures/Bonds Other Securities Investment in Infrastructure & Social Sector

Net Current Assets TOTAL Investment in India Investment Outside India TOTAL

17032517.63
17031702.19 815.44

2841461.54
2841461.54 0

17032517.63

2841461.54

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