Interest Rate Risk Duration Matching A Regulatory Perspective

Interest Rate Risk & Duration Matching: A Regulatory Perspective Chet Szczepanski Chief Actuary Pennsylvania Insurance Department

VFIC Study n n n Timely Utilizes DFA Important Conclusion

Important Conclusion n n Long duration strategies performed better than matched duration strategies. A matched portfolio is not inherently superior to a longer one.

One Regulator’s Conclusion n n The VFIC paper demonstrates that it makes about as much sense to insist that a healthy P&C insurer adopt a duration matching investment strategy as it would to insist that the same insurer hold his assets in passbook savings accounts. This conclusion is pretty much inescapable!

BUT n Should duration analysis and matching be expelled from the regulator’s toolkit?

One Regulator’s Opinion Not yet! n

Key Observations 1. 2. 3. 4. Most P&C insurers invest in portfolios of assets with durations longer than those of their liabilities. Life insurers discount their liabilities bringing them closer to an economic presentation. Two sided risk measures are elegant, but less likely to be relevant to a company’s actual long term success. There is no consideration in this analysis of future cash flows.

Net Duration

What “Risk” Concerns the Regulator? It is most definitely one sided! n It is that the entity will not be able to honor its obligations! n

What Happens When RBC Drops to Company Action Level and Below? n n n Reserves are effectively discounted! Survival, rehabilitation or liquidation become critical question. Duration matching becomes critical!

Hypothetically, What Do We Do When An Entity Is: Highly leveraged with regard to reinsurance, n Writes mostly rating sensitive business? n