Asset Liability Management – realactuarialconsulting

Asset Liability Management (ALM) is a financial technique that can help companies to management the mismatch of asset and liability, and/or cash flow risks. The mismatched risks are caused by different underlying factors affecting the assets and liabilities to move in different direction and magnitude. Asset-liability risk is a leveraged form of risk. The capital of most financial institutions is small relative to the firm’s assets or liabilities, so small percentage changes in assets or liabilities can translate into large percentage changes in capital.

Typically, companies such as banks, insurance companies, pension funds (or their corporate sponsors) adopt such techniques to help them better manage their mismatched asset / liability risks and to ensure that their capital will not be depleted in changing demographic and economic environment.

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. However, the increasing use of options such as embedded prepayment risks in mortgages or callable debt, posed problems that these traditional analyses could not address. Thus, Monte-Carlos simulation techniques are more appropriate to address the increasing complex financial markets.

Traditional ALM strategies are typically single point estimates which require frequent monitoring and updating. However predictions are rarely precise in the real world. Simulation on critical factors can offer insights to the likelihood of success in these strategies.

New financial instruments such as derivatives offer new opportunities to hedge risks. How should you decide on which ones to use? How much resources should be allocated to these commitments, and at what costs? Our advanced simulation and optimisation technologies can help you resolve these critical questions.

Should you implement the ALM strategies now, or wait until more information becomes available before deciding on which of these strategies to execute? Multi-staged real option analysis can help you optimise the timing of execution and evaluate the critical trigger points to implement such ALM strategies.

ALM is intended for protecting against capital depletion. Will you forgo the upside opportunities in order to obtain the downside protection? Real options strategies enable you to formulate downside protection strategies while retaining the upside potentials.