For insurance companies and pension plans, the traditional asset management model can fail to achieve the overall financial objectives even when the investment objectives have been met. By executing asset management within a risk framework the true risk exposure can be reduced and substantial value can be added.
Under the traditional model insurance companies are required to translate the overall financial objectives as best they can into investment objectives then specify a liability benchmark with appropriate risk targets that approximate the actual liabilities. Oftentimes the risk limits are specified using metrics that do not fully describe the actual risk exposure. Using this model, even if an asset manager beats the benchmark and achieves the investment objectives, this does not ensure that the financial objectives will be achieved. Insurance companies can simultaneously realize an increase in portfolio yield and lower financial results due to higher actuarial reserves and/or economic capital required.
Executing asset management within a risk framework uses the actual liability cash flows, eliminating the reliance on a proxy for the liabilities. This ensures that the actual interest rate risk exposure can be effectively managed and reserves and economic capital minimized. By executing the asset management function within a risk framework, companies can add significant value and show immediate improvement to the bottom line. This is accomplished by focusing on the actual overall financial objectives, understanding the interrelationship between increasing total return and decreasing risk exposure, and by managing against actual liability cash flows. ALM strategies are formulated to achieve the financial objectives, then proprietary algorithms are used to optimize the portfolio (i.e. maximize value and minimize risk) on a default free basis and realize significant immediate gains and decrease risk exposure.
The key to formulating and executing effective strategies is to having an in-depth understanding of both the assets and liabilities and how they interrelate. Trying to specify objectives for each side of the balance sheet separately will not necessarily ensure that the overall financial objectives are achieved.
Through strategic partnerships we provide integrated asset management and ALM services for a competitive fee. By managing the assets directly against the liability cash flows and focusing on the financial objectives of our clients we add significant value over the traditional asset management approach. Our services allow our clients to free up resources devoted to ALM while ensuring that ALM best practices are being performed.
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