Matching Assets and Liabilities

Matching Assets and Liabilities


2017 has given us a graphic example of the problems that arise when assets and liabilities are not matched. It has also given us an example of the gains that can be realized by strategically mismatching.US equity prices, measured by the S&P 500, increased by 19.4% in 2017.  Very few, if any, experts predicted such a rise.  However, it happened and continues to happen in the early days of 2018.  The S&P Bond index went up 6.0% during the same period.  That’s actually very good for bonds, but if your liabilities were tied in any way to equities and you were investing in bonds, you had a problem in 2017.

Some sort of modified balanced portfolio, with due consideration of liability behavior, seems to be the right answer.  However, some skill at predicting the future is absolutely essential, and people with such skills have been in short supply recently. Companies with fixed annuity liabilities in 2017 who invested some portion of their portfolio in stocks did very well, those companies could also hedge their stock portfolios to provide some protection against downward movements in equity markets.  Also, these companies saw healthy increases in the bond markets during the past year.  2017 was a great year to be in the fixed annuity business.

Companies with variable annuity liabilities saw their liabilities sky-rocket in 2017. Of course, their assets also sky-rocketed if they were invested in equities.  However, it took a strong optimist to stay in equities throughout the year.  Some hedging against significant increases in liabilities tied to equities could have been purchased, but I’m sure the cost was significant. I think companies with equity-based liabilities must simply look at 2017 as a tough year, and find a way to play another day.

Asset-liability matching has been a hot topic for actuaries since the late 1970’s and early 1980’s. However, the big risk that always scared us (significant increases in interest rates) has not happened.  Instead, we have been dealing with relatively stable interest rates and wide fluctuations in equity markets.  That has certainly made life interesting. My first work in the annuity market was in the late 1980’s and early 1970’s when junk bonds were the problem. Fortunately, my clients were able to work themselves out of that predicament.  Life is always interesting for a life and annuity actuary!

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