Page 78 - Risk Management in current scenario

is easy which is made in the underlying assets chosen by the
customers.

X Term of Liability: (Duration of assets = Duration of Liability) : To
answer the second key question on purchasing of assets is to choose
the tenure of assets. The assets should be purchased in such a way
that the duration of assets are equal to duration of liabilities. Say
for example, the duration of liability in our example if 14 years, then
we should choose the assets from Government bonds or Corporate
bonds so that there combined duration is 14 years. Such duration
matching reduces the sensitivity of movement in value of assets and
liabilities when interest rate changes by small unit.
X Currency of liability, invest in same currency as liability: The third key
question to answer in purchase of assets whether the bonds to be
purchased in the local currency or in international currency. The
guidelines are that the assets should be purchased in the same
currency as currency of the liabilities. For example, if Indian firm has
sold the policy in US and the death benefits will be paid in USD, then
the investment of that part of liabilities should be in US Government/
Corporate bonds. However, in practice in India, it is not allowed to
sell the insurance policies in international currency. So all the
investment is made in INR.

Therefore, for our example the assets should be purchased from mix of
Government and corporate bonds giving due regard to regulation in such
a way that the duration of assets equal to the duration to liability and in
INR currency.

Having decided on to purchase the mix of Government and corporate
bonds, next we have to find the duration of liability so that the duration
of assets equivalent to the duration of liabilities can be purchased. The
duration of liability calculation is shown below. The net Cash flow will
be used to calculate the duration of liability.

76 | Risk Management in Current Scenario