Summary
Through a case study, discover the potential opportunities, in terms of both yield and capital efficiency, that can derive from the implementation of the matching adjustment mechanism proposed by some insurance regulations in a high-interest rate environment.
Key Points
Insurers coped with rapid interest rate shift due to the Covid-19 crisis effects
- The Covid-19 crisis led to a notable shift in interest rates from historically low levels to an upward trajectory. This prompted a swift repricing of global bond markets, requiring insurers to adapt their fixed income investment portfolios accordingly.
- In many countries, insurance companies are regulated by authorities requiring them to set aside a specific amount of capital (“prudential capital charge”) based on the risks associated with their operations including the assets held in their financial portfolio.
Reposition fixed income assets to accompany a rising interest rate cycle, while seeking prudential efficiency using the Matching Adjustment mechanism
- A rising interest rate environment provides more attractive yields for government and credit assets, but this leads to higher costs in terms of capital requirement.
- The Matching Adjustment (MA) is a regulatory provision that allows a reduction in the capital charge when fixed income asset cash flows are aligned (‘matched’) to anticipated liability cashflows.
- Hence, in this environment, there are opportunities to simultaneously improve the overall yield of the assets, and reduce capital requirement.
Case study: simulation of a Matching Adjustment implementation for a Singaporean insurer
- The simulated implementation of a 2-step approach involving a Matching Adjustment strategy for a Singaporean insurer’s portfolio showcased improvement in assets and liabilities alignment, reduced regulatory capital requirements, increased portfolio yield and enhanced prudential profitability.
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