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Understanding ALM, risks and regulatory implications
Assets and liabilities form the foundation of any organisation’s financial stability. Assets - current, fixed, and intangible - are resources convertible to cash, while liabilities represent obligations owed to others. Managing both effectively is essential for risk control and achieving financial goals.
ALM is a dynamic process of planning and adjusting strategies for assets and liabilities to meet objectives within risk limits. In insurance, ALM ensures future cash flow needs and capital obligations are met, promoting solvency and stability. It aligns asset and liability decisions to optimise performance. However, ALM practices differ across companies due to factors like liability characteristics, regulations, and culture. It is critical for insurers, banks, pension funds, and corporations with significant obligations.
Maintain adequate assets and reserves to meet long-term obligations and absorb losses.
Align asset-liability durations to minimise interest rate risk and match cash flows.
Diversify portfolios, manage interest rate exposure, and hedge market volatility.
Enable product development and competitive pricing through effective risk management.
Identify and mitigate interest rate, liquidity, and market risks.
ALM helps insurers meet policyholder obligations while optimising performance. It supports corporate planning, product development, pension schemes, and property/casualty insurance.
Life insurers face long-term liabilities from policy benefits. ALM ensures assets match these obligations through:
Align asset maturity with liability timing.
Manage sensitivity to rate changes for guaranteed benefits.
Maintain liquidity for short-term needs while investing for long-term growth.
ALM is not just a compliance requirement, it is a strategic tool for financial resilience and sustainable growth.
In life insurance, reserves are funds set aside for future policyholder benefits. ALM stabilises reserves by aligning assets and liabilities, reducing volatility and minimising exposure to market fluctuations. Effective ALM also optimises reserve levels, lowering the need for additional capital while meeting regulatory solvency requirements such as Solvency II.
Cash flow management is critical for insurers. ALM ensures liquidity through cash flow matching, guaranteeing timely payouts without forced asset sales. It mitigates reinvestment and market risks by planning asset maturities and reinvestment strategies, reducing exposure to low-rate returns. By aligning inflows and outflows, ALM stabilises profitability and minimises earnings volatility.
General insurance involves shorter, unpredictable liabilities driven by claim frequency and severity. ALM focuses on liquidity, risk management, and asset allocation to maintain stability. It matches assets to short-term liabilities for timely claim payouts, prioritises liquid assets for large claims, and uses inflation-hedging instruments to manage rising costs. Effective ALM reduces capital needs and strengthens financial health.
Reserves for general insurance claims are uncertain. ALM stabilises reserves by aligning assets with liabilities, reducing interest rate impact and ensuring adequacy for regulatory compliance. For cash flows, ALM ensures liquidity for claims, matches investment inflows with payouts, and manages market risks to stabilise investment income.
Health insurance requires managing frequent, inflation-sensitive claims. ALM ensures liquidity for quick payouts, uses inflation-hedging assets to offset rising medical costs, and prioritises short-term, low-risk investments for stability.
Reserves in health insurance are funds set aside for short-term claim obligations. ALM ensures liquidity for quick payouts, uses inflation-hedging assets to offset rising medical costs, and prioritises short-term, low-risk investments for stability.set aside for short-term claim obligations. ALM plays a key role by:
Frequent claims make cash flow management critical. ALM supports this by:
| Key risks include | |||
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Credit risk
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Interest rate risk
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Liquidity risk
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Currency risk
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Model risk
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Underwriting risk |
Reputational risk
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Equity and real estate exposure
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Interest rates fluctuate due to evolving market conditions and expectations of lenders and borrowers. These changes impact asset-liability mismatches, creating interest rate risk - a core focus of ALM. Strategies like duration matching, convexity, and immunisation help insurers manage these risks and maintain stability.
Insurance inflows come from premiums and investments, while outflows include claims and expenses. ALM balances liquidity - too little risks insolvency, too much reduces returns. Understanding duration and immunisation ensures efficient management of cash flows and long-term profitability.
ALM strategies are essential tools for managing the complex risks faced by insurance companies. By effectively implementing these strategies, insurers can ensure financial stability, meet regulatory requirements, and protect their solvency in the face of various risks.
Risk mitigation involves planning for uncertainties and reducing negative impacts through proactive strategies. It focuses on minimising risks before events occur, ensuring business continuity. In ALM, systematic techniques manage credit, interest, liquidity, and market risks to maintain financial stability.
Stochastic modeling predicts probabilities of future outcomes using random variables, incorporating uncertainty. Each run produces different results, enabling insurers to test shocks, assess impacts, and plan strategies effectively under varying conditions for better risk management and financial stability.
IFRS 17 sets consistent principles for insurance contract accounting, requiring separation of components and measuring liabilities as present value of future cash flows plus risk adjustment, discounted at current rates. This enhances transparency, comparability, and highlights interest rate impacts on long-term obligations.
ALM is a strategic framework for aligning assets and liabilities, ensuring solvency, liquidity, and financial stability. It enhances decision-making, mitigates risks, and supports compliance with IFRS 17. By integrating ALM principles, insurers strengthen resilience, optimise investments, and achieve sustainable growth in a dynamic, risk-driven environment.
Series 1: December 2025
