Abstract
This research studies the relationships between the two sides of life insurers’ balance sheet and investigates whether and how they changed during recent past years, when European Central Bank monetary policy drove market rates to unprecedented low levels. By using a canonical correlation analysis, we study the internal structure of the links within and between the asset and liability sides of 24 major European Union (EU) life insurers’ balance sheets over the 2007–2015 time horizon. We find strong and substantial evidence that life insurers’ assets and liabilities have become more independent over time. We argue that the declining trend of market interest rates has contributed to the generalized reduction in the linkage between the asset side and the liability side of EU life insurers, and has made insurance companies more exposed to ALM-related risks relative to the period before the financial crisis.
Highlights
Life insurers' decisions concerning asset and liability management (ALM) depend on a complex set of economic and institutional factors, such as the regulatory constraints and the conditions prevailing innancial markets
We argue that the declining trend of market interest rates has contributed to the generalized reduction in the linkage between the asset side and the liability side of European Union (EU) life insurers, and has made insurance companies more exposed to ALM-related risks relative to the period before thenancial crisis
We argue that the declining trend of market interest rates over the examined time horizon has contributed to the generalized reduction in the linkage between the asset side and the liability side of EU life insurers, and has made insurance companies more exposed to ALM-related risks relative to the period before thenancial crisis broke out
Summary
Life insurers' decisions concerning asset and liability management (ALM) depend on a complex set of economic and institutional factors, such as the regulatory constraints and the conditions prevailing innancial markets From this latter perspective, the issues associated with the decline and the unprecedented low levels of market interest rates pose signicant challenges for both the insurance industry and regulators. The impact of interest rates on a life insurer's balance sheet depends on a possible accounting mismatch and on the extent of the duration mismatch between assets and liabilities As for the former, should assets be marked to market and liabilities be recorded at book value, a decline in interest rates will cause an increase in the insurer's equity. With regard to the latter, since life insurers' liabilities may have maturities longer than 30 years and, in some markets, assets with the same maturity are either unavailable or illiquid, a decline in interest rates threatens companies' protability and can even cause solvency issues if rates stay low for long
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