Risk-Return Optimization for Life Insurance Portfolios

Abstract

Two Fong-Vasicek immunization results are discussed and applied in relation to life insurance fixed income portfolios. Firstly, we analyzed the contribution of Fong-Vasicek (J. Finance 39(5):1541–1546, 1984) providing a lower bound on the “shortfall” of an immunized asset portfolio in the face of an arbitrary shock to the term structure of interest rates. A “passive” strategy minimizing immunization (i.e., reinvestment) risk emerges, such that the exposure to an arbitrary variation of the shape of the term structure is minimized with respect to the “M-squared” risk measure representing the cash-flows dispersion around the duration matching target. Secondly, Fong and Vasicek (Financ. Anal. J. 39(5):73–78, 1983) risk-return approach is generalized in a model which seeks for only a partial risk minimization in exchange for more return potential. The empirical application hints at a perspective of “active” management, highlighting which segregated funds can be re-positioned along the efficient frontier, at a chosen level of the firm’s risk appetite.