Is asset/liab matching ever NOT the answer?

(this is from qbank Question ID#: 93207) Part of the question states “DWC’s workforce has two primary cohorts that are expected to retire and receive benefits in ten years and in twenty years, but detailed forecasts of these obligations are difficult to construct.” The question is: Ms. Green is considering various strategic asset allocation options. Which of the following strategies most likely satisfies DWC’s needs and wishes? A) Asset-only, static asset allocation strategy. B) Asset-liability, dynamic asset allocation strategy. C) Asset-only, dynamic asset allocation strategy. While I understand that asset-liab matching is the best, is it applicable given that the details of the obligations are difficult to forecast? thanks! ----------- details of answer ------------- Your answer: C was incorrect. The correct answer was B) Asset-liability, dynamic asset allocation strategy. Defined-benefit plans are typically subject to surplus risk; that is, the volatility in the difference in value between the assets and the liabilities of the fund. Therefore, an asset-liability asset allocation strategy is typically appropriate for defined-benefit pension plans. Dynamic asset allocation considers the linkages between investment periods whereby performance in one period affects the required return and risk tolerance in a subsequent period. DWC’s liability pattern and board wishes indicate a dynamic asset allocation strategy would be particularly appropriate. The expertise required to implement Monte Carlo or some other simulation method associated with dynamic asset allocation tends to be costly; however, DWC’s large size makes absorbing these fixed costs economically feasible. (Study Session 8, LOS 26.d,e)

Well, you have to remember that there might also be other people who would be retiring during this period and the company will be required to satisfy the cash flows that come up. (I haven’t read original question, but just generally speaking). So, primary cohorts would retire in 10/20 years, but in between, I am guessing there will be other retirements happening. I think DB plans are usually A/L managed, so thats would I would end up eventually choosing.

Also you could answer “asset only, dynamic approach” for a casualty insurance company (liability difficult to forecast), foundation or endowment (no predefined liabilities).

Personally I find it hard to imagine a circumstance where ALM is not the appropriate answer for the underwritten legally enforced insured liability segment of the portfolio… I think this applies equaly to a casualty insurance company – although it may not be easy to forecast the timing and scale of these losses - this volatility is mitigated by reinsurance / company scale and underwriting diversification. I dont know how you can manage a portfolio if you conclude the liability cant be predicted - dont know anyone would underwrite such a crapshoot.

As I understood it, ALM-Dynamic was the best option for all Insurance firms regardless of the type. However, some casualty insurers don’t use it because it is very difficult to maintain/operate due to the fact that the liabilities are so hard to predict. So while virtually all life-insurers use ALM, you will still find some casualty insurers using AO even though ALM is technically a better option. As for portfolios without predefined liabilities, AO is the way to go. I could be off though… let me know if I am.

I am just curious about the followings: --According to the Schwezer and CFA notes, both largely discusses the non-life ins. co. strategies in a ALM setting (e.g. using the sub portfolio of FI & Equity). Am I right?? --So does the CFA text say there are some non-life ins. cos. use AO but most use ALM?? How is the CFAI interpretation of this?? I just want to make sure I grasp the text-book answer for the exam. Thanks!

So I just went back and checked the CFAI text… there is a chart on page 235 of volume III that seems to indicate that all insurance companies are making use of ALM. So I would go with that as a guide. It has a solid run-down of all the types of funds and the appropriate asset allocation approach.