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Summary
In emerging markets like the Caribbean and Latin America, implementation of the concepts of Asset Liability Management (ALM) of insurance obligations are difficult due to the limitations of the financial markets in these regions.
In particular the scarcity of long term fixed income assets and the lack of an efficient equity market (e.g. lack of liquidity, or too much volatility), means that long term obligations cannot be managed in the same manner as in the large mature financial markets of North America or Europe.
Due to the dearth of matching assets, insurers that reside and invest in these emerging financial markets must value their long-term obligations at very low discount rates. Though warranted, this conservatism represents a significant investment of capital, and inefficient use of resources. Also some of these insurance operations are small and resources are limited. Therefore there is a need to seek more efficient methods of investing capital.
This paper explores a reinsurance contract devised to allocate the ALM risk of long duration insurance contracts between the insurer that resides in an emerging market, and the reinsurers that have access to large efficient financial markets in North America or Europe.
In particular this paper introduces the concept of duration tranches for an insurance block of business. From which the term duration coinsurance is coined to describe a coinsurance agreement that transfers the risk of a duration tranche from the insurer to the reinsurer.
While the author is a practitioner in the Caribbean region, the concept is one that can be applied to other emerging markets, such as Latin America, India, China or wherever a free market economy is young and financial markets are inefficient and extremely volatile. |
