Question

In the context of duration gap management (or asset/liability management), explain the difference one would expect to see in the duration of the assets of a life insurance company as opposed to a commercial bank, assuming both institutions want to immunize their exposure to interest rate risk.

Answer 1

Life insurance companies offer a longer term insurance to the consumer, where an amount becomes payable to the beneficiary on death of an owner. It might also have to pay a fixed return after certain period. Hence the duration of such companies are almost higher. Hence they might want to take assets with higher duration to protect themselves from interest rate volatility

Bank takes deposits from public and pay a interest on that. Such deposits are given as loan and bank will earn interest on that. Interest rate on loan is higher than interest on deposit which is the Net Interest Margin. The asset to be invested will be in such a mix that bank has enough cash flows always to pay off the deposit holders. Hence duration is based on the mix of the deposit and are generally lower than the life insurance companies.