INTEREST RATE RISK : A comparative study aimed at finding the most crucial shift in interest rate curves for a life insurance company

Sammanfattning: Risk management is applied in many financial institutions under regulatory supervision. Life insurance companies face many challenges to ensure policy holders of future payouts. The inverted balance sheet of life insurance companies imply that the policy holder pay premiums in advance to the insurance company to later receive payouts at the age of retirement. This means a great responsibility for the life insurance company to be able to meet future liabilities. Due to this, one of the largest risks facing a life insurance company is the interest rate risk. Future liabilities depend on the interest rates and the difference in duration in assets and liabilities creates an imperfect negative correlation between the movements in assets and liabilities when the interest rate change. The bond market holds different types of bonds such as government bonds, housing bonds and corporate bonds with different maturities within each subgroup. The relationship between these subgroups and maturities within these subgroups are interesting to investigate in a forecasting point of view. This relationship is usually referred to as the term structure of interest rates and changes in the term structure are referred to as shifts. This thesis aims to find which of the three shifts, level, slope and curvature, that is most important to capture in interest rate models. This is investigated using three different simulation techniques and the results show that the first shift representing a level shift of the whole term structure has the largest effect on Skandia’s balance sheet.