n fact, result from the systematic risk outlined above. In addition, the idiosyncratic nature of some portion of these losses remains a problem for creditors in spite of the beneficial effect of diversification on total uncertainty. This is particularly true for insurers who take on highly illiquid assets. In such cases, the credit risk is not easily transferred, and accurate estimates of loss are difficult to estimate. There exist other investment risks like the movements in share price or reinvestment risk. It is worth mentioning that all these risks interrelated with each other. If interest rates go down and there is an urgent need to raise funds to finance liabilities due, then liquidity risk comes into play. Eventually, it is very important to manage interest rate risk because it is the core risk for investment business. The second part of this paper illustrates interest rate risk management technique known as asset-liability management.PART IIAsset-liability management (ALM)If an insurer does not coordinate its decisions on assets and liabilities, he might face a financial disaster. One of the best examples is the case of Nissan Mutual Life, a Japanese company with 1.2 million policyholders and assets of JPY 2 trillion. The company sold individual annuities paying guaranteed rates of 5 to 5 percent without hedging these liabilities. Government bond yields dropped sharply, thus creating a large gap between the interest rates that Nissan Mutual had to pay on its annuities and the returns earned on its own investments. The company was to suspend its business. It was the first Japanese insurer to go bankrupt in five decades. Its losses totaled JPY 300 billion. (Sigma, No. 6/2000)ALM initially developed to manage interest rate risk, which became a major concern in the 1970s, when interest rates increased sharply and became far more volatile than in the past. As a result, some major insurers who had not managed their interest rate risk...
