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Managing Interest Rate Risk: A Case of IFFCO Tokio General Insurance Company*

CASE STUDY, BANKING & FINANCIAL SERVICES
ET Cases - FLAME, 14 Pages
AUTHOR(S) : Dr. Monika Chopra, Assistant Professor - IMI Delhi, Dr. Manisha Singh, Associate Dean - IBS Bangalore, Radhakrishnan V., Branch head, Janlakshmi Financial Services Limited, Bangalore

Case Preview

Managing Interest Rate Risk: A Case of IFFCO Tokio General Insurance Company

 

FICCO Tokio General Insurance was incorporated on December 4th 2000. It was established as a joint venture between the Indian Farmers Fertilizer Co-operative (IFFCO) and its associates and Tokio Marine and Nichido Fire Group, Japan.


Like other insurance companies, the role of IFFCO Tokio was absorption of non-life risks. The major issue which IFFCO Tokio was facing, same as with other insurers, was managing the liability payments which at times can be highly variable due to completely unknown business risks as well as contractual nature of obligations. Being a non-life insurance company, the investment policy of IFFCO Tokio could not be the same as any other life insurance company.


Apart from this, the key issues like long tail in claims reporting, processing and payments as well as an underwriting cycle could not allow a long duration of liabilities.


The key objective in front of the company was managing risks efficiently and so as to deliver maximum profit to the shareholders. The major composition of portfolio of general insurance companies and hence of IFFCO Tokio was to be comprised of Central Government and State Government securities. Although these kinds of securities did not bear any default or credit risk, they were exposed to interest rate risk and reinvestment risk. The major issue in such securities was an inverse relationship between the interest rate risk and reinvestment risk. When interest rates increase, bond prices decrease giving better reinvestment return. But in case of decrease in interest rates, bond price increase leading to a capital gain and also increased reinvestment risk.

Given that the insurance companies have large amount of corpus fund which increases daily and which should be invested with top priority, a small change in the interest rates can impact their profit either positively and negatively. A number of factors can lead to interest rate risk and hence affect the portfolio of insurance companies. The portfolio of investment assets of IFFCO Tokio GIC stood worth INR4368 crore and the benchmark yield was 9.16% for the FY 2014-15 which further increased to 9.31% for the FY 2015-16....................

Exhibits

Exhibit I: Interest Rate Risk and How IRS Helps

Exhibit II: Yield Movement of 10-year Benchmark Central Government Securities (FY 2016-2017)

Exhibit III: Total Portfolio

Exhibit IV: Bond Portfolio

Exhibit V: Investments based on Residual Maturity

Teaching Note Preview

Managing Interest Rate Risk: A Case of IFFCO Tokio General Insurance Company

 

Synopsis

When compared to life insurance and general insurance, the most importance difference is the the duration of liability that both are exposed to. In life insurance business, premiums are collected for long term and for that reason, liability for a life insurance would be for long term and in general insurer would be for short term. The main reason is their policy expires in 1 year. General Insurance Companies (GICs) need more liquidity than a life insurance companies because of claims that need to be settled on priority basis.


The IRDA investment regulations for both life insurance and general insurance are different. Their investment includes mutual funds, fixed deposits, equity shares, corporate bonds, government bonds, housing bonds etc. As their investment portfolio is very large, a small change in yield will have a large impact on their profits. GICs should invest minimum 20% in Central Government securities or 30% in approved securities including both Central Government and State Government securities. Even though central government and state government securities do not bear any default or credit risk, it is exposed to interest rate risk and reinvestment risk.

By using Interest Rate Swaps (IRS), general insurance companies can decrease their impact on bond portfolio and the opportunity cost of holding the bond. In a market when interest rates are volatile, IRS helps to hedge against the portfolio loss and opportunity cost. From this case analysis, it has been proven that IRS will help IFFCO Tokio to mitigate the rising opportunity cost and loss in market value of bond investments.

Case Positioning and Setting

The case can be used for discussion of various issues pertaining to the insurance sector, its history, investment practices, hedging portfolio, regulators’ guidelines and various other related concepts mainly risk management tools like Interest Rate Swaps in ‘Financial Risk Management’, ‘Security Analysis and Portfolio Management’ courses, with the participants of MBA/PGDM.

Expected Learning Objectives

• Examine the investment portfolio of a non-life insurance company
• Evaluate the difference between the portfolio of life and non-life insurance companies
• Create an Investment Policy statement of non-life insurance companies
• Understand the concept of interest rate risk and reinvestment risk in case of Non-Life insurance companies as well as exploring the factors affecting them
• Structure Interest Rate Swaps to hedge a bond portfolio against interest rate risk

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Product code: BFS-1-0015, BFS-1-0015A

Abstract

As with any other insurance companies, the role of IFFCO Tokio was working the non-life risks. The major issue which IFFCO Tokio was coping with, just like other insurers, was managing the liability payments which at times could be highly variable due to completely unknown business risks as well as contractual nature of obligations. Being a non-life insurance company, the investment policy of IFFCO Tokio could not be the same as any other life insurance company. So what was the best investment policy and the best way to manage the interest rate risk?



Pedagogical Objectives

The key objectives of the case are:

  • To examine the investment portfolio of a non-life insurance company
  • To evaluate the difference between the portfolio of life and non-life insurance companies
  • To create an Investment Policy statement of non-life insurance companies
  • To understand the concept of interest rate risk and reinvestment risk in case of Non-Life insurance companies as well as exploring the factors affecting them
  • To structure Interest Rate Swaps to hedge a bond portfolio against interest rate risk

Case Positioning and Setting

The case can be used for discussion of various issues pertaining to the insurance sector, its history, investment practices, hedging portfolio, regulators’ guidelines and various other related concepts mainly risk management tools like Interest Rate Swaps in ‘Financial Risk Management’, ‘Security Analysis and Portfolio Management’ courses, with the participants of MBA/PGDM.

* FLAME CASE CONFERENCE 2017

This Case Pack Includes:
- Abstract
- Case Study
- Teaching Note (**ONLY for Academicians)
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