Just Lifetime Income Risk Management

Just Lifetime Income risk management 

The liabilities (guaranteed income for life and future annual increases) change over time, and when they do, the corresponding asset should also immediately be adjusted so that the assets and liabilities continue to be matched. If this is done, the funding level always remains at, or very close to, 100%. This equates to successful risk management.

The change in liabilities can be daily and is exacerbated in times of extreme market volatility. 

Dynamic hedging

As you may remember when we first introduced JuLI to you, the risk management technique Just uses to continuously match the assets to the liabilities is called dynamic hedging. Simply put dynamic hedging is the daily valuation of liabilities with, if needed, an immediate adjustment in the corresponding assets to ensure that the liabilities continue to be hedged (a fancy word for matched).

Each policyholder’s liability is the combined value of the current guaranteed income, over the remaining life expectancy, plus the next annual increase. To apply dynamic hedging, Just’s Asset Liability Management Team value all policyholder liabilities each day and make the required adjustments to the corresponding assets. 

How we value the variable liability of the next annual increase

JuLI has a transparent annual increase formula driven by the rolling six-year return of the selected balanced fund, and the annual increase calculation date is 31 October each year. 

Just receives a daily unit price on each balanced fund from the respective asset manager. We know the published rolling five-year return to 31 October of the previous year, and with each new daily unit price, we are able to build the return of the sixth year as this progresses.

So, because the build-up of the return of the sixth year happens daily, we can value the variable liability of the next annual increase on a daily basis until the next increase calculation date of 31 October.  And then the process repeats for the next annual increase to be calculated on the following 31 October.

How has dynamic hedging performed over the past few weeks?

Over the last few weeks, we have seen dramatic falls in equity markets and changes in interest rates. The impact of this, driven by dynamic hedging, has been:

• The two JuLI investment buckets have been significantly rebalanced with the allocation to the selected balanced fund, falling to about 30% of its long-term position.
• These assets have been transferred to the matching fixed interest portfolio.
• There have been no liquidity constraints to implementing the required dynamic hedging trades.
• The JuLI funding level remains very close to 100%.

Therefore, despite 16 March 2020 being the largest single-day global market crash since Black Monday 1987, Just’s dynamic hedging risk management has accomplished the primary objective of continuously matching the assets to the liabilities and in so doing, insulating JuLI policyholders from the extreme market volatility and protecting their guaranteed annual income.

When markets recover and the daily unit price rises, the liability profile will change again, and this will trigger a rebalancing of assets from the matching fixed interest portfolio back to the selected balanced fund.

JuLI policyholders will therefore fully participate in this recovery because it is the rolling six-year return of the balanced fund that drives the annual increase.  

It is however also important to remember that Just provides JuLI policyholders with a guarantee that their income:

• Will be paid for life, or possibly longer if an income death benefit has been selected
• Will never reduce – so the lowest possible annual increase is 0%
• Once a positive increase is declared, this is locked into the lifetime income

This guarantee is permanently funded by the regulatory capital reserve requirements.  This is capital that Just must hold in addition to the assets required to match the liabilities, referred to as dynamic hedging. 

This regulatory capital reserve is set to withstand a 1-in-200 year “overnight” equity shock that assumes dynamic hedging has not provided any mitigation to that fall.

Because dynamic hedging has maintained the funding level at close to 100%, this regulatory capital reserve remains completely intact.