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IAI Actuarial Core Principles · Actuarial Mathematics for Modelling · Duration, convexity and immunisation

Which of the following is a genuine practical limitation of Redington immunisation for a long-term liability portfolio?

The key limitation is that Redington immunisation protects only against small changes in interest rates, and the portfolio drifts out of immunisation as time passes and rates change, so it must be rebalanced regularly. It does not need identical cashflows and gives no protection against large or non-parallel yield changes.

  1. AIt requires assets to have cashflows identical in amount and timing to the liabilities
  2. BThe conditions only protect against small changes in interest rates and the portfolio must be rebalanced over time as the discounted mean terms drift apartCorrect
  3. CIt can only be applied when liabilities consist of a single payment
  4. DIt guarantees a profit whenever interest rates move in either direction by any amount
  5. It requires the yield curve to be strictly downward sloping

Explanation

Redington's conditions give protection only for small, essentially parallel shifts in the force of interest. As time passes and rates change, the discounted mean terms of assets and liabilities change at different rates, so frequent rebalancing is needed, with transaction costs. Matching cashflows exactly is cash flow matching, not Redington immunisation, and no guarantee applies to large moves.

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