The Impact of Illiquidity on the Asset Management of Insurance Companies

This paper investigates the impact of illiquidity on insurance company asset allocation and selling strategy. The need for insurers to settle claims as they arise by freeing funds immediately make insurers especially susceptible to the effects of transaction illiquidity. Using a simplified model of a risk neutral insurance company, we examine the effect of permanent and temporary price impact on initial asset allocation. The optimal asset allocation and selling strategy are determined numerically. While a clear diversification benefit is evident on the basis of illiquidity, under certain market assumptions, the cash-flow matching strategy is optimal.