The process that an insurance firm undertakes to substitute the components of its portfolios with highly risky assets such as common stocks and junk bonds for lower risk assets (risk-free assets or relatively risk-free assets). Risky asset substitution is common in the life insurance industry where life insurers usually sell guaranteed investment contracts (GICs) to market participants (e.g., pension plan sponsors), and hedge such contracts with portfolios heavily composed of risky assets.
The substitution of portfolio holdings with equities, below-investment grade debt instruments, mortgage-backed securities (MBSs), reduces the risk of an insurer’s asset portfolios.
Asset substitution may also involve the transfer of components from from fixed-income (and less risky investments) to residual claims (risky assets), which increases the risk associated with asset portfolios.
Comments