What Is Liability Matching?

Liability matching is a method of investment wherein investors and companies properly manage their current assets to make sure that future liabilities will be covered. In simpler terms, a company continuously tries to “match” the value of their assents with the cost of future expenses so any financial setbacks will be averted. This approach has been adopted by many corporations and insurance companies that regularly expect future outflows such as monthly pensions for retired employees and payouts when an insurance policy holder dies. Liability matching also helps lessen the risk of bankruptcy and liquidation in the event that a company has to spend an amount larger than expected.

The distinguishing quality of liability matching is that it takes in prime consideration the element of the future, especially when it comes to liabilities that often come in the form of expenses. In this way, both aspects of prediction and preparation also come into play: prediction in the sense that the company knows that there are scheduled expenses in the future. Preparation, on the other hand, means that the company is aware that it might experience unexpected problems. Sufficient assets, therefore, are very important. In comparison, the concern of many investment strategies is primarily the growth of profits and return, regardless of liabilities.

In liability matching, it is important that the company determines the effective maturity of its assets. The term “effective maturity” usually pertains to the time when a party who has contributed to the company’s assets may have to reclaim his funds, often with interest. This can apply to an investor who had purchased bonds to build the initial capital, or a retiree who has regularly paid premiums for a retirement plan. Estimating the effective maturity helps the company create plans to further increase current assets. Typically, the longer the interval between the acquisition of assets and the effective maturity, the better, as this gives the company ample time to increase the value of its assets.

A helpful and popular programming tool when it comes to liability matching is the Monte Carlo simulation. The program can be used to estimate the worth of a company based on its assets and to create best and worst case scenarios for certain projects. Thus, the company can think of different contingency plans in case something goes wrong. Liability matching and the Monte Carlo simulation are not only useful to companies but also to individual investors and insurance policy holders who want to estimate when they can finally regain and profit from the money they have invested.