Paper 2007 AM – Q6 Part B – Risk tolerance of Life Insurance co.

Question

Hi,

Paper 2007 AM - Q6 Part B

Dont understand why the liquidity need for a life insurer increases with a larger share of fixed-rate annuities in the product line, thus lowering risk-taking ability.

Is it because the fixed-rate liabilities are being ALM matched/funded by fixed-rate assets/investments ?

Answer says: Fixed-rate annuities need a higher level of liquidity to meet the CURRENT periodic payouts to annuity holders.

as the investment portf is segmented, wdnt the current payouts be met by the investment cash flows (since ALM matched) that match the fixed-rate annuity payouts required ? and the whole life and Term life product payout requirements are met by their respective matched assets ?

Thanks very much

adossa3 · Answer

Thanks very much Vincentt

vincentt · Answer

Hi @adossa3‌ , I'm not looking at 2007 papers as I don't intend to work on papers that far back. 
I think regardless of whether you are using ALM or asset only approach, the question is just asking the risk tolerance for the portfolio based on the liabilities.

So, if the portfolio has huge surplus, you would have higher risk tolerance than a portfolio without a surplus (all else equals obviously).

Now, all else equals, a fixed-rate annuities liability means the insurance company would require high liquidity on an annual basis (or an even more frequent period). As a PM for the portfolio, i don't think you would want to take higher risk. You just can't afford to have any shortfall. On the other hand, if you're managing a pension fund where their participants have an average age of 15 years to retirement, you have a longer duration to take more risk and any shortfall can be recover over the long duration.