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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

A central bank adopts an explicit inflation target of 4% and announces that it will set its policy interest rate mainly to meet that target. Which is the main way this framework is expected to help an Indian life insurer pricing long-term products?

A credible inflation target anchors inflation expectations, which makes long-term inflation and interest rate assumptions more predictable for an insurer pricing long-dated products. It does not guarantee positive real rates, fix bond yields, eliminate exchange rate risk or force a balanced government budget.

  1. AIt guarantees that real interest rates will never be negative
  2. BIt removes all exchange rate risk on foreign investments
  3. CIt anchors inflation expectations, making long-term cost and interest assumptions less uncertainCorrect
  4. DIt forces the government to run a balanced budget
  5. It fixes the yield on government bonds at the target rate

Explanation

A credible target anchors expectations, so long-run inflation and nominal rate assumptions become more predictable for pricing. It cannot guarantee positive real rates, fix bond yields, remove currency risk or impose fiscal balance.

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