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IAI Actuarial Core Principles · Business Economics · Impact of the macroeconomic environment on business

A life insurer holds a large portfolio of fixed-rate government bonds. Market interest rates rise sharply. Which statement best describes the impact on the insurer, other things equal?

The market value of the fixed-rate bonds falls when rates rise, because their fixed coupons are less attractive than new yields. The insurer can reinvest at higher yields, which helps over time, but coupons and redemption values do not change and liabilities need not fall equally.

  1. AThe market value of the bond portfolio rises, increasing the insurer's assets
  2. BThe market value of the bond portfolio falls, although new money can be invested at higher yieldsCorrect
  3. CThe coupon payments on existing bonds rise automatically
  4. DThe bonds' redemption values fall in line with yields
  5. The insurer's liabilities necessarily fall by the same amount as assets

Explanation

Fixed coupons become less attractive when market yields rise, so existing bond prices fall. Reinvestment at higher yields is a partial benefit. Coupons and redemption values are fixed, and liabilities move only if their duration matches, which is not guaranteed.

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