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IAI Actuarial Core Principles · Business Economics · Impact of macroeconomic policies on businesses

A life insurer holds a large portfolio of long-dated fixed-rate government bonds. The central bank signals a sustained tightening of monetary policy and market yields rise. What is the most likely immediate effect on the insurer?

When yields rise, the market value of existing long-dated fixed-rate bonds falls, because their fixed coupons are less attractive than new issues. The insurer suffers a mark-to-market loss, though future investment of new money benefits from the higher yields.

  1. AThe market value of its existing bond holdings falls, although new money can be invested at higher yieldsCorrect
  2. BThe market value of its existing bond holdings rises because coupons look more attractive
  3. CThe market value of its bond holdings is unchanged because coupons are fixed
  4. DThe bonds are automatically redeemed early at par
  5. The insurer's liabilities become negative

Explanation

Bond prices move inversely to yields. Fixed coupons on existing bonds become less attractive when new bonds offer higher yields, so market values fall, especially for long maturities. Reinvestment of new premiums and maturities occurs at higher yields, which is a partial offset over time.

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