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

A life insurer in India expects a prolonged period of high inflation. Which consequence for its business is most likely if it has sold long-term fixed-sum-assured policies?

High inflation erodes the real value of fixed guaranteed benefits, makes them less attractive and shifts demand towards inflation-protected products, while the insurer's own expenses tend to rise. The other options wrongly assume benefits gain in real value or that bond values rise.

  1. AThe real value of the guaranteed benefits falls, but expenses and customer demand for inflation-protected products may riseCorrect
  2. BThe real value of guaranteed benefits rises, improving customer satisfaction and profit
  3. CThe insurer's expenses fall in real terms, so profit margins always widen
  4. DInterest rates must fall, increasing the value of its bond portfolio
  5. Policyholders will surrender fewer policies because returns look attractive

Explanation

With high inflation, fixed nominal benefits lose purchasing power, making such products less attractive and increasing demand for inflation-linked or equity-linked products. Expenses typically rise with inflation. Rising rates would reduce, not raise, bond values, and surrender behaviour is likely to rise.

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