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IAI Actuarial Core Principles · Business Management · Issues and challenges in each main practice area

A life insurer in India sells 20-year endowment policies with guaranteed maturity benefits but invests mostly in 5-year government securities. The chief actuary warns that falling interest rates will hurt the company when the bonds mature. Which risk is the actuary primarily describing?

The actuary is describing reinvestment risk caused by a duration mismatch. Short-dated bonds mature before the long guaranteed liabilities, so proceeds must be reinvested at lower rates while the promised benefits stay fixed, creating a shortfall.

  1. AReinvestment risk arising from an asset-liability duration mismatchCorrect
  2. BLongevity risk arising from improving mortality
  3. CUnderwriting risk arising from adverse selection
  4. DOperational risk arising from system failure
  5. Lapse risk arising from policyholder surrenders

Explanation

Assets are shorter than liabilities, so when the bonds mature the proceeds must be reinvested at lower yields while the guarantees remain fixed. This is reinvestment risk caused by a duration mismatch. The other risks are real but are not what the scenario describes.

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