FRM Part I · FRM Exam Part I · Insurance Companies and Pension Plans
A life insurer prices a portfolio of annuities using a mortality table. Subsequently, actual longevity improves materially beyond the table's assumptions. Compared with a portfolio of term life policies priced on the same table, how does this development affect each book?
Improved longevity hurts the annuity book, because annuitants live longer and receive payments for longer than priced, while it helps the term life book, because fewer insureds die within the term and claims fall. The two exposures offset each other, giving a natural hedge.
- ABoth books lose, since improved longevity raises payouts on all life products
- BBoth books gain, since longer lives increase premium income
- CThe annuity book gains and the term life book loses, since annuities pay while the insured lives
- DThe annuity book loses because annuitants live longer and are paid longer, while the term life book benefits because fewer deaths occur within the termCorrect
Explanation
Longevity risk hurts annuity writers because payments continue longer than priced. Term life benefits are paid only on death in the term, so lower mortality reduces claims. Thus the two books are naturally offsetting, which is why insurers can partly hedge one with the other.
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