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FRM Part II · FRM Exam Part II · The Global Drivers of Private Credit

A risk manager at a life insurer notes that the firm's private credit holdings have grown as a result of search for yield. Which risk is most directly heightened if policyholders suddenly surrender contracts in a rate-rise scenario?

Liquidity risk is most heightened. Private loans have thin secondary markets, so if surrenders surge the insurer must sell at steep discounts or borrow at high cost, creating a mismatch between illiquid assets and potentially callable liabilities.

  1. ALiquidity risk, because illiquid private loans cannot easily be sold to meet outflows without large discountsCorrect
  2. BBasis risk, because private loans are always priced off the same benchmark as policy liabilities
  3. CSettlement risk, because private loans trade on exchanges with delayed clearing
  4. DModel risk, because private loans are marked to market daily

Explanation

Private loans lack active secondary markets, so meeting surrender outflows forces sales at discounts or use of costly funding. Private loans are not exchange-traded and are typically valued using models, not daily market prices.

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