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

Consumer price inflation in India rises unexpectedly from 4% to 7% a year. A life insurer has sold a large block of long-term guaranteed-benefit policies with fixed rupee sums assured and fixed premiums. Which is the most likely effect on the insurer, other things equal?

Unexpected inflation lowers the real value of fixed rupee benefits, which helps the insurer on liabilities, but rising yields tend to reduce the market value of existing fixed-rate bonds. Premiums are fixed and expenses tend to rise, so the net effect is not simply favourable.

  1. AThe real value of its fixed rupee liabilities falls, though bond yields may rise and reduce the value of its existing fixed-rate assetsCorrect
  2. BThe real value of its fixed rupee liabilities rises, because benefits are fixed in nominal terms
  3. CIts premium income rises automatically in line with inflation
  4. DIts expenses remain unchanged in real terms because policy costs are fixed
  5. Its existing fixed-rate bond portfolio gains in market value as yields rise

Explanation

Fixed nominal benefits lose real value when inflation rises, which helps the insurer on the liability side. However, higher inflation usually pushes yields up, so the market value of existing fixed-rate bonds falls. Expenses typically rise with inflation, so expense overruns are also a risk.

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