Hi everyone,
Can someone please confirm, it seems that life insurance company risk tolerance is actually less than that of non-life insurance companies… despite the fact that non-life cash flows are more unpredictable.
Also seems that the life insurance duration is lower than that of non-life = again less risk tolerance for life insurance
Can someone confirm please? thanks
I think the notion of how “important” it is that life insurance payouts are met comes into play, along with how strictly regulated they are.
Not despite, it’s because non-life cash flows are more unpredictable, you have less tolerance for risk.
Duration is typically higher for life insurance portfolios, which make them less risk averse.
In Life insurance you know how much, you don’t know when the cash flow materialises
In non-life insurance you don’t know how much and you don’t know when the cash flow materialises
So basically both life and non-life insurance companies have “below average” risk tolerance, with non-life insurance generally having lower tolerance than life insurance due to shorter duration of liabilities, more uncertainty surrounding payouts and higher liquidity needs?
Compared to institutions, it is probably below average.
I’d say so. the key point for Life Ins worths to remember is that the portfolio is usually segmented per different LoB to better monitor :
> profitability per product;
> compliance etc
tolerance is based on,
ratings agencies which monitor capital adequacy.
laws and regulations.
mortalilty tables are quite accurate, so i doubt people dying are much of a concern.
Disintermediation has not been mentioned yet as a life insurance liquidity need. Let’s say one can borrow from their life insurance at 5 and current rates are 6. This could cause a run on loans withdrawals, etc. Which can supply a risk like a natural disaster in the non life insurance world.
liquidity requirement and risk are diff things…
But an increased liquidity requirement generally reduces ability to take risk, all else equal…
Great discussion everyone,
In my notes, i read in one of the readings or schweser that life insurance risk tolerance is less than non-life… I think its because of what S666 wrote:
We understand that non-life duration is less than life (except tax exempt bonds - which isn’t an issue for life insurance firms), and the disintermediation risk and the unknown cash flow timing/amounts for non-life, but again… overally, from my understanding, life insurance companies overall have a lower risk ability…
I was hoping someone had a definitive answer, in case a generate point where to come up on the exam… hopefully its more specific relating to disintermediation and all the other factors.
Yes I remember reading somewhere that in general life insurance companies have a lower risk tolerance than non life. The discussion above where people where saying the opposite confuses me as I see the logic of certainty of payouts and duration of liabilities etc…but yes, I think the defining factor is the importance of the payouts and the regulation imposed upon life insurance companies.
Notice how you could easily think the payouts are more important in non-life because they’re bigger / more unpredictable (hurricane)… but yeah life insurance risk tolerance is in fact < non-life
Thanks.
Right…I’ve re read the curriculum and for what it’s worth I now agree with the above posters that a non-life insurance company has a LOWER risk tolerance than a life insurance company due to the points mentioned above regarding uncertainty of payouts and shorter duration of liabilities.
Phew…
top of page 485 it says 50% of the surplus is invested in stocks.(non-life)
life can only only rotate between taxable /untaxable bonds.- because of regulation.
If life insurance is restricted from holding common stock alltogether, while nonlife is allowed (but self imposed limits), then obviously life insurance has a lower risk tolerance.
And… there’s no required asset valuation reserve for nonlife, but there is for life… again … life risk tolerance < nonlife…
I think the saving grace with this one is that I imagine this won’t be tested with a question that asks the difference between risk tolerance of a life vs non-life company. It will no doubt most likely give a situation where you are analysing one or another at any point in time, and have to judge whether it has an above/below/average risk tolerance and why.
In reality both life and non-life have “below average” risk tolerance as a base case, with particular circumstances effecting it one way or another to an extent.
Gents I worked in a Life + non life insurance group for long time.
Let me try to bring some additional light here (hopefully aligned with the curriculum) in terms of
RISK TOLERANCE / OBJECTIVES :
Life ins has higher risk tolerance than non-life ins. In non-life environment (e.g. P&C ) claims come every now and then this make underlying cash flow “ERRATIC and UNPREDICTABLE” that’s a point. Life insurers have easier life than non-life. On the other hand :
Life insurers have to maintain a valuation reserve for policyholders as a buffer to the surplus A/L;
I’d also agree that larger liquidity requirements (and bear in mind we should state all significant cash outflow) lower the overall risk tolerance. Specifically for Life insurance and within the
LIQUIDITY REQUIREMENTS section it’s relevant to mention the below :
A) Disintermediation
B) Asset / Liability Mismatch due to valuation concerns that arise in period of changing interest rates (interest rates risk);
there are also other aspects to take into account but the above are the key words to state within a Life insurer IPS in my eyes.
hope it helps
Just a few points: