Non-Life insurance have shorter duration vs. Life Insurance due to higher liquidity needs and unpredictibility of the claims. On the other side, the have more flexibility (less regulation) to invest in different asset classes (alternative investment, stocks, convertible), something they use to try to increase their growth of surplus.
All in all, which one of the two has the highest risk tolerance ?
Less regulation does not mean they have a higher risk tolerance, it’s kinda like ability and willingness. Just because they are more willing (non-life cause of less regulations) doesn’t mean they have more ability to accept them. You can maybe argue that the surplus for non-life has a higher risk tolerance than life. However overall, if both firms are the same, life has a higher risk tolerance, since they have less liquidity (ability).
I’d say that life-insurance companies have lower risk tolerance as they have: 1. very high liquidity needs due to disintermediation risk 2. more regulatory supervision prohibiting risky investing 3. are public-trust business
Although non-life is a bit ligher in terms of regulations, they have more unpredictable cashflows and also need safe and liquid investments.
Both companies have below-average risk tolerance. (Risk willingness does not come into play here).
the higher the duration the more risk tolerance. less regulation doesn’t mean that they can have higher risk tolerance because their liability duration is shorter. they have unknown time and size unlike life insurance which have unknown time but known value. since they have shorter duration their investments must be matched with their short term liabilities and they should invest in a combination of bonds / equities or follow a ladder portfolio investment approach. But i would say that all in all both have a lower tolerance for risk and show follow asset liability management.
Thanks guys… sounds logic.
My conclusion is then that both have low ability to take risk, but that non-life tend to be slightly lower just for the fact that timing and level of the claim is unpredictible.
I have to disagree with you kobi. Willingness does come into play for the surplus part of the portfolio. If the surplus is high, both life and non-life could have a high willingness to invest in risky assets. However life will be limited (ability) to invest only in certain assets. Non-life would probably take riskier assets because of underwriting cycle and competitiveness of the products
I think Bilal explained it perfectly. They have low duration and unexpected cashflows, therefore they have low risk tolerance.
You are totally right, only in surplus part.