Page 63 - Risk Management in current scenario

The liability side of liquidity risk arises due to product design,
policyholder’s behaviour or through catastrophic events. Many life
insurance products such as endowment assurance have surrender value
where policyholder’s have an option to surrender the policy in between
the term of product while other products such as term assurance do not
have any surrender value and thus have no liquidity risk due to surrender.
The surrendering of policy depends of meeting the policyholder’s
need and when such needs are not fulfilled leading to surrender. The
liquidity risk due to higher death claims occur under catastrophic event
such as natural disaster, pandemic, flood etc. could lead to liquidity risk.

The asset side liquidity risk arises due to impairment in the capital market,
increase in interest rate, lower than expected new business premium,
lower than expected renewal premium or default by reinsurer. In capital
market impairment, a previous liquid asset classes become temporarily
illiquid or materially less liquid for extended period of time raising even
nominal amount of cash can prove to be difficult.

Another important source of liquidity risk is when Life Company is
downgraded by rating agencies. The downgrading of the news spread very
rapidly in the financial media and reaches the policyholders which may
create panic among them leading to higher level of withdrawal and
reduced new business sale. This situation could be very dangerous unless
management act quickly.

Measurement of Liquidity Risk
Before taking actions to manage the liquidity risk, it is important to
measure the liquidity risk. There could be many ways of measuring the
liquidity risk, few are detailed below. Calculating following ratios and cash
flows helps in understanding the severity of the risk to take mitigating
actions.

1. Liquidity Coverage Ratio (LCR) = (Premiums Collected + Liquid
Assets)/Outflows

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