The textbook says banks that borrow short term and lend long term need to be protected from short term rate increase; on the other hand insurance companies need to be protected from rate decline. Why is that? Thanks!
since they borrow short term - if the rates rise - banks would end up paying more borrowing costs.
Thanks. But why is life insurance company the opposite of banks ie why does life insurance company that offer a guaranteed investment contract that provides a guaranteed fixed rate and invest the proceeds in a floating rate instrument need protection from rate decline?
if they are providing a guaranteed fixed rate - that fixed rate is coming from their portfolio - which is invested in floating rate instruments. Now when rate declines - the floating rate is going to be lower - and they need to meet a fixed higher rate from that portfolio. So the funds to meet their fixed rate are going to become problematic.
Got it. Thanks!!
Usually insurance companies face the problem of rising rates, in the form of disintermediation. That said, we have to be careful, as their liabilities are segmented by product, some of which may in fact be vulnerable to rate declines.