Liquidity of LRC and LIC
I'm still really confused about the liquidity of LRC and LIC after reading the past forum posts. And I need help clarifying the big picture around the liquidity concept.
Firstly, if I understand correctly, we should look at the liquidity of liabilities from the policyholder's perspective, for example: based on PH's ability to cancel the contract with before expiry and receive value, LRC is liquid.
So is it fair to say that, from the insurer's perspective, this concept of liquidity of liability seems like it's saying the liability is variable, or not fixed, or likely to be changed/extinguished? In other words, since the insurer can't cancel a policy before expiry, it can't exactly extinguish the liability on demand, that's why we don't look at the liquidity of liability from the perspective of insurers.
Secondly, I wonder is my following understanding correct: the liquidity of liabilities doesn't explicitly come in the numerical calculations of LRC and LIC. The liquidity part is only a qualitative consideration, e.g. we need match liquidity of reference portfolio to liquidity of assets in the top-down approach of determining discount rates.
Thank you.
Comments
From a policyholder's perspective: You are correct. With the LRC/UEP, the PH can cancel and easily get a refund making it really liquid. The LIC is less liquid because the policyholder can't just "withdraw" the amount owed in cash - they need to go through the claims settlement process.
From the insurer's perspective: Mostly correct. Remember the policy is like an option for the policyholder, it can be unilaterally cancelled by the PH but not the insurer (except for certain cases like fraud). Also, while you are correct in saying that the concept of liquidy is related to whether the liability is variable, another important point from the insurer's perspective is the uncertainty around amount and time to final settlement.
You are also correct that liquidity can't be explicitly measured -> It's a qualitative check to make sure there is a good match between your assets in the reference portfolio and your insurance liabilities