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in BUS 4027W - Actuarial Risk Management by (950 points)
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In chapter 36 on valuing liabilities, the assertion is made that an adjustment for risk can be made when valuing a liability by either adjusting the future cashflow amounts or adjusting the risk discount rate. This adjustment is said to depend on:

  • amount of the risk (which I assume is subjective figure)
  • cost of the risk implied by market risk preferences
I'm struggling to wrap my head around that second part. 
I'm thinking more along the lines of an insurer pricing a new product and then valuing the liability of this new book of business based on some initial assumptions. After some time, the experience might mean that the cost of insurance has actually changed. this could for example be that the market becomes less risk averse, which means that less insurance is being taken out. This will then be reflected by a new (likely lower) liability value being calculated. This also all assumes that we are reporting only fair values.
Is this a reasonable interpretation?

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+3 votes
by (460 points)

The cost of the risk implied by the market risk preferences is how much it would cost the holder of the risk to transfer the risk to another party. Thus in a market with less risk averse (risk seeking) preferences, the other party would require a smaller sum to accept the risk and thus the cost of the risk would be decreased, which can be done by decreasing the future cashflow amounts for example.