Currency risk and hedging
The exposure of an insurer whose liabilities and assets are not denominated in the same currency, compounded by claims settled in a currency other than the premium's.
On September 26, 2022, sterling fell to about 1.03 dollars, its lowest level on record, and the sterling value of dollar liabilities carried from London moved with it. An international insurer collects premium in several currencies, invests the funds in others and settles claims in whichever currency they arise. Currency risk is therefore part of the technical result itself. Three distinct exposures overlap, and each is handled its own way. Transaction exposure covers flows due for settlement and is hedged with forwards. Translation exposure covers the accounting conversion of foreign subsidiaries and represents no cash flow at all, which is why hedging it is debated. Economic exposure covers future claims not yet incurred, whose settlement currency is known but whose amount and timing are not. It is the hardest to address, because no instrument hedges a double unknown. The governing principle is currency matching: holding in each currency assets of amount and duration close to the corresponding liabilities. The prudential regime encourages it by reducing the capital charge on matched positions.
On September 26, 2022, sterling fell to about 1.03 dollars, its lowest level on record, mechanically shifting the sterling value of dollar-denominated liabilities carried by underwriters operating from London.
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