2  All speeches are available online at www.bankofengland.co.uk/publications/Pages/speeches/default.aspx  2  I see four main risks: 1. longevity risk - the risk that annuities to pensioners need to be paid for longer and therefore at a higher cost to the insurer because people live longer than expected; 2. market risk - the risk that asset returns are insufficient to pay the pensions: for example, because the insurer holds assets of shorter maturity than its liabilities, market interest rates fall and the insurer cannot afford to buy sufficient bonds to produce the income needed to meet its annuity obligations to pensioners; 3. credit default and downgrade risk - the insurer suffers losses because the assets in which it has invested default or downgrade; and, perhaps most importantly 4. management and governance risk - in the absence of regulation the owners and managers of an insurer may be incentivised to maximise their own short-term returns rather than managing the business in the long-term interest of the annuity holders. The interests of owners and managers are not necessarily aligned with those of the policyholders because owners share the benefits of taking more risk in a good outcome but have limited exposure to losses in a bad outcome because of their limited liability. Policyholders might be unable to monitor how an insurer is run because of the long-term and complex nature of pensions business.
The rapid growth of recent years has brought the economy to full capacity, the unemployment rate has fallen below 1½%, resulting in substantial wage pressures in certain segments of the market. The sharp expansion has resulted in a rising rate of inflation. In the 12 months to the beginning of October, consumer prices rose by 5.3%. The Central Bank issues inflation forecasts every three months. The latest forecast was issued in July and it envisaged a 3% average rate of inflation in 1999 and a 4% inflation rate from the beginning to the end of the year. A new forecast will be issued in the beginning of next week. The deficit on the current account of the balance of payments has risen. In 1998 it equalled roughly 5½% of GDP. It is expected to be lower in 1999. During the upswing, the Central Bank of Iceland has followed a restrictive monetary policy as reflected among other things in the fact that at present the differential between Icelandic and trade weighted foreign money market rates is well in excess of 5%. The yield on 3-month treasury bills in the market is currently above 9%, and the so-called repo rate of the Central Bank of Iceland is 9%. That can be compared with the repo rate of the European Central Bank of 2.5%. Since September of last year, the Central Bank has raised its interest rates four times, by a total of 1.8 percentage points. In early 1999 it also levied a liquidity requirement on Icelandic credit institutions.