Liquidity premium

thesuperactuary

In Wiki page,
"If the insurer's investments were all risk-free, the liquidity premium would be zero. (Ex: government bonds)
If the insurer's investments were all high-risk, the liquidity premium would be very high. (Ex: biotech startups)

In General:
investments with a HIGH degree of liquidity have a low liquidity premium
investments with a low degree of liquidity have a HIGH liquidity premium"

Can someone elaborate on "degree of liquidity" ?
It appears to me that let's say if an insure's investments are high risk => don't they also have HIGHER degree of liquidity as well => Liquidity premium would be also high.

I don't quite get 2 points under "In general" section

graham

According to the source text the term liquid is described as follows:

• an asset is liquid if it's easily convertible to cash (Ex: government bonds)
• a liability is liquid if the liability can be extinguished on demand (Ex: LRC for most P&C insurance contracts - see p 21 of source text.)

According to the source text, liquidity premium is:

• an adjustment made to a liquid risk-free yield curve to reflect the difference in liquidity between assets and liabilities

The text does seems to imply that HIGHLY liquid assets are also low-risk. So degree of liquidity refers to how easily an asset can be converted to cash and how risky it is.

• a HIGH degree of liquidity means the asset is easily convertible to cash and is low-risk
• a low degree of liquidity means the asset is not easily convertible to cash and is HIGH-risk

Another way to think about it is that the liquidity premium is the difference between the risk-free rate (refers to assets) and the actual discount rate (refers to assets) that's actually used to calculate the present value of the liabilities.