ges associated with systematic factors. It is sometimes referred to as market risk. As such, it can be hedged but cannot be diversified completely away. In fact, systematic risk can be thought of as undiversifiable risk. All investors assume this type of risk whenever assets owned or claims issued can change in value as a result of broad economic factors. Systematic risk comes in many different forms. For the insurance sector, however, three are of greatest concern: variations in the general level of interest rates, basis risk, and (especially for property-liability insurers) inflation. Because of the insurers' dependence on these systematic factors, most try to estimate the impact of these particular systematic risks on performance, attempt to hedge against them, and thus limit the sensitivity of their financial performance to variation in these undiversifiable factors. To do so, most will both track and manage each of the major systematic risks individually. The first of these is undoubtedly interest rate risk. Here, they measure and manage the firm's vulnerability to interest rate variation, even though they cannot do so perfectly. At the same time, insurers with large corporate bond, mortgage, and common stock holdings closely monitor their basis risk. Here the concern is that yields on instruments of varying credit quality, liquidity, and maturity do not move together, exposing the insurer to market value variation that is independent of fluctuating liability values. In this case, too, they try to manage, as well as limit, their exposure to it. Finally, to the extent that the frequency and severity of claims are influenced by inflation risk, expected losses will also be affected. This is particularly the case where insurance policies are written on a replacement cost basis. The inflation of concern can be general inflation--affecting repair costs, medical costs, and the like--or specific and localized inflation--like the quadrupli...
