Embedded value

Abstract: This paper assesses the impact of longevity risk management on insurer shareholder value and solvency for an annuity portfolio. The analysis uses a multi-period stochastic mortality model with both systematic and idiosyncratic longevity risk. We consider both survivor, or longevity, swaps that provide a full longevity risk hedge, and index-based survivor, or longevity, bonds that do not hedge idiosyncratic longevity risk. Shareholder value includes the impact of the costs of transferring longevity risk, policyholder demand elasticity, regulatory capital requirements, capital relief, and frictional costs including the insolvency put option, agency costs, and financial distress costs. Shareholder value is based on an Economic Value (EV) and a Market-Consistent Embedded Value (MCEV) approach. Capital management is assessed based on a recapitalization and dividend strategy that maintains regulatory capital requirements, as defined under Solvency II. We demonstrate how longevity risk management strategies significantly reduce the volatility of shareholder value and frictional costs. Longevity risk managementreducesthe probability of insolvency, increases policyholder demand and hence increases shareholder value.

Abstract: The latest developments of both prudential (Solvency II) and financial reporting (MCEV, IFRS) frameworks seem to consecrate market consistent valuation as a kind of paragon of insurance liabilities assessment. In this chapter, we initially try to analyze the underlying motivations of this evolution. We show that it results from an objective of harmonization of measurement of quite different insurance contrats. This heterogeneity being the result of heterogeneous national insurance regulations. In the second part, we analyze the limitations of this measurement principle. For that, we mobilize some of the arguments opposed to Fair Value Accounting. Moreover, we insist on the limitations resulting as well from the implementation issues as of their use in a risk management perspective.

Abstract: How does a change in the risk-free interest-rate affect the value of a non-life insurance company or portfolio? Risk managers typically argue that there should be little impact as long as assets and liabilities are properly matched. However, the risk-management perspective focuses on existing assets and liabilities, while neglecting the value of future business potential. This paper argues that interest-rate changes can have a significant impact on the appraisal value of a non-life insurance company, even if assets and liabilities are matched. This impact can be positive as well as negative, depending on the underlying parameters. Relevant parameters include reserving intensity, combined ratio, business growth-rate, asset allocation, risk-capital relative to premium income and the correlation between interest-rate and technical insurance results.