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Market-consistent valuations and Solvency II: Implications of the recent financial crisis

  • Kamran Foroughi

Abstract

The recent financial crisis has raised challenges to market-consistent valuation, both in its implementation and application. These include both commercial and technical challenges. The whole concept of mark-to-market accounting has been questioned in some quarters.

There have been commercial challenges in deciding how to assess business strategies given recent volatile market-consistent results, including the implications for ALM and new business pricing. Industry-wide, macroeconomic concerns have been raised regarding procyclicality.

This paper recognises these commercial challenges and highlights how a combination of different forms of management information covering both market-consistent and other measures can help in making decisions. This paper sets out some possible approaches to mitigate procyclicality.

There have been technical challenges in:

  • assessing how to value instruments in markets which are or have become illiquid
  • selecting an appropriate ‘risk-free’ or reference rate
  • deciding whether and how to make additional allowance for the liquidity premium or own credit risk
  • the calibration of stochastic models used to value embedded financial options and guarantees
  • assessing an appropriate allowance for non-hedgeable risk.

This paper discusses these technical challenges. The paper proposes a way forward in some areas, taking into account the recent dislocation of the financial markets and drawing on recent Solvency II, IASB, FASB and MCEV developments.

Copyright

Corresponding author

*Correspondence to: Kamran Foroughi, Towers Watson, 71 High Holborn, London WC1V 6TP, UK. Tel: +44 (0) 20 7170 2743, E-mail: kamran.foroughi@towerswatson.com

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Keywords

Market-consistent valuations and Solvency II: Implications of the recent financial crisis

  • Kamran Foroughi

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