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.