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Economic Valuation Models for Insurers

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  • David F. Babbel
  • Craig Merrill

Abstract

Recently much attention has been given to the approaches insurers undertake in valuing their liabilities and assets. For example, in 1994 the American Academy of Actuaries created a Fair Valuation of Liabilities Task Force to address the issue. In 1997, the Academy established a Valuation Law Task Force and a Valuation Tools Working Group to investigate the various valuation approaches extant and to make recommendations on which models are best suited to the task. Much of the published work has focused on attributes of the various models, their strengths and shortcomings. Some of the work has addressed the larger questions, but in our view, it is useful and necessary to provide a taxonomy of approaches and evaluate them in a systematic way in accordance with how well they achieve their aims. In this paper we focus primarily on the economic valuation of insurance liabilities, although we do address some valuation issues for assets. We begin in Section I by defining insurance liabilities. Next, in Section II, we discuss the criteria for a good economic valuation model. This is followed by a taxonomy of valuation models in Section III. In Section IV, we examine insurance liabilities in the context of this taxonomy and identify the minimum requirements of an economic valuation approach that purports to value them adequately. An illustration of the application of a modern valuation model is given in Section V. We conclude in Section VI by discussing some limitations of our analysis, and offer some recommendations for implementation.

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Bibliographic Info

Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 97-44.

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Date of creation: Oct 1997
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Handle: RePEc:wop:pennin:97-44

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  1. Babbel, D.F. & Eisenberg, L.K., 1991. "Quantity-Adjusting Options and Forward Contracts," Weiss Center Working Papers 29-91, Wharton School - Weiss Center for International Financial Research.
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  18. Boyle, Phelim P., 1977. "Options: A Monte Carlo approach," Journal of Financial Economics, Elsevier, vol. 4(3), pages 323-338, May.
  19. Brennan, Michael J. & Schwartz, Eduardo S., 1979. "A continuous time approach to the pricing of bonds," Journal of Banking & Finance, Elsevier, vol. 3(2), pages 133-155, July.
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Cited by:
  1. Andrea Consiglio & Flavio Cocco & Stavros A. Zenios, 2001. "The Value of Integrative Risk Management for Insurance Products with Guarantees," Center for Financial Institutions Working Papers 01-06, Wharton School Center for Financial Institutions, University of Pennsylvania.
  2. Cocozza, Rosa & Di Lorenzo, Emilia, 2007. "A Dynamic Solvency Approach for Life Insurance," MPRA Paper 28015, University Library of Munich, Germany.
  3. Consiglio, Andrea & Cocco, Flavio & Zenios, Stavros A., 2008. "Asset and liability modelling for participating policies with guarantees," European Journal of Operational Research, Elsevier, vol. 186(1), pages 380-404, April.
  4. Shen, Weixi & Xu, Huiping, 2005. "The valuation of unit-linked policies with or without surrender options," Insurance: Mathematics and Economics, Elsevier, vol. 36(1), pages 79-92, February.
  5. Giandomenico, Rossano, 2006. "Pricing of the Policy Life in Absence of Default Risk and Asset Liability Management," MPRA Paper 18844, University Library of Munich, Germany.
  6. Grosen, Anders & Lochte Jorgensen, Peter, 2000. "Fair valuation of life insurance liabilities: The impact of interest rate guarantees, surrender options, and bonus policies," Insurance: Mathematics and Economics, Elsevier, vol. 26(1), pages 37-57, February.
  7. Consiglio, Andrea & De Giovanni, Domenico, 2008. "Evaluation of insurance products with guarantee in incomplete markets," Insurance: Mathematics and Economics, Elsevier, vol. 42(1), pages 332-342, February.
  8. Patrick McAllister & Pavlos Loizou, 2007. "The Appraisal of Data Centres: Deconstructing the Cash Flow," Real Estate & Planning Working Papers rep-wp2007-04, Henley Business School, Reading University.
  9. Eckhard Platen, 2009. "Real World Pricing of Long Term Contracts," Research Paper Series 262, Quantitative Finance Research Centre, University of Technology, Sydney.
  10. Kevin Fergusson & Eckhard Platen, 2013. "Real World Pricing of Long Term Cash-Linked Annuities and Equity-Linked Annuities with Cash-Linked Guarantees," Research Paper Series 338, Quantitative Finance Research Centre, University of Technology, Sydney.
  11. Giandomenico, Rossano, 2006. "Asset Liability Management in Insurance Company," MPRA Paper 16333, University Library of Munich, Germany, revised Jan 2009.

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