From Principle-Based Risk Management to Solvency ... - Scor

2
Valuation of Insurance
Liabilities
The SST is based on an economic balance sheet. This implies in particular
that insurance liabilities have to be valued market-consistently. There is no
obvious answer to date on how to calculate the value of insurance liabilities.
For this reason, we attempt in the following to provide a very general discussion
of valuation, which will then lead to the methodology proposed for
the SST.
This section is structured as follows. In Section 2.1.1 we introduce the
crucial concept of replication for the valuation of financial instruments. In
Section 2.1.2 we consider how to treat instruments which cannot be (perfectly)
replicated, such as most insurance liabilities. This introduces socalled
basis risk. The following Section 2.1.3 specializes this discussion to
one particular method of accounting for the basis risk, which in turn can be
translated into a cost of capital margin approach.
Section 2.1.4 introduces one particular and common “replicating” portfolio,
which is often used (sometimes implicitly) in the context of valuation
of insurance liabilities.
In Section 2.2.1, the preceding discussion is applied to present the SST
methodology and its underlying assumptions. Our proposed implementation
of the SST methodology is outlined in Sections 2.2.2, 2.2.3, and 2.2.4.
Section 2.3.1 outlines the proposed treatment of external retrocession
and fungibility in the implementation of the SST. Section 2.3.2 discusses
limitations of the proposed approach, and, finally, Section 2.3.3 outlines
similarities and differences between the valuation approaches used in the
SST and in the pricing of contracts.
We refer the reader to Philipp Keller’s article on internal models for SST,
Keller [2007].
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