Christoph Moehr | Searcharxiv

arXiv2025

A framework for the valuation of insurance liabilities by production cost

This paper sets out a framework for the valuation of insurance liabilities that is intended to be economically realistic, elementary, reasonably practically applicable, and as a special case to provide a basis for the valuation in regulatory solvency systems such as Solvency II and the SST. The valuation framework is based on the cost of producing the liabilities to an insurance company that is subject to solvency regulation (regulatory solvency capital requirements) and insolvency laws (consequences of failure) in finite discrete time. Starting from the replication approach of classical no-arbitrage theory, the framework additionally considers the nature and cost of capital (expressed by a ``financiability condition"), that the liabilities may be required to be fulfilled only ``in sufficiently many cases" (expressed by a ``fulfillment condition"), production using ``fully illiquid" assets in addition to tradables, and the asymmetry between assets and liabilities. We identify necessary and sufficient conditions on the capital investment under which the framework recovers the market prices of tradables, investigate extending production to take account of insolvency, implications of using illiquid assets in the production, and show how Solvency II and SST valuation can be derived with specific assumptions.

q-fin.PR↗

arXiv2010

Market-consistent valuation of insurance liabilities by cost of capital

This paper investigates market-consistent valuation of insurance liabilities in the context of, for instance, Solvency II and to some extent IFRS 4. We propose an explicit and consistent framework for the valuation of insurance liabilities which incorporates the Solvency II approach as a special case. The proposed framework is based on dynamic replication over multiple (one-year) time periods by a portfolio of assets with reliable market prices, allowing for "limited liability" in the sense that the replication can in general not always be continued. The asset portfolio consist of two parts: (1) assets whose market price defines the value of the insurance liabilities, and (2) capital funds used to cover risk which cannot be replicated. The capital funds give rise to capital costs; the main exogenous input of the framework is the condition on when the investment of the capital funds is acceptable. We investigate existence of the value and show that the exact calculation of the value has to be done recursively backwards in time, starting at the end of the lifetime of the insurance liabilities. The main question only partially considered in this paper is the uniqueness of the value. We derive upper bounds on the value and, for the special case of replication by risk-free one-year zero-coupon bonds, explicit recursive formulas for calculating the value. Valuation in Solvency II and IFRS 4 is based on representing the value as a sum of a "best estimate" and a "risk margin". In our framework, it turns out that this split is not natural. Nonetheless, we show that a split can be constructed as a simplification, and that it provides an upper bound on the value under suitable conditions. We illustrate the general results by explicitly calculating the value for a simple example.

q-fin.PR↗