Application & Implications of Fair Value Accounting Part ll(b): Managaing Guarantee Risks
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Document ID: 2003-781 (previously Report 71)
Published on: 1st January 2003
Our first two reports on fair value/realistic accounting considered some of the issues relating to how the fair values of insurance liabilities might be calculated. In this report, we turn our attention to the management of the profit/solvency volatility that realistic valuation will create. We show how the stochastic models used for calculating fair/realistic values can also be used for measuring the risks created by guarantees. This is demonstrated using a case study based on the with-profits policy discussed in report 69. Armed with these measures of risk, we then proceed to identify and appraise a number of candidate risk management solutions, including dynamic hedge portfolios and suitably-selected portfolios of vanilla options. Finally, we consider the implications these strategies can have for risk-based capital requirements.
