Comments on Fair Valuation of Life Insurance Company Liabilities

I have been asked to comment on the paper prepared by members of the American Academy of Actuaries Fair Valuation of Liabilities Task Force (hereafter Task Force). The Task force has done a commendable job in presenting and making sense of the numerous approaches that have been applied toward the valuation of insurance liabilities. They compare and contrast the approaches, give critical appraisals of their strengths and limitations, and add their own views regarding the ultimate usefulness of models. If you think of the market value of a stock insurance firm as the value of its stock, it is comprised of three elements: the franchise value (or as some call it, the going concern value), the liquidation value, and the put option value. This is true for any financial institution. The franchise value stems from what economists call economic rents. Liquidation value is simply the market value of tangible assets, less the present value of liabilities. Put option value is the value of issuing debt (i.e. insurance policies, the debt of the insurance company) at rates below market. It‘s the value to equity holders of capturing upside earning while not incurring all the downside costs of default. If I were a regulator, I would endorse the constructive valuation approach and provide to insurers the basic market parameters for the valuation process, be it simulation or lattice approaches that are to be used in all reported valuations. Naturally, these parameters would be identical for all companies, for they are designed to capture market processes which are virtually independent of the actions taken by a given insurer.