A market-consistent framework for the fair evaluation of insurance contracts under Solvency II

IFRS 17 is effective from 1 January 2021. A company can choose to apply IFRS 17 before that date, but only if it also applies IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customers. The board will support the implementation of IFRS 17 over the next three and half years.

See definition (7) (Commission 2015), insurance and reinsurance undertakings’ valuation of the assets and liabilities using the market-consistent valuation methods prescribed in international accounting standards adopted by the Commission in accordance with Regulation (EC) No. 1606/2002, should follow a valuation hierarchy with quoted market prices in active markets for the same assets or liabilities being the default valuation method in order to ensure that assets and liabilities are valued at the amount for which they could be exchanged in the case of assets or transferred or settled in the case of liabilities between knowledgeable and willing parties in an arm’s length transaction. This approach should be applied by undertakings regardless of whether international or other valuation methods follow a different valuation hierarchy.

The estimates of future cash flows shall be current, explicit, unbiased and reflect all the information available to the entity without undue cost and effort about the amount, timing and uncertainty of those future cash flows. They should reflect the perspective of the entity, provided that the estimates of any relevant market variables are consistent with observable market prices [IFRS 17:33, Measurement].

See data on life insurance market at https://​www.​insuranceeurope.​eu/​insurancedata.

For a comprehensive introduction to ESGs and their applications to insurance and pension funds, see SOA (2016).

By and large, liability-driven investments are saving or pension products, like segregated fund, where the way assets performance affects liabilities is critical for the sustainability and success of the investment strategy.

For the definition of equivalent martingale measure and the fundamental theorem of asset pricing, see for example Bjork (2009).

In market-consistent evaluations, liability cash flows are discounted using a risk-free curve derived from six months Euribor, which is constructed as prescribed by EIOPA. After the financial crisis in 2008, some European sovereign bond issuers (as Portugal, Italy, Greece and Spain) began to trade with a material spread over Euribor. Therefore, the assets of many insurance companies began to deteriorate while liabilities did not due to the basis or liquidity effect between market prices and discounting factors used to assess the economic value of technical provisions.

At the heart of the prudential Solvency II directive, the own risk and solvency assessment (ORSA) is defined as a set of processes constituting a tool for decision-making and strategic analysis. It aims to assess, in a continuous and prospective way, the overall solvency needs related to the specific risk profile of the insurance company.

With valuation risk, we mean correlation, basis, liquidity and model risks in accordance with the prudent person principle as stated in the article 132 of Solvency II Directive.

For an overview of insurance participating contracts, see Pitacco (2012).

See, for example, the hedging requirement under IFRS 9 financial instruments.

A stochastic time is a real positive and increasing right continuous process with left limits, for every \(t \ge 0\), \(\tau (t)\) is a stopping time, \(\tau (t)\) is finite almost surely, \(\tau (0) = 0\) and \(\lim \nolimits _{t \rightarrow \infty } \tau (t) = \infty \) (see Barndorff-Nielsen and Shiryaev 2010 for a complete discussion).

The relevance of the Italian traditional with-profit business as an example is explained in Gambaro et al. (2018). The same paper includes more information on the certainty equivalent and the market-consistent approach to insurance valuations.

A consequence of an higher turnover on the assets portfolio is the reduction of unrealised gains (or losses), which are used by insurance companies to steer the performance credited to and shared with the policyholder.