Valuation portfolio in life insurance

In Chapter 3 we define the valuation portfolio for a life insurance policy. The valuation portfolio is a portfolio consisting of financial instruments that replicate the insurance liability cash flows. The construction of the valuation portfolio is done with the help of an explicit example. We proceed in two steps: First, we assume that the cash flows have deterministic insurance technical risk, i.e. we have a deterministic mortality table, and only the value of the financial instruments describe a stochastic process. Then, we map the cash flows onto these financial instruments. In the second step, we introduce stochastic mortality rates yielding insurance technical risk. In that case we follow the construction in step 1, but we add loadings for the insurance technical risk coming from the stochastic mortality table. This construction gives us a replicating portfolio (protected against insurance technical risks) in terms of financial instruments.