Valuation Portfolios in Life Insurance

Abstract

In recent years insurance companies in a series of European countries have been committed to finally implement several new initiatives of supervision and politics in their insurance business. These uidelines are known under the notion of "Solvency II" and play a similar role for insurances as the "Basel II" regulations for banks. The main objective of this new framework is roughly speaking to ensure the ability of the insurer to meet its liabilities for all contracts at each time under "appropriate" conditions. More specifically, these guidelines are required to be risk-adjusted and based on market-consistent valuation of the balance sheet of the insurance company. The value of assets of an insurance company is often measured through market prices, whereas its liabilities arising from contractual obligations are usually valued by actuarial methods. A proper asset liability management (ALM) of the insurance however requires a market-consistent valuation of its balance sheet. The latter can be e.g. achieved by decomposing the insurance portfolio into financial instruments which can be evaluated by asset managers. The resulting portfolio is called valuation portfolio and can be considered a replicating portfolio for insurance liabilities. This concept enables a consistent analysis of financial risk in ALM.