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SP2 - Active and Passive valuation approach

Discussion in 'SP2' started by Bharti Singla, Jun 17, 2021.

  1. Bharti Singla

    Bharti Singla Senior Member

    IAI - Nov 2019 - Qus.6(ii)

    Discuss the advantages and disadvantages for the insurer in moving towards using active valuation approach instead of a passive valuation approach.
    Ans.
    Disadvantages of using an active valuation approach:
    • Under adverse market conditions may indicate need for higher capital requirements.
    • May results in systemic risk, as other insurance companies may also face similar market conditions at the same time.
    1. How it is a disadvantage if by using this method, the company can assess that it may require higher capital to meet its obligation? It should be good for the company if it is getting this indication, the passive valuation method may not provide this information.
    2. How this method can result in systematic risk?
     
    Bharti Singla, Jun 17, 2021
    #1
  2. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hi Bharti

    It all depends on your point of view. I personally agree with you that active approaches are better because the insurer should be taking action after adverse market conditions and a passive approach may lead to the insurer taking no action until it is too late. However, to maximise our marks we need to give all points of view. The counter argument is that markets can be overly volatile, ie prices tend to fall by more than the fundamental value due to market panic, so the insurer shouldn't be taking action and should calmly wait for markets to recover.

    We have systematic risk because the active approach leads to all insurers having to take action at the same time. This action is usually selling risky assets to buy government bonds, which causes risky assets to fall in value yet further, hence systematic risk.

    Best wishes

    Mark
     
    Mark Willder, Jun 17, 2021
    #2
  3. Bharti Singla

    Bharti Singla Senior Member

    Hi Mark,

    Thanks for your response. I agree with your points.

    However, in second point, I am assuming systematic risk will happen only if most or all of the companies will use active valuation approach? Different companies can use different approaches?
     
    Bharti Singla, Jun 18, 2021
    #3
  4. Mark Willder

    Mark Willder ActEd Tutor Staff Member

    Hi Bharti

    True, but the regulator may have specified an active approach for the solvency calculations.

    Best wishes

    Mark
     
    Mark Willder, Jun 18, 2021
    #4
    Bharti Singla likes this.

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