Q1: I want to know is there any difference in best estimate reserve ,realistic reserve? Is there any difference of assumptions? As per my understanding there is no difference and use best eatimate investment return on backing assets as valuation rate . Q2: what is the difference between realistic reserve and market consistent reserve? Is there difference of valuation rate as best estimate of investment return and risk free yield ?other assumptions in market consistent as "best+ risk margin "? Plz correct me if I m wrong..
Best estimate and realistic assumptions are the same thing. Market-consistent assumptions are different to realistic assumptions. Realistically we expect equities to have a return of say 6%. However, we do not use this return to calculate the reserves. Market-consistent valuations use the risk-free rate say 4%(regardless of whether we invest in the risk free asset or not). The reason to use the risk-free rate goes back to CT8 - in simple terms, we deduct 2% from the expected return on equities to allow for their additional risk. For assumptions such as mortality, we would use best estimate assumptions to calculate a market-consistent value. However, we would add a risk margin to reflect the risk surrounding this assumption. Best wishes Mark
Thanks Mark If equity is expected to earn 6% then for realistic reserve calculation we will use 6% as valuation rate .m I right? Q2:In market consistent valuation , will valuation rate and future investment rate are both would be assumed as 4% ? Q3: In market consistent world , why we adding risk margin which is based on coc in Best estimates for mortality,expense ...i mean how mortality risk ,expense risk etc can be taken care by risk margin?
Yes, if we wanted to calculate a realistic reserve we would use 6% in my example. I'm not sure how useful that would be in practice though given that reserves are usually prudent or market-consistent. Yes, for market-consistent calculations we would use 4% to project the investment returns and would also use 4% to discount cashflows. A market-consistent valuation of the liabilities gives the value at which the market would accept those liabilities. For example, if we are transferring a block of annuity business to another insurer, we could use the market-consistent value of our annuity liabilities to calculate the assets we should transfer across. Nobody would be prepared to take on those liabilities for their best estimate cost - there would be a 50/50 chance of them making a profit/loss. So we add a risk margin to provide the extra return required by the insurer to reward them for taking on the annuity risk. The course covers the commonly used method of the cost of capital approach to calculate this risk margin. Best wishes Mark
