Hi All, I have a query on using illiquidity premium in discount rates. Incorporating illiquidity premium in discount rates to value annuity liabilities is prudent or imprudent? Assuming we are backing liabilities with Corporate bonds and we are using illiquidity premium in our discount rate, then our liabilities will go down. Falling of liability by increasing of discount rate is prudent for Insurance company or imprudent? Will regulators allow for it? Regards, Rajat
It reduces the prudence if you are moving from risk-free rate to r-f rate plus IP. All regulations are different but course says: This would normally be restricted to long-term predictable liabilities for which matching assets can be held to maturity. Since the insurer is not exposed to the risk of changing spreads on such assets (although is still exposed to default risk), it may be permitted to increase the risk-free discount rate accordingly. Have a look at IFoA April 2017 Q2 - it's quite a good question on this.
