Hi Lindsay,
Thanks for your reply! That makes perfect sense. Just want to clear 2 things:
1. when calculating MCEV with Solv II liabilities, does the illiquidity spread embedded in the investment assumption cover the spread for default risk? I'm asking because in Solv II discount rate fundamental spread is explicitly deducted from MA (I guess there's a same deduction of default spread in VA calculation?), so wondering if the illiquidity spread in investment assumption in MCEV also deducts default spread, such that no profit emerges from the difference in default spread as well.
If the answer is Yes, then are the methods of calculating default spread under MCEV investment assumption and Solv II discount rate the same? Or in companies' real practice, would they set these 2 the same value?
2. when calculating traditional basis EEV with Solv I liabilities, then would companies use the same discount rate as their BE investment assumption, i.e. risk free + their own view of a spread?
Basically I'm trying to come up with a table below (sorry about the format! hope it's comprehensible...). Could you help me if the understanding is correct or not? Thank you so much!!!
Assume rf is the same and spreads are different due to difference in various valuation methods. The first 3 columns are conditions and the last 2 are conclusions.
reason 1: differences in the methods adopted for calculating spreads.
reason 2: investment doesn't include spread while discount rate has spread.
………........Invmt assup………...Disc assup-Solv I...….Disc assup-Solv II.....Invmt variance-Solv I.....Invmt variance-Solv I
MCEV........rf+illiquid sprd……..rf+sprd…………………..rf+MA or VA...……....Yes, reason 1...…………....Yes, reason 1
EEV-MC.....rf(most likely)……...rf+sprd…………………..rf+MA or VA...….......Yes, reason 2..................Yes, reason 2
EEV-Trad...rf+sprd..................rf+sprd.....................rf+MA or VA............NO..................................Yes, reason 1
Last edited: Jan 22, 2021