From the notes it seems that reserve for guarantees are calculated using the option that gives the highest value, while reserve for options are calculated using stochastic modelling/market option prices. So is it fair to say that under pillar 1 peak 1, reserves for guarantees is prudent however for options best estimate? Thanks!
Yes, this does sound odd. Pillar 1 Peak 1 is a very old set of regulations which isn't really effective in many ways (which is why we need Peak 2, ICA and Solvency II), so maybe this discrepancy reflects this. INSPRU 1.2.67 says the following (which shows that options are valued in a market-consistent way rather than prudently, although our best estimate might have been that the option would expire worthless under our central assumptions): "Where there is considerable variation in the cost of the option depending on conditions at the time the option is exercised, and where that variation constitutes a material risk for the firm, it will generally be appropriate to use stochastic modelling. In this case prices from the asset model used in the stochastic approach should be benchmarked to relevant market asset prices before determining the value of the option. Where stochastic modelling is not undertaken, market option prices should be used to determine suitable assumptions for the valuation of the option. If no market exists for a particular option, a firm should take the value of the nearest equivalent benefit or right for which a market exists and document the way in which it has adjusted that valuation to reflect the original option." Best wishes Mark
