This paper brings together the work of the GI Solvency II Technical Provisions working party. The working party was formed in 2009 for the primary purpose of raising awareness of Solvency II and the impact it would have on the work that reserving actuaries do. Over the years, the working party’s focus has shifted to exploring and promoting discussion of the many practical issues raised by the requirements and to promoting best practice. To this end, we have developed, presented and discussed many of the ideas contained in this paper at events and forums. However, the size of the subject means that at no one event have we managed to cover all of the areas that the reserving actuary needs to be aware of. This paper brings together our thinking in one place for the first time. We hope experienced practitioners will find it thought provoking, and a useful reference tool. For new practitioners, we hope it helps to get you up-to-speed quickly. Good luck!

This paper investigates market-consistent valuation of insurance liabilities in the context of Solvency II among others and to some extent IFRS 4. We propose an explicit and consistent framework for the valuation of insurance liabilities which incorporates the Solvency II approach as a special case.

The proposed framework is based on replication over multiple (one-year) time periods by a periodically updated portfolio of assets with reliable market prices, allowing for “limited liability” in the sense that the replication can in general not always be continued. The asset portfolio consists of two parts: (1) assets whose market price defines the value of the insurance liabilities, and (2) capital funds used to cover risk which cannot be replicated. The capital funds give rise to capital costs; the main exogenous input in the framework is the condition on when the investment of the capital funds is acceptable.

We investigate existence of the value and show that the exact calculation of the value has to be done recursively backwards in time, starting at the end of the lifetime of the insurance liabilities. We derive upper bounds on the value and, for the special case of replication by risk-free one-year zero-coupon bonds, explicit recursive formulas for calculating the value. In the paper, we only partially consider the question of the uniqueness of the value.

Valuation in Solvency II and IFRS 4 is based on representing the value as a sum of a “best estimate” and a “risk margin”. In our framework, it turns out that this split is not natural. Nonetheless, we show that a split can be constructed as a simplification, and that it provides an upper bound on the value under suitable conditions. We illustrate the general results by explicitly calculating the value for a simple example.