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valuation of the business, is how far it plays a role in the constitution of that value. In other words, value (like solvency) largely depends on how well the business is managed (which in turn depends in part on how well the management is supported by investors and other stakeholders). The question is therefore how well different approaches to accounting can provide information (e.g. analysis of product costs and profitability) that can assist managers and others in understanding and controlling the factors that drive the creation of the profitable business operations and related investment management.

c) Sheldon & Smith, 2004: ‘Market consistent valuation of life assurance

business’ This paper was presented on 23 February 2004. The profession’s website69 reports that ‘it drew a large gathering to Staple Inn including a diverse range of visitors from the FSA, ABI and taxation experts. Jeremy Goford chaired the proceedings and invited Tim Sheldon, as co-author of the paper to provide an introduction. He explained that the background to the paper was, in part, due to the contents of CP195 which requires production of market consistent valuations for use in producing realistic balance sheets. He openly admitted that there was is no universally accepted definition of what constitutes a market consistent valuation and noted that there are a range of models, assumptions and algorithms that may fit the requirement. It was stated that the problems of choice of model and assumptions are by no means simple. On assumptions alone, there are particular issues around whether to derive the use a risk free discount rate from gilt rates or from interest rate swaps or interest rates SWAPs and whether implied or historic volatility is appropriate. Tax adds a further complication. In trying to calibrate models there was considerable discussion around availability of data, and it was suggested there may be mention that there is possibly a need to start collating data. With complexity of the model, also comes the challenge of explaining the output and conclusions to third parties.

It was acknowledged that some offices already use Monte Carlo simulation which permits reasonably accurate modelling of cash flows and is successfully used to price relatively simple guarantees. It can appropriately reflect internal investment and bonus philosophy at fund level. The majority of the effort with this approach comes in the time to construct and run the simulations. The authors however believe there can be advantages to closed form solutions particularly in the current climate of lower equity holdings and bonus rates. Calculations are much quicker and there is ease and flexibility in performing re-runs on differing assumptions. However, the authors do not advocate abandoning Monte Carlo simulation. Indeed they acknowledge that there are merits in combining the two approaches. For example, the Monte Carlo approach can be used to derive fund level assumptions for use in the closed form solution.

Whilst the majority of the discussion centred around applications to with profits life business, notice was drawn to possible alternative applications such as within pension funds, and in general insurance. Even within the life industry, the use may not be restricted to valuation but can be applied to pricing and in dealing with mergers and acquisitions.

Throughout the evening it was emphasised that the new approaches to determining market consistent valuations are still in their infancy. It was stated that

69 http://www.actuaries.org.uk/Display_Page.cgi?url=/sessional/sm20040223_report.html (accessed 11 June 2005)


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