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Draft for discussion at ICAEW IISC meeting, 20th June 2005 - page 42 / 51





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there is much scope for exercising judgement and it is unlikely that strict rules will emerge. As such there is a general call for guidance to be issued as the methodology comes into more widespread use. All speakers congratulated the authors on the broad range of the paper though it is clear there will be more welcome debate still to come.’

Our overall review comment: Sheldon and Smith’s’ paper was prompted by the FSA’s new ‘realistic balance sheet’ approach under Solvency II. It brings out many of the highly technical issues that actuaries are grappling with as they try to implement the ‘market consistent’, including MCEV, approach. The authors identify three main motivations for this development:

  • (i)

    Understanding the behaviour of a company’s share price (important in M&A negotiations).

  • (ii)

    Offering a new (or at least additional) perspective on solvency testing: what could the insurance company’s assets and liabilities be ‘closed out’ for now? This approach, as required for the FSA under Solvency II, is comparable to recent approaches to banking solvency assessment.

  • (iii)

    Providing more objective, comparable valuations (as well as preventing accounting manipulations, e.g. through the timing of market realisations of assets and liabilities accounted for at ‘historical cost’).

However, under (iii) the authors cite the example of the BT pension fund where, at 31 March 2003, disclosed deficits, both apparently arrived at on ‘market’ bases’, were a SSAP24 deficit of £1.4bn and an FRS17 deficit of £9.0bn (relative to assets with a market value of £21.5bn).

So, as far as life insurance company financial reporting goes, it seems likely that it is the discipline of undertaking the valuation on a basis which requires checking at all stages that it is indeed reasonable to regard assumptions and parameters as ‘market consistent’ (and if not why not)—together with disclosure of the most significant of these and related ‘sensitivities’— that is at present the most important feature of this development in practice.

d) O’Keefe et al. 2005 ‘Current Developments in Embedded Value Reporting’ This paper, presented at the Institute of Actuaries sessional meeting on 23 February 2005, represents the report of a working party of the UK actuarial profession set up to review current practice and future developments in EV reporting, in particular the approach to risk measurement and the role of ‘MCEVs’. It mainly comprises a review of existing literature and practice, focussing in particular on two recent developments: the CFO Forum’s (2004) European Embedded Value Principles and the financial- economics based development of MCEV’s. While recognising that MCEV techniques are in relative infancy it proposes that they are the way forward and sets out areas for possible future development, including ways in which to ‘repackage’ the various risk allowances in the EEV principles into ‘market consistent’ elements. (For example, non-diversifiable risk impacts asset/liability measurements directly, but allowance for ‘diversifiable’ risk only comes through in MCEV approaches as part of the ‘frictions’ between the value of a company and the value of its assets and liabilities.)

Our overall review comment: The O’Keefe et al. paper reasserts the fundamental theorem that, in principle, both ‘traditional’ and ‘MCEV’ approaches, if applied


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