How do we square the circle between accounting and solvency

Abstract

The paper makes a clear case for economic valuation. Whether it is companies internal models, rating agencies, regulators or standard-setting organisations, differing stakeholder views on the required and available capital are converging towards economic and risk-based capital and valuation models. Even though the measurement of insurance liabilities on a fair value basis remains a challenge, there seems to be no viable alternative at this point. Economic valuation will help foster innovation and advance the search for the most efficient risk transfer mechanisms, regardless of their form. Solvency II not only contains a clear commitment to economic valuation. It also effectively addresses some key issues highlighted by the current financial market crisis. Consequently, it should be implemented in the European Union without delay. Full credit should be given for diversification effects on a global scale, which will strengthen the motivation to actively manage portfolio diversification and will encourage stronger risk management. © 2009 The International Association for the Study of Insurance Economics.