Illiquidity Premium, Market-Consistent Valuation and Solvency in Insurance

The insurance industry currently discusses to which extend they can integrate an illiquidity premium into their best estimate considerations of insurance liabilities. The present position paper studies this question from an actuarial perspective that is based on marketconsistent valuation. We conclude that mathematical theory does not allow for discounting insurance liabilities with an illiquidity spread. 1 An actuarial view on the illiquidity premium 1.1 Aim and organization of this position paper The aim of this position paper is to analyze the application of an illiquidity premium to discount the liability side of the balance sheet of an insurance company. We start with an introduction to market-consistent actuarial valuation in Section 1.2. In Section 1.3 we discuss the illiquidity premium from a rather non-mathematical perspective and we give arguments why it should not be used for the above purpose. In Section 2 we present a simple model exemplifying the conclusions from Section 1.3. 1.2 Market-consistent actuarial valuation and regulation The main task of an actuary is to predict and value insurance liability cash flows. These predictions and valuations form the basis for premium calculations as well as for solvency considerations of an insurance company. In most situations, insurance cash flows are not traded on a market. Therefore, current accounting and solvency regulation requires that these insurance ∗ETH Zurich, RiskLab, Department of Mathematics, 8092 Zurich, Switzerland