Johdanto

IFRS 17 accounting standard states that the market consistent value of liabilities should takeinto account the liquidity of liabilities by introducing a liquidity premium when defining thepresent value of liabilities. Similar premium is also present in Solvency II standard formula.This paper studies how one can evaluate and analyze the liquidity premium of insurance liabilities and how it can affect the investment operations of an insurance company if it evaluates liability driven investment strategies. The main purpose of this paper is to present concepts and tools how to understand and calculate the liquidity premium and how it affects the market consistent valuation of liabilities. And lastly it is studied how replicating portfolio theory can be utilized to hedge this volatility of this market consistency.

This paper briefly introduces the concepts of liability driven investment strategies and how the liquidity premium in question is related to it. Then it is analyzed how one can estimate the liquidity of insurance liabilities when the insurance portfolio is known. After understanding the liquidity of liabilities one can form a portfolio of investment products that have the similar liquidity profile. Lastly when this investment portfolio is known this paper demonstrates three different methods to calculate liquidity premium to this investment portfolio which would ultimately correspond to the liquidity premium of insurance liability.

It is also briefly presented how similar liquidity premium is calculated within Solvency II standard formula and how it potentially differs from the methods shown in this paper and what kind of problems might arise from this difference.

Share Share Share