The indexed discount rate method for fair valuation of liabilities
The indexed discount rate method for fair valuation of liabilities calls for projections of liability cash flows using realistic assumptions as to future experience. Multiple scenarios are projected covering the range of options that might be exercised by contract holders and by the company, and the range of different levels of experience that might be observed. The projected cash flows for each scenario are discounted at the Treasury spot rate appropriate to the duration of the cash flow. No adjustment spread is added to the Treasury rates because that would inappropriately make further adjustment for risk. The fair value is selected as the mean of the range of present values. The discount rate is determined objectively as of the date of valuation.
This method reflects the uncertainties in the cash flows, and determines their value based on the current yield curve in an objective manner. Actuarial judgment is necessary in developing the various assumption scenarios, but not the discount rate. The fair value of liabilities so determined is consistent with the market value of the supporting assets, but is not derived directly from them. Specific assets may be modeled in order to test assumptions, but the fair value of liabilities is not dependent on any current or future portfolio of assets.
KeywordsInterest Rate Discount Rate Cash Flow Yield Curve Risk Free Rate
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