Abstract
Traditional life company appraisal methods use projections of reported profit rather than of cash flow, and use discount rates typically selected without any theoretical underpinning. The theme of this paper is that life company valuation can be based on an analysis of the characteristics of the individual cash flows which form the net cash flow. Projected future cash flows may be compared with the income and gains expected from traded securities, such as common stock and government bonds, in order to assess their values. Individual rather than overall cash flows are selected for this market value based analysis because of their generally simpler distribution characteristics. Cash flow interactions are taken account of separately. Standard asset pricing models enable one to allow for lapse, mortality and other risks, and for option features. The resulting overall value is an estimate of the value of future returns discounted at risk rate(s) consistent with the estimated risk/return trade-off implicit in the capital markets.
Comment: This is an adaptation of a paper previously published in the Journal of the Institute. It is an attempt to wed the valuation process to modern financial theory so that valuations may be based upon more realistic discount rates etc. — Ed.
This paper is based on Allowing for asset, liability and business risk in the valuation of a life office. Journal of the Institute of Actuaries, 119, 1992, 385–455, and is included with permission of the Institute of Actuaries.
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Mehta, S., Boyle, P. (1998). Allowing for asset, liability and business risk in the valuation of a life company. In: Vanderhoof, I.T., Altman, E.I. (eds) The Fair Value of Insurance Liabilities. The New York University Salomon Center Series on Financial Markets and Institutions, vol 1. Springer, Boston, MA. https://doi.org/10.1007/978-1-4757-6732-2_5
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DOI: https://doi.org/10.1007/978-1-4757-6732-2_5
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