Predicting the market value of liabilities

We have developed models for predicting the market value of liabilities for some of the largest life insurance companies in Norway. Our software is regularly used for financial reporting and assessment, contributing to stability and transparency in the sector.

Ensuring financial stability in the insurance industry

Solvency II is a regulatory framework for the insurance industry commissioned by the European Union (EU). Its aim is to ensure financial stability in the sector, subsequently protecting consumers, minimising company losses and working towards a reporting standard that is consistent and transparent.

A key aspect of Solvency II is assessing the amount of risk capital needed within an annual time period. This is known as the Solvency Capital Requirement (SCR). Usually, the value of assets is determined under different shocks, for instance fluctuations in the market, natural disasters or geopolitical events, and computed with corresponding market values of the company’s liabilities. Liabilities can be any type of financial obligation the company may have, such as loans, bonds and debts.

Determining the market value of liabilities

The market value of liablities is estimated by using the current value of future cash flows, factoring in the time value of money (discounting). These computations can be complicated for a number of reasons, one example being the interplay between dynamic managerial decisions and the unpredictable behaviour of policyholders.

We have developed software that calculates the market value of liabilities for several of the largest insurance companies in Norway, namely Sparebank1 Livsforskring, DNB Livsforsikring and Fremtind Livsforsikring. An efficient and cost-effective solution, our model is frequently used to generate underlying quantities for Solvency II reports and, as of recently, IFRS17 reports (International Financial Reporting Standards).

The necessity of stochastic models

Changes in economic variables like interest rates, equity, bond returns and currencies, can significantly impact liability present values for life insurers. Due to the unpredictability of the market, these companies therefore need stochastic models that consider uncertainty when predicting future paths. The expected return of all assets should be the same as the risk-neutral rate used for discounting cash flows. For life insurance companies, interest rate predictions are particularly crucial within the Solvency II framework. We have developed models specific to this task using the two-factor G++ model, subsequently helping insurers to make financial predictions and plans and, crucially, remain solvent despite other shifts in the market.