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The British Take on Fair Value
The Implication of Fair Value Accounting for General Insurance Companies
by P. K. Clark, P. H. Hinton, E. J. Nicholson, L. Storey, G. G. Wells, and
M. G. White
, British Actuarial Journal, 9, V, 1007-1059 (2003).

Reviewed by Philip E. Heckman

Editor's Note: In the August 2004 issue of The Actuarial Review, Phil Heckman focused on fair value accounting in an opinion piece. For this issue he reviews how the British interpret fair value accounting.

This paper was originally presented by a Working Party (WP) of the General Insurance Research Organisation (GIRO) in October 2002. It has since been updated through February 2003 and presented to the Institute of Actuaries (IA) on March 24, 2003. (For the entire text of the article, see the "Research" section.) Besides being interesting and informative, it offers the reader a veritable festival of acronyms. It is not, however, a quantitative study like those recently commissioned by the CAS, which look at the effect of fair value prescriptions on realistic reserve numbers.

The fair value accounting initiative now being spearheaded by the International Accounting Standards Board (IASB) is aimed at ensuring, to the extent possible, that the assets and liabilities appearing on an enterprise balance sheet carry values that can be realized if assets are sold or liabilities ceded in the open market. Thus assets should be recorded at values acceptable as asset prices, and liabilities at values acceptable to a guarantor agreeing to take over the obligation—an extremely

The authors point out that IASB has tabled its attempt to publish a comprehensive standard for financial instruments, leaving this area much as it was and shifting focus to insurance contracts.

The paper explores the implications of the Draft Statement of Principles (DSOP), first exposed for discussion in November 2001. Not much has happened in the meantime. The most significant intervening event is the IASB's issuance, on March 31, 2004 with a January 1, 2005 effective date, of IFRS 4, which contains no material surprises. Among the issues raised in the DSOP are:

  1. Reconfiguration of accounts. As a consequence of the fair valuation paradigm, reporting will be on the basis of closed cohorts of contracts. This has the effect of eliminating unearned premium reserves and deferred acquisition costs.
  2. A strong preference for stochastic reserving methods over deterministic methods.
  3. And, closely tied to 2 above, a strong insistence that loss reserves be reported with Market Value Margins (MVMs), a concept very close to the actuarial one of risk load. IASB has decreed that the MVM reflect both diversifiable and systematic risk. All in all, both the GIRO WP and their IA discussants regard these as very muddy waters indeed and make their perplexity very clear.
  4. Entity specific value. This is a somewhat elusive concept. When direct market information is unavailable for valuation purposes, fair value dictates using information for a typical market player. Entity-specific value allows use of the company's own information. For general insurance (P&C), this boils down to some technical points in the evaluation of MVMs.

The WP discusses these issues at some length and in detail, producing a fairly comprehensive catalog of problems and concerns. The overall impression is that insurance fair value is no closer to prime time than financial institutions fair value.


Several underlying issues impede the adoption of fair value for insurance contracts. The first is that the accounting community does not understand liability valuation in sufficient depth to get it right. Prime evidence is the issue of reflecting one's credit standing in liability valuations and prevailing confusion regarding the role of the guarantor. This has deep roots in traditional practice but is puzzling to anyone who values liabilities for a living. For details, I refer the reader to my paper published in NAAJ, January 2004.

The issue of Market Value Margins also betrays confusion as to the role of the guarantor. A guarantor will seek to assemble a diversified portfolio of guarantees and face a risk dominated by market systematics, not individual company volatility. Stochastic loss models will not be useful in quantifying this effect until they are capable of measuring market risk. I know of no models in such a state of development. Many have not yet adopted a realistic probability measure.


The working party is to be commended for a thorough and insightful presentation of the issues. The IA discussion was also timely and illuminating. Fair value implementation has not been, and will not be, a smooth process. In my own opinion, many of the issues that must be resolved are general accounting issues and involve insurance only incidentally. Actuaries should be wary of calls to surrender their intuition in the name of accounting uniformity. Actuarial intuition in liability valuation has had longer to develop and is arguably more reliable than that of accountants, for whom valuation is a new thing.

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