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Dilemmas when valuing swaptions

Persistently low interest rates are presenting financial institutions with challenges when valuing and managing the risks on interest rate options. The limitations of traditional valuation models are being exposed. Increasingly, they do not offer a solution and are no longer suitable for calculating interest rate sensitivities. But why is that? And what can be done about it?

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The Matching Adjustment versus the Volatility Adjustment

What is their impact and what are the main differences

On April 30th 2014, the European Insurance and Occupational Pensions Authority (EIOPA) published the technical specifications for the preparatory phase towards Solvency II. The technical specifi cations on the long-term guarantee package offer the insurers basically two options to mitigate ‘artificial’ fluctuations in their own funds, the Volatility Adjustment and the Matching Adjustment. What is their impact and what are the main differences between these two measures?

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The politics of equivalence

In March 2015 the European Insurance and Occupational Pensions Authority (EIOPA) released its fi nal report on the equivalence of the Swiss supervisory system in relation to some articles of the Solvency II directive. This article explains the impact of this assessment for insurance groups from the European Union and Switzerland operating in the other’s supervisory territory, and provides a high-level comparison of how similar these regimes really are.

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 A key to stable solvency

Matching Adjustment

The market valuation principles embedded in Solvency II ensure that an insurer’s equity is directly affected by financial markets. In many respects, this is desirable. However, market value fluctuations only have a limited impact on the ‘true’ solvency of stable life insurance portfolios when the corresponding assets are adequately managed. To recognize such different dynamics, in 2014 the European Parliament approved the introduction of the ‘matching adjustment’. The requirements cover only two articles – but looks can be deceptive. This article highlights some of the ambiguities in the requirements and the consequences for governance, systems, processes and reporting that use of the adjustment entails. The benefits outweigh the costs, however.

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Longevity swaps and value creation

Due to better healthcare and a safer living environment, the average life expectancy in the developed world has been increasing. For life insurance companies this uncertainty creates ‘longevity risk’ – one of their major risks. They can use longevity swaps to hedge the possibility of people living longer. Can longevity swaps create value too?

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