Multiple-prior valuation of cash flows subject to capital requirements

Understand

We study market-consistent valuation of liability cash flows motivated by current regulatory frameworks for the insurance industry.

• Building on the theory on multiple-prior optimal stopping we propose a valuation functional with sound economic properties that applies to any liability cash flow.
• Whereas a replicable cash flow is assigned the market value of the replicating portfolio, a cash flow that is not fully replicable is assigned a value which is the sum of the market value of a replicating portfolio and a positive margin.
• The margin is a direct consequence of considering a hypothetical transfer of the liability cash flow from an insurance company to an empty corporate entity set up with the sole purpose to manage the liability run-off, subject to repeated capital requirements, and considering the valuation of this entity from the owner's perspective taking model uncertainty into account.