An Approach for Measurement of the Fair Value of Insurance Contracts

The paper explores developments through 2006 in the application of market-consistent concepts to the measurement of fair values of liabilities for financial reporting purposes. A set of criteria is presented that should be useful in the evaluation of proposed fair value measurement approaches where inputs based on prices observed in an active market with reliable transaction prices are not available. Based on these criteria, one approach is examined that might serve as a basis for the fair value measurement of the liability of life insurance contracts and other financial instruments issued by insurers. The margin under this approach is determined in a manner similar to that currently used under U.S. GAAP for an investment contract, a Funding Agreement–Backed Note Issuance Program (FANIP), which is calibrated to its transaction price. The approach is generalized by use of an insurance example, a 20-year term life insurance policy, to illustrate the concepts involved as they might be applied to insurance contracts. In part, this indicates that a consistent approach to the measurement of the liability for these two types of contracts is practical and desirable, thus not requiring that contracts issued by insurers be classified (e.g., as insurance, investment, or derivative) and can be applied in a consistent manner between differen