Life Insurance Liabilities at Fair Value: An Analysis of Unitized With Profit Contract in China

The International Accounting Standards Board (IASB) is leading a project aimed at. requiring the insurance companies' balance sheet to be reported at fair value. To establish a new accounting system on the basis of fair value, the most important issue is to find an appropriate approach to evaluate the insurance liabilities. Focusing on a new kind of participating life insurance in China, this paper introduces the fair value measurement attributes into the liability valuation of Unitized With-Profit contract. Unlike traditional valuation methods, this paper presents a dynamic model which captures several essential elements of Unitized With-Profit contracts, such as interest rate guarantees, various bonus options and default option. Based on the classical contingent claim pricing theory, these elements can be valued separately in the model underpinned by Monte Carlo techniques. The impact of various bonus policies and levels of interest rate is analyzed numerically and we find that fair values are highly sensitive to the bonus strategy and interest rate scenario.