Longevity Risk in Fair Valuing Level 3 Assets in Securitised Portfolios

Fair value accounting aims to establish a three-level hierarchy that distinguishes (1) readily observable measurement inputs from (2) less readily observable measurement inputs and (3) unobservable measurement inputs. Level 3 longevity valued assets will pose unique valuation risks once securitised pools of these alternative asset classes come to market as investment vehicles for pension plans and individual retirement accounts. No uniform framework is available to assure consistent fair market valuation and transparency for investor decision-making. Applying existing international auditing standards and analytical procedures (IFRS 13) will offer a platform upon which fund managers, their auditors and actuaries can agree upon uniform valuation and presentation guidelines. Application of these quasi-governmental standards will bring future liquidity to otherwise illiquid capital market instruments. This paper presents a valuation methodology consistent with fair value accounting and auditing standards. The methodology incorporates the longevity predictive modelling of Stallard in a form that is compatible with Bayes Factor weighted average valuation techniques based on the study by Kass and Raftery. The methodology is applicable to fair valuation of life settlement portfolios where the combination of too few large death benefit policies and large variances in individual life expectancy estimates currently challenge accurate valuation and periodic re-valuation. The Geneva Papers (2011) 36, 516-543. doi:10.1057/gpp.2011.25