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Market equilibrium with management costs and implications for insurance accounting

Author

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  • Olivier Gossner

    (CNRS-CREST, Ecole Polytechnique and London School of Economics)

  • Michael Florig

    (Economics Department, Ecole Polytechnique)

Abstract

We study a general equilibrium model with uncertainty where agents incur costs for managing a risky assets. The equilibrium price, as characterized via a (risk neutral) probability measure on the state space is employed for valuation in several regulatory accounting regimes such as Solvency II for the European Economic Area, SST for Switzerland, BSCR for Bermuda and going forward under IFRS17. We find that the valuation approach used in practice under these accounting regimes is missing a correction term by ignoring that not only the insurance business to be valued is incurring investment management costs, but also other insurers, and more generally market participants as well are incurring such costs. For insurers subject to Solvency II regulation, we estimate the value of the correction term to be of the order of € 150 billion or 2% of insurer's investments.

Suggested Citation

  • Olivier Gossner & Michael Florig, 2021. "Market equilibrium with management costs and implications for insurance accounting," Working Papers 2021-22, Center for Research in Economics and Statistics.
    • Handle: RePEc:crs:wpaper:2021-22
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    References listed on IDEAS

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    3. Cox, John C. & Ross, Stephen A., 1976. "The valuation of options for alternative stochastic processes," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 145-166.
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