B.3 FAS 157 & 159

Question 1

Purpose of FAS 157

Answer 1

• defines FV
• provides guidance on how to apply when other FAS require FV
• Establishes framework for FV calculations
• expands disclosure for items measured at FV

Question 2

How FAS 157 defines FV

Answer 2

FV = the price of either, at the measurement date:

• amount received to sell an asset, or
• paid to transfer a liability
• assuming the sale is not a forced liquidation or distress sale
• FV = exit price

Question 3

FAS 157: Standards that require FV

Answer 3

FAS 133 (ASC 815) requires FV for certain derivatives and embedded derivatives
ex: GMsBs, index credits, COI waiver on ULSG

FAS 107 - requires disclosure of financial instruments at FV

FAS 141 - requires day 1 FV for financial instruments acquired via business combinations

FAS 142 + 144 impairment testing
impairment test passes if FV > carrying value

FAS 159 FV option. Applies to any financial instrument where the company elects to do a FV calc under FAS 159

Question 4

Principle vs Most Advantageous Market

Answer 4

FAS 157 requires FVs to be based ont he most ‘principal market’… if that doesnt exist then the ‘most advantageous’ market

Principal market = market with the greatest volume and level of activity for the asset or liability

Most advantageous = market with the best price available

FV is based on the market participants pricing assumptions

Question 5

Potential markets for determining FV

Answer 5

• Life insurance company market. prices here are generally not readily observable
• Policyholder market (although this is an entry price)
• Reinsurance Market
• Capital Markets

Question 6

Valuation Considerations

Unit of account and premise

Answer 6

• Unit of account should be determined by other accounting pronouncements
• GMxBs = usually accounted at contract level
• intangibles = usually at the block level

Premise: ‘in exchange’ vs ‘in use’

• use whichever has a higher FV
• ‘In Exchange’ - FV of the asset = value of the asset on its own when exchanged to another market participant
• ‘in use’ - FV of the asset considers its value when used in conjunction with other assets

Question 7

FAS 157: Valuation Techniques that can be used

Answer 7

Market Approach - use price info from market transactions with comparable assets/liabilities

Income Approach - PV future amounts into a single present amount

Cost Approach - based on the amount that currently would be required to replace service capacity of the asset

Question 8

FAS 157: Actuarial techniques that can be used for the income approach

Answer 8

1. Actuarial Appraisal Method - CFs are projected with unbiased and observable actuarial assumptions
2. Risk Neutral Valuation
   - FV = avg PV of stochastic CFs discounted @ RFR
   - advantage - maximizes use of observable inputs
   - common for GMxBs
3. Budget Method
   - FV = value of gt + value of future renewal gts
   - for index credits on Indexed annuities
4. Black Scholes - simplified case of (2)
5. ‘other method’

Question 9

FAS 157: Fair Value Hierarchy

Answer 9

Most preferable to least preferable inputs:

Level 1 Inputs.
- quoted prices in active markets for identical assets

Level 2 inputs.

• inputs other than quoted prices from level 1 that are observable; yield curves, volatility, etc
• quoted prices for similar assets/liabilities
• quotes of identical assets in non-active markets

Level 3 inputs.
-unobservable for assets and liabilities

Question 10

FAS 157: Risk Margin Considerations

Answer 10

risk premium should be considered for inputs like mortality, morbidity, and lapse rates if the significantly impact the PV of CFs