Core to a market value framework is the ability to value all assets and liabilities on a market or “fair value” basis. Because market prices do not exist for all elements of a bank or insurer's balance sheet, mark-to-model standards have been developed to fill the gaps. Given the complexity of the financial products offered by banks and insurers, these standards can be complex. This chapter provides an overview of market or fair valuation techniques used in the insurance industry to value insurance liabilities.
A fair value standard was introduced in 2006 by the Financial Accounting Standards Board (FASB) under Statement 157, entitled Fair Value Measurements. The statement defines fair value, establishes a framework for measuring fair value in Generally Accepted Accounting Principles (GAAP) and expands disclosure about fair value measurements.
Under the rules, fair value is an exchange price in an orderly transaction between market participants to sell the asset or transfer the liability. The price is an exit price, not the price for the entity to purchase the asset or assume the liability (an entry price). Consequently, fair value is not an entity-specific measurement.
In order to increase consistency, the FASB standard provides a hierarchy of preferred methods for calculating the fair value based on the available market data.