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A Study on the Estimation of the Discount Rate for the Insurance Liability under IFRS 17

  • Journal of Insurance and Finance
  • 2018, 29(3), pp.45-75
  • DOI : 10.23842/jif.2018.29.3.002
  • Publisher : Korea Insurance Research Institute
  • Research Area : Social Science > Business Management
  • Received : May 20, 2018
  • Accepted : August 20, 2018
  • Published : August 31, 2018

Sekyung Oh 1 OUH, CHANGSU 2 Park,Sojung 3 Siyeol Choi 4 Park Kinam 4

1건국대학교
2한양대학교
3서울대학교
4한국자산평가

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ABSTRACT

This study aims to suggest a method to estimate the illiquidity premium and the discount rate for the insurance liability and provide their estimates based on it. To identify a financial instrument whose characteristic of illiquidity is most similar to that of the insurance liability, we calculate the internal rate of return (IRR) of the insurance liability which reflects the characteristics of the cash flows and the illiquidity characteristics of the insurance liability, using the data of the three largest life insurance companies in Korea. When we mirror the IRRs of the insurance liability with the yields-to-maturity of corporate bonds, we find that AA-rated corporate bonds match the most with the insurance liability in case of publicly issued bonds. As a methodology to estimate the liquidity premium of corporate bonds, we apply the methodology of Oh et al. (2016) which extends Fama-French two factor model. The results show that the liquidity premium of public AA-rated corporate bonds increases steadily from one-year maturity bonds (12 bp) to twenty-year maturity bonds (75 bp) except seven-year maturity bonds. The average liquidity premium is estimated to be 53 bp, when extending the maturity up to fifty years which is the longest maturity of government bonds observed in Korea. The discount rates for the insurance liability can be calculated if the estimated liquidity premium is added to the risk-free yield curve. We expect that the estimated discount rate and the liquidity premium for the insurance liability can be used by the regulatory body and the practitioners of the industry, since it is not only estimated based on the principle of IFRS 17, specifying “the discount rates should reflect the time value of money, the characteristics of the cash flows and the liquidity characteristics of the insurance contracts”, but also it reflects the Korean circumstances the best.

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