Market Value Margin calculations under the Cost of Capital approach within a Bayesian chain ladder framework

Abstract

In the Solvency II framework, insurance companies need to calculate the Best Estimate valuation of Liabilities (BEL) and the Market Value Margin (MVM) for non-hedgeable insurance-technical risks. The Cost-of-Capital approach defines the MVM as the present value of the current and future Solvency Capital Requirement (SCR) of the non-hedgeable risks to protect against adverse developments in the run-off of the insurance liabilities. However the SCR at time t itself depends on the increase in the MVM between t and t+1. Hence there exists an intricate circularity dependency between both quantities. In this paper we present exact and accurate approximate analytic formulas for MVMs within a Bayesian log-normal chain ladder framework.