Risk Adjustment Measurement Methods For Chinese Life Insurance Companies

In order to reduce the differences of the accounting treatment on the insurance contracts in different countries, and to increase the comparability of the financial statements of the insurance companies in different countries, the IASB has dedicated to establish a global insurance financial accounting standards since1997. The IASB and the FASB jointly published the Exposure Draft:Insurance Contract (ED) on July30,2010, and decided to give a final decision in June,2011. The ED has specified the definition of the insurance contract, the measurement of the insurance contract and the statement of the insurance contract. The ED has suggested to use the Building Block Approach to measure the liability of the insurance contract, and the Building Block Approach is composed of three blocks: the fulfillment cash flow, the discount rate and the margins, the margins include the risk adjustment and the residual margin. In order to increase the comparability of the risk adjustment in different countries, the ED only allows the insurance companies to use the Confidence Level method (VaR), the Conditional Tail Expectation method (CTE) and the Cost of Capital method (CoC) to measure the risk adjustment.There has been convergence between the China accounting standards and the international accounting standards since2006. After several regulators published by the MOF and the CIRC, China has become the first country to use the new achievements of the ED to measure the insurance contract. But there are still some differences between the China insurance accounting standards and the ED.According to the requirements of the CIRC, the risk adjustment of the non-life insurance reserve should be measured by the75%Quantile method and the CoC method, the proportion of the risk adjustment and the best estimate of future cash flow should be between2.5%and15.0%, for those companies who don’t have the ability and the data to measure the risk adjustment, there risk adjustment of the unearned premium reserve should be at3.0%of the best estimate, and there risk adjustment of the outstanding claim reserve should be at2.5%of the best estimate. While the CIRC hasn’t showed which method should the life insurance companies use to measure the risk adjustment of the life insurance reserve, and now, most of the life insurance companies in China are using Scene Contrast method to measure the risk adjustment of the life insurance reserve. So, the measurement of the risk adjustment in China is different from the ED.As the measurement of the risk adjustment is an important part of the measurement of the liability, and the method to measure the risk adjustment can affect the result significantly, so it’s important to choose suitable methods for the life insurance companies in China. This thesis will introduce the methods required by the ED and the methods used by the Chinese life insurance companies, and will compare them with each other. According to the final results, this thesis will give some suggestion on which methods should the Chinese life insurance companies use to measure the risk adjustment.The first two chapters of this thesis are mainly to introduce the background of the research, the definition and the characteristic of the risk adjustment. The third chapter has discussed the VaR method, the CTE method and the CoC method, this chapter has shown the steps, advantages and disadvantages of each method. The last two chapters are the most important parts of this thesis. The fourth chapter has used the three methods required by the ED to measure the risk adjustment of different life insurance products under certain hypotheses, and according to the results, this chapter has compared the method with each other. The last chapter has introduced the methods used by the Chinese life insurance companies to measure the risk adjustment, and has also compared the methods used by Chinese life insurance companies and the three methods required by the ED. At last, considering about the Chinese life insurance market and the ability of the Chinese life insurance companies, the author has given some advice.There are few papers discussing the methods of measuring the risk adjustment, and this thesis is the first one to show how to use the VaR method, the CTE method and the CoC method to measure the risk adjustment, and also the first one to compare the three methods required by the ED with the methods used by Chinese life insurance companies. Besides these, there are still other innovations in this thesis. Some definitions in this thesis are translated from English to Chinese, so there may be some misunderstandings on some definitions. And because of the lack of data, there may be some differences when using the methods required by the ED in the reality, and these differences may affect the Chinese life insurance companies’decisions when they choose the methods of measuring the risk adjustment.