Combined approach for estimating LLP
In the wiki, step 1 of the approach says to calculate the rate of return of the reference portfolio not adjusted to match the risk profile of insurance contracts. However, in the first illustrative example in the text they are using the adjusted portfolio yield after removing credit risk (Appendix 2B). Is there a contradiction here?
Comments
In the Appendix it is just saying ILP = Portfolio Ref Rate - Credit Risk - Rf
In the wiki it is just saying ILP = Portfolio Rate - Adjustments to match risk profile of insurance contracts.
Adjustments to match risk profile of insurance contracts = Credit Risk in the example
But why does the wiki say to use the reference portfolio yield "not" adjusted to match the risk profile of insurance contracts when calculating the ALP? It sounds like we are subtracting credit risk from it.
Okay I see what you mean. Yes, in the example from the CIA we subtracted credit risk only which is a simplified approach. You would also technically need to subtract market, timing and currency risk also. In the wiki example, the ILP would also contain all non relevant risks which is not correct. The portfolio Ref Rate should remove (credit, market, timing and currency risk) @graham
@dogechow
I removed the word "not" from the parenthetical statement in step [1].