Educational session: measuring the risk margin
At the request of a FASB member, the FASB staff had prepared a paper that examined and explained the role that risk adjustments play in standard option pricing techniques. The FASB member wished to explore whether the Boards' challenge in attempting to adjust for the risk margins could be accommodated more efficiently using option pricing models as opposed to the alternatives being considered.
The FASB staff also presented a selection of current (and significant historical) academic research on the use of option pricing models in the measurement of liabilities. It was unclear how many of these studies were based on data not based in the United States or on US GAAP (nor was this question asked by any Board members).
The principal paper was being discussed in 'education session' format, and Board decisions were not requested. However, it was apparent that both Boards were split, with some preferring using option-pricing models to measure insurance contracts and others preferring the current staff position.
Members of both Boards expressed concern that using option pricing models to price the risk margin was essentially inviting preparers to use a 'pick a number' approach to measurement. There was no apparent means to limit approaches to measurement or to inputs, so it was difficult to see how using option pricing models would be better than the model currently being developed. In defence, the chief advocate of the FASB model noted that, in some cases, there was less subjectivity in the option pricing model-approach than, for example, value-at-risk approaches.
A FASB member was concerned that the Boards were suggesting a greater rigor for insurance contracts than they require for other [fair value] measurements: was this because the Boards had abandoned the exit price as the measurement objective and had yet to articulate clearly a replacement? The lack of a clear measurement objective was at the root of the Boards' problem.
An IASB member concurred, suggesting that the Boards were trying to achieve an 'exit price', or something very close to it, without using that phrase or 'fair value'. The exit price was, for him, the right answer and the Boards should be honest about using it as the measurement objective. Exit price is well understood by both users and the measurement professionals and would have well-established measurement methods already embedded in IFRSs and US GAAP.
The discussions did not suggest broad support for using option pricing techniques in determining inputs to the measurement of insurance contracts. However, that may change as Board members reflect on the discussions between today and when they debate the paper in technical session in the week of 22 March.