The add-on to the best estimate of liabilities representing what a third party would require to take them over, and which swings sharply with interest rates.
The risk margin answers a precise question: if the undertaking disappeared tomorrow, how much would a third party have to be paid to take its liabilities over? The answer the prudential regime adopts is not a market price but a construction, namely the cost of tying up, year after year until the portfolio runs off, the regulatory capital that third party would have to hold, remunerated at a cost-of-capital rate fixed in the rules. Two properties follow and explain most of the argument. The margin grows with the duration of the liabilities, which makes it very heavy for lifetime annuities, and it moves inversely to interest rates, so a period of low rates mechanically inflates a margin meant to represent a stable transfer cost. The United Kingdom regime drew the consequences of that sensitivity by sharply reducing the margin applicable to life business from the end of 2023, and the European review followed a comparable path by damping the time dependence.
The United Kingdom prudential regime cut the risk margin applicable to life insurance business with effect from 31 December 2023, as part of the Solvency UK reforms, on the ground that its level tied up capital without improving policyholder protection.
risk margin, marge de risque, coût du capital prudentiel