For the purpose of the valuation, the balance sheet is divided into two parts: the technical provisions and the balance sheet items other than the technical provisions.
The technical provisions are equal to the amount to be held by an insurer on the balance sheet date in order to settle all existing obligations towards policyholders. In some cases, these obligations may lie far in the future, as is the case for pension insurance. The valuation of the technical provisions consists of a best estimate plus a risk margin. The risk margin serves as compensation for making available the own funds that are present. On the transfer of the insurance portfolio an acquiring insurer will wish, after all, to receive such a risk margin over and above the neutral estimate of the insurance liabilities.
The best estimate for a life insurer is based on the balance of the cash flow of all benefits yet to be paid, less the cash flow of all future premium inflows. In the case of non-life insurance, use is made of a premium provision, namely the amount of benefits payments for future claims for which insurance cover is already present on the balance sheet date. In addition, there is a claim provision intended to cover claims from the past, whether or not reported to and known by the insurer on the balance sheet date, and the claim payments still required for this purpose. The determination of such technical provisions is generally based on statistical patterns and rules derived from past experience, intended to provide an objective estimate.
Balance sheet items other than technical provisions
To determine the economic value of the assets and liabilities other than technical provisions, for most balance sheet items, insurers must make as much use as possible of the IFRS valuation rules. A condition is that this should result in an economic valuation (also known as the current or market value). In determining the economic value the insurer must make as much use as possible of the observable market prices or, if that is not possible, other information from the market.
Differences between the Solvency II balance sheet and the corporate balance sheet
Insurers prepare their corporate balance sheet, which forms part of the financial statements, on the basis of the valuation principles in IFRS or the Dutch Civil Code. Parts of the Solvency II balance sheet discussed above will differ from this corporate balance sheet in certain respects for nearly all insurers. This is unlike the situation with the present Dutch supervisory framework for insurers, under which the same balance sheet is used for corporate and prudential purposes (known as ‘one-track reporting’). In the case of the technical provisions, differences may arise because the valuation rules under Solvency II are more detailed and prescriptive. Differences in the valuation of assets and other liabilities are possible because IFRS and the Dutch Civil Code permit certain balance sheet items to be valued by reference to principles other than economic value, for example amortised values. In addition, specific valuation rules are defined in Solvency II for several balance sheet items that differ from the rules and possibilities in IFRS.
The differences between Solvency II and the corporate balance sheet are disclosed annually by insurers in the report on their solvency and financial position.