1. Four Key Questions Bondholder’s Original Cost
Bond as a Financial Asset
Extinguishing Price
Third-Party Reimbursement

2. ISC Definition
“The fair value of a corporate liability is the amount that the enterprise would have to pay a third party at the balance sheet date to take over the liability.”

3. Three Key Implications
Fair value of liability not necessarily equal to market value of countervailing asset
Market value of liability (as an asset) depends on credit risk of issuing company; FV of liability depends on credit risk of 3rd party
ISC definition is incomplete

4. In the Insurance World...
Premium = PV of EL (no default) – PV of Default + Undwg Costs + PV (FIT on I.I.)
PV (asset) = PV of EL (no default) – PV of Default
Fair Value of Liability = Reinsurer’s Premium = PV of EL (no default) – PV of Reins’s D.O. + Rein’s Undwg Expenses + PV (FIT on Rein’s I.I.)

5. Fair Value depends on ... PV of EL (no default)
Underwriting expenses and FIT’s of Reinsurance Company
Financial Strength of Reinsurance Company

6. AAA Monograph & Credit Risk
Cost of Capital Method to Determine RADR for a liability
RADR = rL = rA – e(rE – rA)
AAA unclear on scope of variables: company vs. third party
AAA appears to use company; should use third party

7. AAA “COC Method” vs. Actuarial “Risk Loads”
AAA method – combined adjustment for time and risk via RADR
Actuarial methods – separate adjustment for time and risk (“risk load”)
If inputs are identical both methods give same answer
Two advantages of risk load approach

8. FV of Insurance Liabilities & Actuarial Judgment
Need to “close loop” in ISC Definition
Still cannot reduce FV to “cookbook” approach – requires sound actuarial judgment to determine marginal surplus and cost of capital of third party