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Fair value of mortgage loans taken into account in adequacy test
Insurers with mortgage loan portfolios are obliged to value their mortgage loans for annual reporting purposes and, insofar as these loans are used to cover for the technical provisions, also for the adequacy test. The loans may be valued at amortised cost in the balance sheet. However, a valuation at fair value should be included in the notes to the balance sheet and is required for the adequacy test. This fact sheet sets out which statutory provisions and external reporting provisions are relevant in this regard, as well as any other aspects that play a role in the valuation of mortgage loan portfolios.
Insurers reporting under the IFRS accounting principles determine the valuation basis for mortgage loans in accordance with the provisions of IAS 39. In practice this often means that the loans are valued at amortised cost. Where that is the case, IFRS 7.25 stipulates that the mortgage loan must also be valued at fair value, and that this value should be disclosed in the notes to the balance sheet. Determining the fair value of mortgage loans is required for the adequacy test (Section 121(3) of the Decree on Prudential Rules for Financial Undertakings (Besluit prudentiële regels Wft - Bpr)) and for insurers that include the added value in the calculation of the available solvency margin in accordance with Section 97(1), subparagraph a of the Bpr. In individual cases De Nederlandsche Bank (DNB) may decide that the values for coverage of the technical provisions can be set at a lower value. Section 122b(3) of the Bpr. DNB's prudential statements are based on the annual financial statements (single-track reporting in line with Section 130(3), subparagraph a of the Bpr This means that the fair value of mortgage loans used for the adequacy test and solvency calculations is the same as the fair value included in the balance sheet and the notes to the balance sheet.
The fair value valuation of mortgage loans valued at amortised cost in the balance sheet is determined on the basis of provisions in the Dutch Civil Code and IFRS (IFRS 13 in particular). This means that the fair value of a mortgage loan at a set valuation date is equal to the value of the mortgage loan should it be exchanged on that date between knowledgeable, willing and independent parties (“Orderly transaction”, IFRS 13.9). The fair value valuations focus on an estimate of an exit price, regardless of the appropriation of the mortgage portfolio by the portfolio owner (e.g. under a hold-to-collect business model). In accordance with IFRS 13 the fair value should be determined on the basis of the "fair value hierarchy". There are three “fair value hierarchy” levels:
- Level 1: quoted prices (unadjusted) in an active market for identical assets;
- Level 2: valuation methods in which all inputs other than quoted prices are based on observable market data (observable inputs);
- Level 3: valuation methods in which inputs is based on unobservable market data (unobservable inputs).
Level 1 should always be the first step in determining the fair value, based on quoted prices in active markets. If insufficient information is available for a Level 1 fair value valuation, a Level 2 valuation method can be used, based on observable inputs. The Level 3 valuation method should only be applied when insufficient observable and relevant market data are available to perform a full valuation based on unobservable inputs.
For long-term mortgage loans, information on a borrower's creditworthiness in practice often concerns the borrower itself. The provisions for determining the fair value of loans require insurers to search for additional, market-based, information. According to IFRS 13.17 it is not necessary to conduct an exhaustive search and collect as much market information as possible. However, this does not imply that any information that is reasonably available may be disregarded. Transaction prices of comparable loans (mortgage loans) are often relevant when determining market values. The loan's cash flow and relevant discount rate indicators are also relevant in this respect. The cash flow projections and the choice of discount rate should reflect the risk characteristics of the loan in question.