A great piece of research from InsuranceERM, here for those with access. For those who haven’t (and for everyone, really), a few of the key points.
The sleuths at InsuranceERM found that the MA provided a total of €77bn ($87bn) of capital benefit in 2018, while the VA provided €29bn in 2017. Of the €77bn, their earlier report found that MA boosted own funds by €40.2bn, and reduced SCR (capital requirement) by €37.1bn in 2018.
That’s a lot of made up capital benefit. I am quoted as follows.
“The principle underlying matching adjustment is that actively trading an asset creates exposure to ‘artificial’ market volatility, unlike if the asset is held to maturity. Under matching adjustment, firms with long-term exposure are allowed to meet capital requirements by discounting liabilities at a rate higher than risk free,” [DB] says. “This makes no sense. The capital requirement for an asset is computed using a historic distribution of the asset price, so if volatility really is artificial it is the calculation of the capital requirement that is wrong, not capital available. Eiopa should be looking at reforms aimed at a market consistent valuation of net assets, combined with a more flexible capital requirement regime that reflects ‘artificial volatility’, if there is such a thing.”
That’s it. If you really believe in artificial volatility, then you believe the historical distribution used to set the capital requirement is artificial, hence so is the capital requirement itself. So you have an artificial capital requirement. What’s the point of falsifying the regulatory balance sheet (and the statutory one with it) so that you have an artificial capital amount meeting an artificial capital requirement? Does that really make sense?
As I told InsuranceERM, Eiopa should be reforming the capital requirement regime, not encouraging people to invent a new accounting system. To the objection that lowering the capital requirement would increase the risk to policyholders, I reply: we would be lowering the capital amount too, so the risk remains the same, at least if you believe in ‘artificial volatility’. And if you don’t believe in artificial volatility, you remove the reason for the MA.
Sam Tufts, not to be confused with Sam Woods, comments that “Some might consider the benefit from the MA to be ‘fake capital'”, i.e. us, but “but it serves a genuine economic purpose – it allows insurers to offer better rates on annuities for policyholders and allows them to ride the cycle out due to the fact that they are long-term investors.”
Clearly Sam believes in artificial volatility, given the remark about ‘ride the cycle out’. Then next time the markets dip, he should be mortgaging his house and borrowing whatever he can to invest in AA bonds, a large equity portfolio, whatever, in the sure belief that the cycle will turn and the market will go up again. As for the ‘better rates’ argument, to be sure, you can give better rates if you back the annuities with a pile of crap. London Capital & Finance used to offer some great rates, I heard.
Oh, did you say something? Never mind.