Unbalanced sheets

The Independent Expert report on the Prudential-Rothesay transfer has a curious statement in footnote 17.

The figure of c.£11.3 billion differs from the figure of c.£12.9 billion in paragraph 5.17 because £11.3 billion is the gross BEL held by Rothesay in relation to the reinsured business, whereas £12.9 billion is PAC’s gross BEL in relation to the reinsured business. The difference between these figures principally arises because the Transferring Business is not part of PAC’s Matching Adjustment portfolio (and therefore its BEL is not calculated using the Matching Adjustment), whereas the inwardly reinsured business in Rothesay under the Laker Reinsurance Agreement is part of Rothesay’s Matching Adjustment portfolio, which means that Rothesay’s BEL is calculated using a discount curve that includes a Matching Adjustment, resulting in a higher discount rate and a lower BEL.

My emphasis.

I asked the Expert about this, who confirmed it was true, and I separately checked against the 2017 and 2018 solvency balance sheets for PACL and ROTH. These suggest that at the end of 2017, PACL had about £13bn of bonds and equities which they subsequently lost in 2018, but with reinsurance assets of approximately the same amount taking its place. I.e. PACL transferred £13bn of actual assets to ROTH, in return for the reinsurance asset. PACL lost some money on the deal, for reasons that were not sufficiently explained, but that is not relevant here.

However the very same reinsurance contract is represented with a value of £11.3bn on the ROTH solvency balance sheet.

That illustrates nicely the weirdness of Matching Adjustment. As a friend suggested to us, the figures are a powerful way to show that either the accounting treatment is absurd or someone (annuitants/FSCS?) is set to lose £1.6bn in expected value. Or a bit of both.

Imagine e.g. if the two firms were owned by a single consolidated entity, ROTH-PACL holdings. Then the very same asset owned by the one entity is valued differently by the very same liability owed by the other.

An unbalanced balance sheet?