Sam Woods was questioned by the Treasury Committee on Wednesday. Transcript below, starting 16:50.
A few odd things. Woods says there have been defaults and downgrades, but soon after claims that ‘blowouts in bond spreads’ are driven by liquidity. He mentions the Matching Adjustment as the ‘piece of machinery that is operating quietly in the background’, and Baldwin asks whether without it there would be actual insolvencies. Woods first says that there wouldn’t, or he thinks there wouldn’t, then says that without it there would be ‘a major problem’.
Why don’t they just state the accounting numbers as they are, i.e. some firms with no net assets at all, or negative assets, adding that this doesn’t make the firms insolvent, because it’s merely a liquidity effect and the spreads will narrow back again? Why falsify the accounting?
More later, I expect.
[16:50] Harriet Baldwin: I’d like to switch over to Sam now in terms of the solvency of the insurance sector and you said at the beginning of the evidence that the sector went into the crisis very solvent. I know that you have encouraged some of them to avoid paying dividends, you have been putting some pressure on the industry in that regard. Do you feel that there are any companies in the sector that are going to suffer from a solvency problem here?
Woods: Well, as you say, going into the crisis they [insurers] are well capitalised. The first hit for them is the financial markets hit – we’ve had these enormous movements in financial markets. They’ve broadly weathered that quite well, and where it leaves them is at a coverage ratio relative to their capital requirement broadly in the range of 130-160%, so 30% to 60% more capital than they need in order to be sure they can meet a further stress. But that’s down to something like a range between ‘not down at all’ to down 20 percentage points of coverage through this stress. There’s also been a bit of liquidity stress during this market turbulence because people have to meet collateral calls from the banks where they have hedged risk through derivatives and some of that has put some strain on, but that’s all been managed. So the main two issues that we are focused on now are – one, that the prudential side of the general insurance stresses, so that as firms need to make good on business interruption policies they’ve written, the sort of thing Chris was writing about – firms today, travel etc, that will obviously cost them but we think they have that covered in capital requirements and provisions but you never know until the thing flows through completely.
And the other is more on the life insurance side, the topic we touched on earlier. Corporate downgrades have happened already, and defaults, and those are painful because insurance companies hold bonds from those companies, and as those things happen, obviously they become worth less, but also the capital requirement and their technical provisions adjust as well and we are having to work through with those companies. Again, we should have captured it in the stress testing that we do already to set their capital requirement but we want to work through it and see have we really got it all, and that’s what we are doing.
Baldwin: So this is the technical issue around transitional measures for technical provisions, and the smoothing of the insolvency and without that would you have some insolvencies do you think?
Woods: I don’t know. We certainly wouldn’t have insolvencies. The TMTP that you mentioned has alleviated the strain of the financial market stresses a bit, but I don’t want to overdo it, you know it’s a few percentage points relative to those numbers I was giving you. The other piece of machinery that is operating quietly in the background is this thing that we have discussed in the committee before called the Matching Adjustment which effectively shields life insurance companies in particular from blowouts in bond spreads which are driven by liquidity and that has softened the blow somewhat as well, it’s probably doing a more important job than the TMTP at this stage.
Baldwin: But again you don’t feel that without it there would be actual insolvencies?
Woods: No I don’t think we would have insolvencies but the matching adjustment is a major part of our regime, and to give you a sense, the end 2018 figure is the latest one we have on a consistent basis across the industry for publication but that’s £68bn of benefit and that is pretty significant – if that went away there would be a major problem but we have no intention of taking it away.