Not one but two articles on Matching Adjustment in mainstream media today.
The Times:
L&G ‘sitting on £10bn of bond losses’ Pressure grows on insurer to abandon dividend
Legal & General is sitting on estimated bond market losses of as much as £10 billion, according to a shareholder group which is urging the insurer to postpone its planned dividend. The UK Shareholders Association argues that the outlook for financial markets is much too uncertain to justify L&G making its £754 million payout promised for next month. Dean Buckner, its policy director and a former Prudential Regulation Authority official, said L&G would be sitting on huge paper losses because of the slide in many bond prices since the start of the year.
Slightly misquotes me. I actually said that mark to market losses could be high as £10bn, but without knowing the breakdown by rating and sector it would be difficult to say.
In the Financial Times:
Investors should beware the insurance magic money machine
Ford gives one of the best layperson explanations of the Matching adjustment that I have seen yet. He supposes a company with £100 of risk free assets and thus £100 of liabilities swaps them for £100 of higher yielding risky assets.
The matching adjustment kicks in when it shifts some of that money into higher-yielding assets. In theory this should change things: higher yields carry more investment risk. So to continue protecting the annuitants, the insurer needs more loss-bearing capital than its present zilch.
But here’s where our convention really earns its corn. Using matching adjustment, our insurer can discount its liabilities at a higher rate, reflecting the extra return it hopes to make from those higher-yielding assets. This reduces its liabilities to, say, £90. So without anyone contributing a penny, or the company retaining any earnings, hey presto, its equity “buffer” has risen from £0 to the more substantial level of £10.
No less helpful is what happens when market turmoil strikes and spreads balloon. Then our insurer gets to discount its liabilities at even higher rates, creating more artificial capital and thus compensating for falling asset prices.
Then we are back to masks versus cushions again.