Keeping an eye on things
The Tonight program can be viewed on catch-up here. It was a useful critique of equity release, although some of the wider issues were skirted, such as why people would need the product in the first place, given that their pension or health insurance should have been adequate.
The story behind the mystery shop (see 14:00 onwards) is more complex.
The Tonight Programme, ITV Thursday 7 November, 19:30-20:00. On equity release mortgage selling.
A commenter comments.
If your theories are correct, it is Eumaeus who should be
able to make unlimited arbitrage profits if the matching adjustment is mis-pricing. Why have you not done this? The answer is that outside the university classroom, arbitrage is not possible for illiquid assets / liabilities.
Eumaeus replies
On the contrary, arbitrage is easy. (1) Borrow from pensioners at close to risk free through the buyout market, receive payment in safe assets (2) replace safe assets with higher yielding ones (3) persuade PRA that some or all of the spread on higher yielding assets is risk free (4) discount liabilities at the higher rate and create capital (5) when you have created enough capital, distribute some of it to owners.
I.e. Matching Adjustment is an effective a way of shorting the illiquid asset. You have bought the illiquid at market price, including the ‘illiquidity premium’, although it is difficult to prize away the illiquidity element from the market risky element. Then, by discounting your illiquid riskless pension liability at higher than risk free, you have beautifully captured that illiquidity spread. Arbitrage courtesy of PRA, thank you regulators!
Just spotted this from Hansard (02 October 2019, Volume 664), reporting a debate that day on Leasehold and Commonhold Reform. Sir Peter Bottomley:
As an example for those who do not read Private Eye on the day it comes out, there is a story about Rothesay Life, which apparently has £1.5 billion of loans. It can revalue the interest over 30 years and take it almost as instant profit. That is the kind of thing that leads people to say, “I am going to be greedy and get away with things as long as I can.”
Rothesay’s chairman (Naguib Kheraj) has written to the Financial Times saying that the policyholders and experts’ letter to the PRA “contains so many inaccuracies as to be unhelpful and irresponsible”.
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.
An interesting article in the FT published this Sunday, quoting one expert as saying that the Prudential Regulation Authority is playing “fast and loose” with pensions over its willingness to nod through transfers of savings from long-established insurers to newer specialist rivals.
Continue reading “PRA playing fast and loose”
Sorry for the lull. Our latest work, and this was always the plan, has been on the wider issue of specialist insurers who make excessive use of the Matching Adjustment ‘benefit’ to create capital, both statutory and regulatory, on their balance sheet.
The recent High Court judgment which blocked the proposed transfer of annuities from Prudential to Rothesay was welcome to us, but came as a surprise, and raised legal questions about what we can publish while the judgment is under appeal.
We hope to say something next week, so stay tuned.
Excellent article in the Eye this morning on the high court win for Prudential policyholders.
