According to InsuranceERM, actuaries (we don’t know which ones) have voted for Monte Carlo simulation as the most appropriate way to model the cost of no-negative equity guarantees. “Only 9% of the audience opted for the closed-form Black-Scholes model as the most appropriate tool for costing NNEGs.”
Discounting by risk free
http://batmanytb.com/Actuary%20(Comics)
As I commented the other day, life insurers have for a long time used arbitrary methods of discounting insurance obligations. The idea permeates actuarial culture and most actuaries, including even the younger actuaries who qualified under the new actuarial syllabus designed to drag actuarial valuation into the 1950s, show surprise when you suggest that this is completely wrong.
Continue reading “Discounting by risk free”
Bricks for making halfway houses
Yesterday the Institute announced that the project to research equity release mortgages will be delivered by the University of Kent, led by Professor Radu Tunaru (Senior Researcher).
Insurance fundamentally different?
In a piece last week, Oliver Ralph of the FT says
Many insurers privately argue that the rules will fail to make accounts more comparable because insurance markets worldwide are fundamentally different. They say that the new standard simply imposes a huge burden on the industry in time, effort and expense, for little benefit.
I am sure they would privately argue that, but this is completely false.
Trend or mean reversion?
Many readers, not all, will be familiar with the Herengracht chart shown above. As Wikipedia explains, the index – of house prices along the Herengracht canal in Amsterdam – was created by real estate finance professor Piet Eichholz of Maastricht University. Eichholz was frustrated by the tendency of papers to take a ‘long run’ view of house prices that only went back 20 years or so. He suspected there was a myth which says that real-estate values go up significantly over time, and that this is especially true for central city locations, so he began studying transaction records for the Herengracht area going back to the mid 16th century. More than 300 years of data should be sufficiently ‘long run’, right? His data ended up challenging that myth. Note that the chart here is adjusted for the Dutch retail price index.
Date for diary
“Sessional Research Event: Equity Release Mortgages”. 11 December 2018, 17:00 onwards.
The Equity Release working party will be presenting its paper titled ‘Actuarial Management of ERMs’.
Presenters
- Tom Kenny, (Just)
- Charles Golding (Golding Smith and Partners)
- Alex Mockridge (Legal and General)
- Nigel Hayes (Aviva)
- Scott Robertson, (Phoenix)
Sadly Kevin and I cannot attend the event as it is actuaries only.
Minsky moment?
According to the Equity-release-graph, the product continues to grow apace. £1bn lent in the third quarter of 2018. But if the trend continues, it will lead to the first of the two problems I highlighted in this previous post. Lending will follow house price growth, house price growth will fuel the capitalisation model used by ERM firms, which will capitalise future predicted growth. This will then result in the second problem, namely that if the growth is not realised, it will go horribly wrong. Note ‘not realised’. It will go horribly wrong even if the growth is flat, and because of the large amounts lent, it will be horribly wrong in a horrible way.
You have to ask what the BoE, the guardian of financial stability, was thinking of when it approved these models in 2016. Actually I know what it was thinking of, but cannot say.
Time decay
Most people with even the slightest familiarity with option pricing will know of time decay, or the tendency of the option value to decrease through time independent of any interest rate effect. The chart above shows the price of call option through 40 years, struck at 100 with the underlying price also constantly at 100, and with interest rate set to zero to remove the effect of interest carry. I.e. the only change to the model is the time to expiry. The effect of time decay or theta is apparent.
Now I have discussed in several posts, such as here, how a real option can be replicated by means of a synthetic option – a series of linear positions in the underlying market adjusted frequently to match the delta or sensitivity of the real option.
Paying the price
In this fine article in the FT, Alan Miller argues that the Financial Conduct Authority fails all of its statutory objectives — consumer protection, integrity and competition.
The lost weekend
According to some history books, the dreaded mob went into riot mode after it was proposed in February 1751 that Great Britain adopt the Gregorian calendar, already used in most of western Europe. ‘Give us our Eleven Days’ they cried.