I heard that I was a ‘market consistent fundamentalist‘. I guess that means I am a bad thing. But there are two things to be unpicked here.
The whole truth
I wrote on 10 August1 about how possibly material facts – in this case a missing £1bn itemised as ‘other valuation differences’ – have been hidden in plain view, scattered across different reports or couched in opaque regulatory language. But there was something else in plain view that I failed to notice. Page 4 of Just Group’s 2017 Solvency and Financial Condition Report states
The main reason for the change since the publication in March 2018 follows the Group’s decision to change the assumptions underlying the valuation and credit rating of the LTM notes (described in D.2.6) in the Matching Adjustment in JRL as at 31 December 2017.
My emphasis. Further on it says that the impact of the reduction in Matching Adjustment was £470m. I had previously queried this with the firm on 31 July, via their publicist Alex Child-Villiers, who simply reiterated the same statement, and declined to answer my question about the £1bn. I asked again, and the whole firm (and their auditor KPMG) went into radio silence. A number of others have asked since then, and received the same stony silence.
Perfect foresight
Guy Thomas replies here to my earlier posts on distribution. As usual, he comes up with objections that are both ingenious and (in my view) weirdly mistaken. Today’s topic is the prospectively assumed distribution.
Growth of equity release
The chart above shows the growth of the equity release market since 2000, based on figures published by the Equity Release Council on their website. Blue line shows the number of new customers (including returning customers) each year. The red line shows new lending for the same year.
An ingenious objection
Ingenious objections are always interesting, particularly when they are wrong. An actuary has objected to my post here, where I considered a put written at 90 on a price series which goes 95,96,95 etc. The point of the post was to show that the standard formula works perfectly well for such a distribution. The objector objects that if the series really does oscillate between 95 and 96, the price will clearly never reach 90, so the standard pricing formula must be wrong. The true price of the put must be zero.
Just an update
Just Group’s business update for the 9m period ended 30 September 2018 is here. Shares were up 5% on the news this morning.
Headlines: £483m of ERM business written, which they say is CP 13/18 compliant, and they write:
CP13/18 is for us primarily a back book issue. The Group has no further clarity on the outcome of the consultation
In the same period, they took on about £1bn of defined benefit derisking business. ‘Derisking’ is actually an odd name for this kind of business, but Kevin and I shall be discussing that in Q1 next year.
The firm awaits the publication of the PRA’s final supervisory statement, as we all are. As I commented here, it is not certain whether it is just the implementation that has been delayed, or the publication. All we know is that it will be published in due course.
Get on with it then!
Weird distributions #2
The Institute says, in its reply to CP 13/18 (p.10), that
Using the Black-Scholes formula in pricing NNEG will affect the cost of the guarantee, since allowance is not made for the features of mean reversion, momentum and jumps described above. Under geometric Brownian motion the volatility increases with the square root of time while for other models it does not; the value for long term derivatives such as NNEG could materially differ from that assumed under the Black-Scholes model.
This second article on strange distributions discusses the mean reversion claim.
From the head downwards
One of the members of the joint review group set up by the Institute of Actuaries is Charles Golding of Golding Smith & Partners. It states here that the firm has ‘been providing advice to clients in the equity release market since 2003’. Who better to be on a board of independent experts advising the Institute on the selection of specialist Equity Release advisors?
Messing with the market
You saw it here first. At 10:00 yesterday we published the news that the PRA had delayed the implementation of CP 13/18 until at least the end of December 2019. The impact was dramatic, with a certain firm’s share price leaping by nearly 30% at one point.
Mr Market still doesn’t understand, if you ask me.
Update from the Bank
Update 25 October 2018 from the Bank.
The consultation period for PRA CP13/18 ‘Solvency II Equity Release Mortgages’ closed on 30 September 2018. The proposed implementation date for the proposals in the CP was Monday 31 December 2018. Based on feedback to the consultation, the PRA has decided that the implementation date will not be before 31 December 2019. The PRA is making this announcement now in order to clarify the position for insurers planning their year-end 2018 processes. The PRA is currently giving careful consideration to the consultation responses and the impact, if any, of the updated implementation date to the proposed phase-in period. The PRA will publish final policy and supervisory statements in due course.
This is hardly surprising.
[edit] Our own letter to the consultation team is here. It said (point 1).
It is a worry that the consultation as a whole has taken such a long time. The Dowd report ‘Asleep at the Wheel’ identified a number of letters going back to October 2014 and resulting in a stream of consultation papers, discussion papers and supervisory statements (see, e.g., CP 48/16, CP 23/17, CP 24/17, DP 1/16 and SS 3/17) expressing concerns on ERM valuation. Yet the valuation issue is a simple one: once the decrements have been quantified using standard longevity modelling, the ERM valuation model embeds a simple European put option. Clearly the deferment rate concept has caused an intellectual challenge for some, but it is a natural consequence of modern derivative pricing theory, which dates back more than 40 years. The PRA has apparently confirmed this assessment in judging that the valuation changes are not a consequence of Solvency II, but should have been applied all along. Yet during this extended consultation period the ERM market has grown significantly and the PRA has approved the raising of sub-debt and tier 3 debt, not to mention dividend payments, all based on valuation models it has known to be flawed. Investors could rightly complain that they have been misled.
Our emphasis. How long does it take to price a simple European put option?