Category: matching adjustment

Posted on

Wood’s Solvency UK comments welcomed by industry

Insurance ERM this morning on Sam Woods’ comments to the UK Treasury Committee last Monday.

“Dean Buckner, policy director of the UK Shareholders’ Association, welcomed Woods’ admission the new regime would put policyholders at more risk.

He has repeatedly argued how the use of the matching adjustment grants life insurers upfront capital against future investment returns, which may not emerge, and therefore puts firms at risk of running out of capital.

“Our members are increasingly fearful of investment in life insurance companies, given the tendency to decreasing levels of capital, and increasing levels of risk. We thank Sam Woods for speaking out. However, we are disappointed that the government appears to be ignoring these valid concerns,” Buckner said.”

At the same time, the Bank has published the results of its insurance ‘stress test’. Scare quotes, because

In the spread widening stress, the MA increases to offset most of the corresponding fall in asset values within the MA portfolio; and balance sheet deterioration through increased credit risk is not observed until assets start to downgrade. While this result is to be expected under the regime, it does illustrate that the MA does not automatically take account of market signals relating to elevated credit risk at the point where they start to come through

The exam that no firm can fail.

Posted on

When less equals more (capital)

Source: WTW, Analysis of Proposed Solvency II Reforms, 21 July 2022

The Association of British Insurers came out yesterday with a firm statement on the proposals to increase the capital that insurers ‘hold’, arguing, based on analysis by Willis Towers Watson that the proposals would in fact on average lower the capital ‘held’.

This results conflicts somewhat with UK government claims that the proposals would free up capital to support investment in wind farms and other worthy things.

Figure 4.1 from Willis is copied above. It had Eumaeus scratching his head for a long while, even with help from his dogs. The block colour represents the range in which ‘all’ the sample of 16 firms sit, except for the maximum and minimum outlier values, so the block colour does not in fact represent ‘all’ firms, but never mind.

But the results are intriguing. Under the PRA scenario A, for example, the average reduction in  own funds (Solvency II ‘capital’) leads to an average reduction in capital of about 5%. But that is for all firms. For all annuity providers – who are the main customers for MA – the average reduction is 20%. And worse, there is an outlier firm that loses 30% of its capital. Yikes!

Admittedly, scenario A is severe, and the PRA always signalled this, but none of the other scenarios look particularly encouraging given the purpose of the government proposals. For the proposals were to free up capital for long term infrastructure projects, which could only come from firms with long term liabilities, i.e. annuity providers. But it is annuity providers who are most severely affected under all the scenarios!

It’s all a mess and will lead to more friction between the government and the Bank of England.

That is not to say the reforms are a bad thing. Far from it: in Eumaeus’ view they do not go nearly far enough. But the mess is an indication of the broken nature of life insurance, and of the failure of regulation to deal with the problems in a timely way in the aftermath of the Great Financial Crisis.

Those who sow the wind etc etc.

[UPDATE] The Eumaeus response to HMT is here.

Posted on

Rip off policyholders to save the planet

Reported in InsuranceERM

On investment in green finance, Evans [Huw Evans, on his last day as director general of the Association of British Insurers] said a useful debate about how the Solvency II Matching Adjustment can be improved has been somewhat overtaken in the UK by a series of Bank of England/PRA interventions. According to Evans, these are seeking to force changes to the fundamental spread element of the Matching Adjustment.

“Not only is this an issue that wasn’t even included by HM Treasury when it set the remit for the review, any changes are almost guaranteed to increase insurer capital levels and make the UK less competitive than insurers based in the EU. And any chance of a significant boost to green investment will almost certainly be lost.”

Loving it!

 

Posted on

The Controller speaks

Speech at the Institute and Faculty of Actuaries

There is a concern that Solvency II as a negotiated compromise has created risks to our primary objectives. The Fundamental Spread does not include explicit allowance for uncertainty around defaults and downgrades, and appears low compared with ranges implied by academic literature for the credit risk portion of spreads. Second, the Fundamental Spread is not sensitive to changes in credit market conditions and changes little as spreads change over time. This means that any increase in spreads not accompanied by a downgrade is assumed to be entirely due to increased illiquidity of the assets, and therefore taken credit for as Matching Adjustment. Finally, the Fundamental Spread is not sensitive to risk and spread across asset classes, and thus assets that have the same rating but higher spreads will attract a higher Matching Adjustment despite what can appear to be a higher level of credit risk. This creates a risk of adverse selection based around the regulatory rules.

My emphasis.

Posted on

It’s over

The High Court judgment on the PAC Rothesay transfer is here. I won’t comment for now, except to say it was a complete joke, even by the standards of such things.

Posted on

Transfer window

Just noticed an article in the latest Eye about the PAC-Rothesay transfer. The Court Hearing is slated for 8 November.

Includes this:

Concerned Prudential policyholders say this puts them at greater risk, not least because they have a higher age profile (believed to be largely 75 -plus). Without applying the matching adjustment, an analysis in InsuranceERM magazine exposed recently, Rothesay is one of only two out of 14 life insurers in the UK that would be insolvent. So if anything goes wrong in the relatively short term, or the rosy view of Rothesay’s portfolio proves over-optimistic, they’re in trouble.

The policyholders also say the independent expert, Nick Dumbreck of risk management advisory firm Milliman LLC, hasn’t listened to their concerns adequately, including on the critical point of matching adjustment.

Milliman advises on a number of pension transfers, and the current dispute is effectively a test case for the business of selling portfolios regardless of the wishes of policyholders. If the Pru and Rothesay lose, it could kibosh the practice.

 

Posted on

It’s official: the MA is complete crap after all

Gareth Truran speaks at some conference.

Over the last year, the PRA has highlighted publicly on a number of occasions the risk that the MA specification may not have kept up with the changing nature of the market. The MA should only include the component of asset spreads that reflects compensation for risks to which firms are not exposed by virtue of being long-term investors. But it is possible that some of the returns which are currently treated as an illiquidity premium might, in fact, reflect compensation for variability around future credit losses. If so, in adverse scenarios, these profits might not materialise. Firms might be forced into recovery actions such as fire-sales of illiquid assets to manage solvency and meet policyholder commitments, reducing their ability to support sustainable long-term investment in the economy. As firms have invested in recent years in a much wider range of assets with different risk characteristics, the basis risk between these assets and the assets originally used to calibrate the MA has also increased.

So we think we need to look again at this issue, to be confident that the MA regime can safely support our ability to widen MA eligibility, encourage further expansion into new and innovative asset classes, and streamline our upfront review of firms’ MA applications.

Oh yes!

Posted on

Meanwhile back at t’mill

A technical paper here on the UKEB website suggests more trouble brewing around discount rates.

As usual it’s hard to tell, given the impenetrable language used by accountants, but I suspect the problem is the so-called Contractual Service Margin (CSM). This is a mechanism that weirdly takes away the effect of excess discount rates like Matching Adjustment (or rather, the statutory equivalent of Matching Adjustment), forcing a firm to release day one MA gains over time. How this practice differs from just discounting by riskfree is a mystery to me.

The paper says “Profit recognition will be significantly slower than under current practice, mainly due to the absence of gains on initial recognition (sometimes referred to as ‘day 1 gains’),” then continues, ominously:

Data on the likely transitional impact from this change across the industry is not available to us, but the expectation is for material reductions in equity. The scale of the impact will depend in part on the transition approach adopted …

Unfortunately the rest of the paragraph makes almost no sense.