Keeping an eye on things
Today marks the first anniversary of Eumaeus, coinciding with the publication of Asleep at the Wheel and the broadcast of The Equity Release Trap (partial transcript here).
As is customary on such occasions, we ruminate on developments over the past year and look forward to the next.
A friend of Eumaeus comments on my post yesterday, where I said “I have argued many times in the past that we should look at the default experience of the 1930s (or the 1880s or whenever) in assessing the true default risk of long term credit exposure.” He objects that the PRA have done exactly that, citing Supervisory Statement 8/18:
When using transition data, the PRA expects firms to … compare their modelled 1 in 200 transition matrix and matrices at other extreme percentiles against key historical transition events, notably the 1930s Great Depression (and 1932 and 1933 experience in particular). This should include considering how the matrices themselves compare as well as relevant outputs…
Continue reading “The experience of the 1930s – more from the postbag”
A topical article in the FT today on the queues spotted at Metro Bank over the weekend, which received almost viral attention in ‘social media’.
The long queues that formed at several Metro Bank branches in west London on Sunday have been seen by some, especially on social media, as an alarming echo of the days just before Northern Rock’s collapse in 2007. The comparison is irresponsible. This lender’s problems — a few dozen customers emptying their safety deposit boxes amid unfounded rumours of imminent collapse — cannot be likened to those of a defunct bank whose woes foreshadowed the global financial crisis. Conflating them risks creating a vicious circle of customer panic.
By DB and KD
Our friends Tony Jeffery and Andrew Smith have some wise advice that the PRA should consider in their new insurance stress tests. Our advice was not to bother, but assuming the PRA chooses for once not to follow our advice, they might look at the following passage from Andrew and Tony’s recent Society of Actuaries in Ireland (SoAI) report on NNEG valuation:
In 1995 a SoAI paper (Demographic Margins for Prudence – Jeffery & Quinn, 1995) suggested that a valid approach to setting margins was to consider how it would look to a public with the benefit of hindsight if it has gone wrong, noting that with the clarity that hindsight brings can be harsh.
By DB and KD
Late in April, the PRA announced that it was planning a new life insurance stress test for 2019. At first sight, the test looks plausible: to stress AAA bond holdings by 150bp, going up to 400bp for unrated. However, the spread is divided into the Matching Adjustment, which is the spread deemed to represent illiquidity and which is therefore considered risk free, and the ‘fundamental spread’ (FS), which represents the true credit risk, as it were.
Actually it should be the return of Ulysses, but never mind.
We are still working on the now very comprehensive report on equity release and the valuation of the NNEG, but the blog is back in business.
Quite a few things happened in our absence, including the publication of the Smith and Jeffery report to the Irish actuaries. We will comment on that later.
Meanwhile, fresh off the press, is the transcript of this speech by David Rule. We will comment on that too, when we have worked out what is going on.
Jonathan Ford, Financial Times, 17 March 2019, on the less observed phenomenon of how regulators can capture themselves through government influence or intellectual fashion.
He cites two examples. Metro Bank, which fulfilled a government need for more competition in the banking sector without costly break-ups for the high-street banks, and equity release which promised a way to address the looming pension shortfall without the state having to pick up the tab.
There was a similarly relaxed view to the rapid growth of ERMs. Firms were allowed to flog these complex products while hugely undervaluing the embedded guarantees contained within them, despite the baleful example of Equitable Life, the world’s oldest insurer, which hit the rocks in 2000 having made the same mistake. Unsurprisingly, ERMs proved highly popular with consumers and the market grew very quickly, ultimately forcing the UK’s Prudential Regulation Authority to re-examine the rules.
The problem with closing the stable door belatedly is that the horse has long bolted. Volumes of ERMs containing mispriced guarantees had already been sold. Capitalising those retrospectively is extremely difficult for the lender, and runs the risk of exposing less strongly-funded providers. Consequently the PRA chose to pull its punches.
I have got round to preparing my presentation for Friday 8th. The sacred text is from the co-founder of Wikipedia.
Wales: “The internet interprets any type of centralized planning as a malfunction and routes around it. The command-and-control model is doomed to failure here by the very nature of the network. This is inevitable”.
My question is whether ‘the secretive nature of regulation threatens, rather than supports, the stability of the financial system’.
You see the tension. If the command-and-control model really is doomed to failure, as though by a process of historical materialism, then we can sit around and watch while it eats itself.
But regulation is still with us, more than 20 years after Wales said that (in 1997). So is the command-and-control model really doomed to failure? Doom: from OE dōm ‘statute, judgement’, from a Germanic base meaning ‘to put in place’, figuratively speaking fate or destiny etc.
Find out. There will be quotations from Marx and Sartre, no less (but don’t let that put you off).
I am currently staring at a bizarre letter from the Financial Reporting Council, saying that the issues I have raised about misvaluation of guarantees do not fall within the purview of the FRC, for the FRC is limited in its oversight role of the Institute of Actuaries, ‘as per recommendations made in the Morris Review‘.
