Keeping an eye on things
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.
As I discussed here, the sensitivity of an option to one parameter can change as another parameter changes. A rough and ready check using CMI longevity data (nothing for CBD yet) bears out my intuition that as property values change, the longevity sensitivity of a no negative equity guarantee (NNEG) on a loan written on that property will also change.
Those who tuned in to my presentation here may have noticed a teensy hesitation at slide 12 where I discussed the sixth stress test on an example ERM. Continue reading “Equity release and annuities”
I have updated the links page as follows.
Stress Tests – links mostly to Kevin Dowd’s work on the failures of the Bank’s stress testing regime, which seem to be manifold. There will be more to come as ‘No Stress IV’ approaches publication.
Equity release and the actuarial profession – links forming the source for our work on Equity Release: A New Equitable in the Making.
Treasury Committee – links to the work of the Treasury Committee’s Solvency II investigation, including its report The Solvency II Directive and its impact on the UK Insurance Industry, October 2017.
Jonathan Ford’s recent article in the FT 1 prompted some extraordinary comments. It’s great to know that ordinary working people are still stressed up by financial stability. But what’s all the fuss about?
It’s November again and time for the annual Bank of England stress test results.
To be honest I don’t take too much notice of these. The tests are hardly going to show that the UK banking system is not resilient to deep simultaneous recessions in the UK etc etc., although they may show Brexit is the worst thing ever.
But I was sad to see one chart has gone missing.
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.
Just’s quarterly results presentation on September 6th was a hoot. I couldn’t help noticing the cancelled dividend and the auditor (KPMG) suggesting that the final outcome of CP 13/18 could constitute a material uncertainty that may cast significant doubt on the Group’s ability to continue as a going concern. These look like red flags to me but I am not an analyst and may have missed the finer points.
One point however that did jump out at me was its innovative “NNEG loss shortfall” metric. This metric appears to be the loss that occurs when the loan is repaid and the house price is below the loan value. This metric sounds plausible at first sight and sure does make the NNEG risk look small.
Unfortunately this “NNEG shortfall” as used by the company tells us nothing about the valuation of the NNEG or the riskiness of the firm’s equity release portfolio.