Posts

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

Now we can all relax

“Bank of England to stress test risks in non-bank financial markets” (link)

Phew! Now we can all relax as the Bank looks at a risk that came to its attention. Hope it is also looking for risks that haven’t yet come to its attention!

Posted on

IFOA Thematic Review Report on Equity Release

The Institute of Actuaries report on  Equity Release is published today.

It opens “Actuaries have played a leading role in developing the market for equity-release products”. From my memory, the role that actuaries played in developing the product was an active resistance to developing a correct pricing model, but never mind.

The report found, astonishingly, that “actuaries view much of equity-release pricing and proposition work as (technical) actuarial work, in common with valuation and capital activity”.

Unsurprisingly, the extensive bibliography did not include  The Eumaeus Guide to Equity Release Valuation: Restating the Case for a Market Consistent Approach, 2nd edition. KSP Books.

 

 

Posted on

More nonsense from the Bank

Sarah Breeden (Bank Of England Executive Director, Financial Stability Strategy And Risk) who has said this today:

Many UK DB pension schemes have been in deficit, meaning their liabilities – their commitments to pay out to pensioners in the future – exceed the assets they hold. DB pension schemes invest in long-term bonds to hedge the interest rate and inflation risk that arises from these long-term liabilities. But that doesn’t help them to close their deficit. To do that, they invest in ‘growth assets’, such as equities, to get extra return to grow the value of their assets. An LDI strategy delivers this, using leveraged gilt funds to allow schemes both to maintain material hedges and to invest in growth assets. Of course that leverage needs to be well managed.

She does not mention at all the risk to these funds from investing in risky assets (anywhere in the speech) and the part above would lead an outsider (like many pension fund trustees) to think that taking risk via leverage is a sensible thing to do.

To be fair, she adds

Leverage is of course not the only cause of systemic vulnerability in the non-bank system – as we have seen with liquidity mismatch driving run dynamics in money market funds (MMFs) and open-ended funds (OEFs) during the dash for cash. ] But it is important where any form of leverage is core to a non-bank’s business and trading strategy. Indeed what happened to LDI funds is just the latest example of poorly managed non-bank leverage throwing a large rock into the pool of financial stability. From Long Term Capital Management in 1998; to the 2007 run on the repo market; to hedge fund behaviour in the 2020 dash for cash; and the failure of Archegos in 2021.

Nice of her to set out where the Bank failed in one of its two core objectives! As for the other core objective, er …

Posted on

The Liability Driven Investments Problem is Bigger than It Looks

I (Buckner) will be presenting on the subject of LDI and the ‘bigger than it looks’ problem on Nov 3, 2022 04:30 PM London, by Zoom.

If you would like to attend, please contact me here for the flyer, and the Zoom link.

“The September 28th collapse in the gilts market led the Bank of England to announce a £65bn programme to stabilise long-term interest rates and save UK pension schemes from defaulting on their Liability Driven Investment (LDI) positions by the end of that day. Schemes had experienced liquidity problems on their Interest Rate Swap positions, losses on which had triggered margin calls requiring them to sell assets.

“The affair has highlighted the danger of hedging illiquid positions with liquid ones. I shall argue, based on a model of the underlying interest rate transformation involved in LDI, that there is more to the issue than has yet been appreciated.”

 

 

Posted on

So what’s going on then?

Another mystery. This report from PwC says that the total pension deficit has reduced as a result of rise in yields.

They say that their source is data from the Pension Protection Fund.  But see the chart above which I have overlaid with my estimate of the price of a 2030 gilt. You see that the 2030 gilt value precisely tracks the PPF liability estimates.

Here is the mystery: why so, given that LDI exists, and that LDI immunises schemes from changes in the long gilt rate?

Note also that the PPF say “”Conventional and index-linked gilt yields are used to value liabilities. *We do not hold sufficient data* to capture the impact of any structural changes to asset allocations nor to accurately capture changes in any leveraged LDI portfolios.”

So what is the true position?

Posted on

Ups and downs

The chart above simulates the price history of a 2% coupon 30 year gilt purchased at the beginning of January 2017 and held until  now (18 October). As you clearly see, the price rose throughout 2019, 2020 and most of 2021, then abruptly collapses, with the decline accelerating towards the third quarter of 2022. As journalists live to say “gilt prices fall as yields rise”. Quite.

No comment for now. I will discuss the odd but significant blip in March 2020 in the next post.

Posted on

What are the losses from LDI?

 

The coverage of the Liability Driven Investments affair has been highly polarized. On the one hand, there are those (mostly consultants) suggesting it is a storm in a tea cup, LDI working ‘as expected’, nothing to see here, move on.

On the other hand, actuaries like Richard Lund, speaking  at the First Actuarial Conference about severely disrupted core gilt market functioning, excessive and sudden tightening of financing conditions for the real economy etc etc.

Someone should at least be answering questions. E.g. if there have been losses, how much are they?  See the chart above. A long-dated bond (here 18 years) could easily have halved in value with a move in rates from 2% to 5%. Any scheme that sold at those levels will have incurred a massive loss, or so you would think. Clearers like Northern Trust reported being overwhelmed by a slew of margin calls during bond market turmoil, so we know that selling happened.

So who was selling? And how much was lost? “We should be told”.