Asleep at the wheel again

I have so far dwelt on the positive aspects of PS 31/18. It is a landmark paper by the PRA in that for the first time it settles, with great authority and a wealth of cogent reasoning, how life insurers should correctly value a portfolio of simple European put options. Other non-insurance institutions have valued them correctly for a long time, but never mind that, it is an important breakthrough notwithstanding. In his letter of 10 December, David Rule stresses the importance of not valuing options in a way that assumes future house price growth (and by implication any asset growth) in excess of the risk-free rate.

But all is not well.

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Long, Long, Long

As noted earlier, there was a presentation at Staple Inn yesterday evening on equity release mortgages, and this appears to be the paper. The strange jumble of ideas presented in the paper is connected with a much deeper question, namely why it took so long (more than four years) for the PRA to decide how to value a simple European option.

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Out today

Policy Statement 31/18 was published this morning. Contains a lengthy section addressing comments to the proposals of CP 13/18.

The main part which will interest the market is the removal of the proposals relating to the TMTP (paragraphs 3.9A, 3.24 and 3.25). Para 3.25 is the one that reads:

3.25 Although the PRA does not consider the purpose of TMTP to be a transitioning of an updated assessment of risk, the PRA does recognise that the consequences of applying the new calibrations in the proposed updates to SS3/17 when calculating their ICAS illiquidity premium may be significant for some firms. In such cases, the PRA would consider making a proportionate allowance for that impact on the firm. The PRA would expect this to be a short phase-in period, dependent on the circumstances of the firm, unlikely to exceed three years in any event. The PRA would not expect firms to require this phase in period in relation to calculating their ICAS illiquidity premium consistently with principles (ii)-(iv) in SS3/17 already published in July 2017.

The updated CP is here

We will comment later!

More on Jonathan Ford on the UK’s Undercapitalised Banks

Kevin Dowd, 5 December 2018

Capital heaven

Dean wrote positively yesterday about Jonathan Ford’s Financial Times piece “The Illusion of UK bank capital strength,” published on 2 December 2018.

Jonathan is right to warn about UK banks being under-capitalised and it’s good to see a journalist of his standing picking up on this issue.

It is however disheartening to see some of the disgraceful abuse made in the ‘comments’ section underneath his article. “Please keep comments respectful,” the guidelines say. “By commenting, you agree to abide by our community guidelines and … terms and conditions.”

Maybe the FT should consider introducing a moderation process to filter out such abuse in future.

Turning to the subject at hand:

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The Search for the Holy Grail

“We believe more research needs to be completed”

Kevin Dowd 3 December 2018

Chris Cundy at InsuranceERM has just written a nice piece on Dean’s and my new report, Equity Release: A New Equitable in the Making published by the Institute for Applied Economics, Global Health, and the Study of Business Enterprise in their Studies in Applied Economics series. This new report is a follow-up to the Adam Smith Institute report Asleep at the Wheel: The Prudential Regulation Authority and the Equity Release Sector published on August 6th. To quote Chris’s article:

More criticism has emerged from Dean Buckner and Kevin Dowd on the valuation approach taken by some UK insurers investing in equity-release mortgages (ERMs) [who] earlier this year published a critique [Asleep at the Wheel] of how the no-negative equity guarantee (NNEG) element of ERMs was being under-valued, which results in ERM portfolios being over-valued.

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