As we (Kevin and I) are now getting ERM and other work published in peer reviewed journals, we have set up a page. Enjoy.
City watchdog on alert
The Sunday Times featured our UKSA letter to the FCA yesterday.
Just days before the deadline for 1.2 million policy members of the mutual insurer to vote on the controversial deal, concerns were raised with Charles Randell, chairman of the Financial Conduct Authority.
The UK Shareholders’ Association wrote to Randell to query a description of the “with-profits” fund that, in effect, owns the insurer and is backed by policyholders as being “ring-fenced”.
The lobby group fears that the fund could be used to prop up the business if the Bain-owned business ran into financial difficulty.
Our letter coincided with a letter in similar vein sent by solicitors Leigh Day on behalf of some LV members, urging the FCA to withdraw its non-objection to the acquisition by Bain Capital and postpone the vote until it addresses a series of issues. The Mail reports:
They [the members] claim the process has been defined by a ‘material lack of procedural fairness’ and accuse bosses of providing ‘incomplete and/or contradictory information’ about the £530million takeover by Bain Capital. …’This is a deeply unsatisfactory situation which the FCA has allowed to take place and is unfair to the members of LV,’ the letter states.
The Leigh Day letter outlines a number of concerns, including the question whether the with-profits fund is really ‘ringfenced’.
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.
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.
Dodgy Dealing?
Lovely article “Baroness Bowles questions UKEB over “true and fair” assessment” by Cintia Cheong in today’s Guy Fawkes special edition of Insurance ERM. In essence, the good baroness accuses the UK’s accounting standard Endorsement Board (UKEB) of dodgy dealing.
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.
In da house
An interesting set of questions here from Baroness Bowles of Berkhamsted about a possible conflict of interest in advice to the UK Endorsement Board.
Question[s] for Department for Business, Energy and Industrial Strategy Baroness Bowles of Berkhamsted Liberal Democrat, Life peer.
Asked 14 October 2021
Due for answer in 13 days (by 28 October 2021)
To ask Her Majesty’s Government why the UK Endorsement Board is not using in-house counsel to instruct barristers for public interest legal advice; and why they are instead using Katherine Coates.
To ask Her Majesty’s Government what assessment, if any, the UK Endorsement Board have made of any potential conflict of interest of instructing Martin Moore QC to work on the endorsement of accounting standards either (1) directly, or (2) indirectly.
To ask Her Majesty’s Government whether the UK Endorsement Board has sought the advice of Martin Moore QC in the course of seeking endorsement of for its accounting standards either (1) directly, or (2) indirectly through Michael Todd QC.
To ask Her Majesty’s Government whether they will place copies of the tender documentation of the UK Endorsement Board for the procurement of legal advice and legal opinions in the Library of the House.
What could all that be about?
Letter to IASB
The UK Shareholders letter to the IASB is now published here, in response to the Board’s public consultation on its activities and its work plan for the next five years.
Naturally we argue that discount rates should loom large in the Board’s forthcoming work.
In the Appendix, we reject the Board’s argument that we should discount liabilities by more than the risk free rate, their thinking being that a liquid bond has an embedded option to sell the bond at market, an illiquid bond does not contain that option, ergo the illiquid bond should be cheaper.
Their thinking is utterly fallacious, for the reasons given in the Appendix. Perhaps I shouldn’t call it ‘thinking’. Wittgenstein “Thought can never be of anything illogical, since, if it were, we should have to think illogically” (Tractatus 3.03).
Other comment letters are listed here.
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!
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.