Changes in ALM under LAGIC

15 Pages·2014·0.23 MB·English

by  Sarah Gibson

Changes in ALM under LAGIC
Gerard Callaghan
Peter Baker

© 2014 Deloitte Actuaries & Consultants Limited

This presentation has been prepared for the Actuaries Institute 2014 Financial Services Forum.
The Institute Council wishes it to be understood that opinions put forward herein are not necessarily those of the Institute and the Council
is not responsible for those opinions.
Agenda
- Impact of LAGIC changes on Life Insurer Capital Slides 3-7

- Target surplus setting Slides 8-10

- How to manage the resulting volatility Slides 11-13
LAGIC has made capital requirements more
risk sensitive
- Now “risk based” rather than scenario based
- Key impacts on Capital (old vs new):
- Net DTA must be
written off
- Asset risk charges are Supervisory
Adjustment
higher
- Explicit stresses on Combined - Less diversified
Stress
inflation (liabilities) and Aggregation Scenario insurers “suffer” –
infrastructure (assets) Asset Risk Benefit Adjustment small amount of
Charge
diversification
Prudential Single benefits
Capital Scenario
Insurance risk
Requirement
PCA charge
- Liability “cliff” –
- Some insurance stresses Operational sudden impact of
Risk Charge
now not so conservative Policy Liability
as scenarios implied Asset exceeding TV
Concentration
- Asset “cliff” –
Risk Charge
APL sudden impact of
- Explicit operational risk
PH assets running
charge
Individual lessAB plus
out.
charges Adjustments
Capital requirements are more volatile
FI book – stronger stresses
Decreasing volatility Increasing volatility
Capital Requirement -Risk, 100% FI
- Insurance risk – - Larger asset stresses
7.00
some stresses less now applied
6.00
conservative - Explicit CPI stress
5.00
- Diversification – (liabilities) and e
helps to smooth infrastructure stress Titl4.00
s
capital introduced xi3.00 Old
A
- Illiquidity premium 2.00 New
1.00
0.00
Risky annuity book – illiquidity premium 7 7 8 8 8 9 9 0 0 0 1 1 2 2 3 3 3
0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1
Capital Requirement -Annuities, 80% FI risky assets, Mar- Aug- Jan- Jun- Nov- Apr- Sep- Feb- Jul- Dec- May- Oct- Mar- Aug- Jan- Jun- Nov-
20% Equities, plus illiquidity prem
Standard Risk Annuities w/Illiq prem
14.00
Deviation 100% FI 80% risky FI, 20% Eq
12.00 Old New Old New
10.00 Last 4 years 0.35 0.75 0.11 0.39
al 8.00 Last 2 years 0.11 0.22 0.07 0.32
pit
a 6.00 Old
C
More volatility under both scenarios.
4.00 New
2.00 • Risk scenario: 30% CGS, 60% CGS indexed bonds, 10%
0.00 corporate debt (AA rating). Ca 3yr effective duration.
7 7 8 8 8 9 9 0 0 0 1 1 2 2 3 3 3
0 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 • Annuities scenario: 10% CGS indexed bonds, 70%
Mar- Aug- Jan- Jun- Nov- Apr- Sep- Feb- Jul- Dec- May- Oct- Mar- Aug- Jan- Jun- Nov- corporate debt (AA rating), 20% equities. Source: Deloitte analysis.
Volatility from “new risks” : Solvency 2 example
• Liabilities are discounted using Swap (LIBOR) based rates
• Inflation (RPI / LPI) and interest rate swap cash flows use are discounted using
Overnight Index Swap (OIS) rates (i.e SONIA) when marking to market
• Historically SONIA and LIBOR were almost identical
• This changed dramatically during the GFC…meaning liabilities did not move
similarly to assets as was expected

• Could something similar happen in stressed conditions in Australia?
• Liabilities discounted at Commonwealth government bond yields
• Swaps pricing based on BBSW and discounted using OIS rates?
Pre Crisis Mid Crisis Post Crisis
15 October 2008
SONIA vs LIBOR 29 Oct 2013
SONIA vs LIBOR
• Difference between LIBOR & 5.1 5
4.9 4.5
SONIA almost zero
4.7 4
3.5
4.5
3
% 4.3 % 2.5
4.1 2
1.5
3.9
1
3.7 0.5
3.5 0
Terms (yrs) Terms (yrs)
Sonia Libor
Sonia Libor
Difference Difference Difference

Difference Difference
LIBOR - SONIA
LIBOR - SONIA

1.2 1.2
• Difference almost zero
1 1
0.8 0.8
% 0.6 % 0.6
0.4 0.4
0.2 0.2
0 0
Terms Terms
Australian 5 year swap
Australian 10 year swap
spreads
spreads
9 140
8 120
8
120 7
100
7
6
100
) )
6 p 80 p
%) 80 d (b (%) 5 d (b
s (5 ea ds ea
Yieldd4 60 ap Spr Yield 34 60 ap Spr
3 w 40 w
S S
40
2
2
20
20 1
1
0 0
0 0
4 4 5 6 6 7 8 8 9 0 0 1 2 2 3 4
4 4 5 6 6 7 8 8 9 0 0 1 2 2 3 4 0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1
0 0 0 0 0 0 0 0 0 1 1 1 1 1 1 1 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2
3/2 1/2 7/2 3/2 1/2 7/2 3/2 1/2 7/2 3/2 1/2 7/2 3/2 1/2 7/2 3/2 03/ 11/ 07/ 03/ 11/ 07/ 03/ 11/ 07/ 03/ 11/ 07/ 03/ 11/ 07/ 03/
1/0 1/1 1/0 1/0 1/1 1/0 1/0 1/1 1/0 1/0 1/1 1/0 1/0 1/1 1/0 1/0 01/ 01/ 01/ 01/ 01/ 01/ 01/ 01/ 01/ 01/ 01/ 01/ 01/ 01/ 01/ 01/
0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
Government yield Swap rate Swap Spread
Government yield Swap rate Swap Spread
How to manage a volatile capital
position?
• Accept a certain level of volatility through
risk appetite and set commensurate
target surplus?
• Actively seek to reduce volatility – tighter
hedging programs (e.g. inflation), asset
allocation?
• A bit of both?
Formalisation of Target surplus setting
ICAAP has formalised the process of
target surplus calculation:
• What do we need target surplus for?
– New business
– Change in market conditions –
more so than before
– Change in risk from assumption
changes

• Considerations to include
– Board’s risk appetite framework
– Sensitivities of PCR calculation
– Business plan considerations
– Access to capital / shareholder
preferences
– Desired credit rating
Source: Ian Laughlin, FSAA presentation, 6 June 2013
http://www.apra.gov.au/Speeches/Documents/FSAA-Presentation-3-June-2013-Ian-Laughlin-for-Publication.pdf
Approaches to Target surplus setting
How is it typically done?
– Par funds in run-off – need for derisking
Advantages Disadvantages Market popularity
LAGIC approach, but • Clear, objective calculation • More volatile • Still less common, but
with stronger shocks • Aligned with LAGIC/ICAAP • Need to watch out for gaining popularity
“cliffs”
• Can be built on existing LAGIC
calcs • Technical to explain
movements to management
Stress and scenario • Aligned with ICAAP • Subjective • Less popular – to the extent
testing approach • Easy to explain to management required under ICAAP
High level allocation • Stable • Can lead to higher amount • Popular amongst well-
of excess assets – inefficient capitalised companies
• Easily understood
Combined approaches • Best of both worlds • Additional work • Popular amongst larger
(high level plus LAGIC) sophisticated companies