Market Value Based Accounting and Capital Framework

Transcription

1 Market Value Based Accounting and Capital Framework Presented by: Erik Anderson, FSA, MAAA New York Life Insurance Company Prannoy Chaudhury, FSA, MAAA Milliman 2014 ASNY Meeting November 5, November 2014

2 Agenda 1. Introduction (PC) FSB/IAIS Proposed International Capital Standards: BCR, HLA, ICS 2. Implications of use of Market-Based Capital Standards (PC) Modelling illustrations (EA) Real world case studies: Switzerland and Netherlands (PC) Macroeconomic consequences (PC) 3. Alternatives to using Market-Based Frameworks for Capital (EA) 2 07 November 2014

3 Agenda 1. Introduction (PC) FSB/IAIS Proposed International Capital Standards: BCR, HLA, ICS 2. Implications of use of Market-Based Capital Standards (PC) Modelling illustrations (EA) Real world case studies: Switzerland and Netherlands (PC) Macroeconomic consequences (PC) 3. Alternatives to using Market-Based Frameworks for Capital (EA) 3 07 November 2014

4 Impact of Financial Crisis G20 tasks the Financial Stability Board ( FSB ) to develop policy guidelines for regulating systemically important financial institutions ( SIFIs ), including insurance companies. o G-SIIs Global Systemically Important Insurers FSB relies on the International Association of Insurance Supervisors ( IAIS ) for setting policies relating to insurers 4 07 November 2014

5 IAIS Established in 1994 Represents insurance regulators and supervisors from 200 jurisdictions and 140 countries. o Constitutes 97% of world s insurance premiums Objectives: 1. Promote effective and globally consistent supervision 2. Contribute to financial stability IAIS does not have the ability to require implementation of policies/guidelines it promotes November 2014

6 What is the IAIS doing? Developed methodology, used by FSB, to determine: 1. G-SIIs Global Systemically Important Insurers Insurers whose failure could destabilize global financial system 9: Allianz AIG Aviva Axa Generali Metlife Ping An Prudential Financial Prudential plc 2. IAIGs Internationally Active Insurance Groups Premiums are written in not fewer than 3 jurisdictions, and % of gross premiums written outside of home jurisdiction is not < 10% of total gross premium, and Size: total net assets not less than $50 bln, or Gross premiums not less than $10 bln Develop capital requirements for G-SIIs and IAIGs 6 07 November 2014

7 Capital Requirements BCR Basic Capital Requirement For G-SIIs Consolidated group-wide capital requirement Covers material asset and liability risks; excludes business risks HLA Higher Loss Absorbency For G-SIIs Additional capital to for G-SIIs reflecting their systemic importance Guided by work on BCR ICS Insurance Capital Standard For IAIGs (initially) Group-wide capital requirement, also covering business risks BCR (only G-SIIs) maybe be replaced by ICS. (HLA would still apply for G-SIIs) 7 07 November 2014

8 Capital Requirements - Timeline BCR HLA Endorsed by FSB on Oct (To be endorsed by G20 in Nov. 2014) To be reported by G-SII s starting in 2015 (on confidential basis) To be completed by end of 2015 Applies from 2019 ICS Consultation Dec Finalise in 2016 Implement in November 2014

9 BCR Guiding Principles 1. Major risk categories to be reflected 2. Comparability across jurisdictions 3. Resilience to stress 4. Simple design and presentation 5. Internal consistency 6. Optimize transparency and use of public data 9 07 November 2014

10 BCR BCR % = Total Qualifying Capital Resource / Required Capital Required Capital Αα = 100% Insurance Non-Insurance November 2014

11 BCR Total Qualifying Capital Resource: Core Capital permanent capital fully available to cover losses E.g., Assets with fixed maturities cannot qualify as core capital Additional Capital lacks characteristics of core capital, but still is subordinated to rights of policyholders Cannot exceed 50% of Required Capital November 2014

12 Current Estimate of Assets & Liabilities Based on a Market Adjusted Valuation Approach Liabilities Calculated as probability-weighted average PV of benefits (net of reinsurance) and expenses, discounted at IAIS specified curve IAIS specified curves are based on swaps/government bonds plus adjustment to account for portion of the credit spread on investment grade corporate bonds Assets To be based on fair-value as determined by the G-SII s presiding IFRS or GAAP standards November 2014

13 Agenda 1. Introduction (PC) FSB/IAIS Proposed International Capital Standards: BCR, HLA, ICS 2. Implications of use of Market-Based Capital Standards (PC) Modelling illustrations (EA) Real world case studies: Switzerland and Netherlands (PC) Macroeconomic consequences (PC) 3. Alternatives to using Market-Based Frameworks for Capital (EA) November 2014

14 Concerns with a Market-Based Approach A market-based approach may be sensible for products with relatively short-term, liquid liabilities However, it is ill suited for illiquid, long-duration life insurance, annuity and long-term care products offered by many U.S. life insurers Introduces significant, pro-cyclical volatility to the solvency balance sheet November 2014

15 Market-Based Balance Sheet Modeling Illustrations Modeling illustrations demonstrate that a market-based approach inappropriately increases balance sheet volatility for insurers writing long-duration illiquid products in times of stress Illustrative Case Studies: 1. Single Premium Immediate Annuity (SPIA): Credit Spread Shock, similar to Long Term Care Insurance (LTC): Interest Rate Shock-Down, similar to November 2014

16 Illustrative SPIA: Credit Spread Shock (2008) Which of these lines paints a realistic picture of how SPIA blocks performed in the recent financial crisis? $ Millions Projection Year U.S. GAAP Equity Adjusted U.S. GAAP Equity (Excluding AOCI) U.S. SAP Surplus "Market-Based" Surplus November 2014

17 Illustrative LTC: Interest Rate Shock-Down (2011) Which of these lines paints a realistic picture of how LTC blocks performed during the 2011 debt ceiling stalemate? $ Millions Projection Year U.S. GAAP Equity Adjusted U.S. GAAP Equity (Excluding AOCI) U.S. SAP Surplus "Market-Based" Surplus November 2014

18 Potential Adverse Consequences Volatility would unnecessarily increase the cost of capital for long-duration insurance products Unnecessary additional capital needed to offset the optics of market-based volatility In an effort to reduce this non-economic volatility, life insurers may take one or more of the following actions: Make considerable changes to product design De-risk their portfolios by increasing investments in gov t bonds Raise prices or exit the market Negative impact on consumers: Higher prices Less generous product offerings Loss of availability of long-duration products November 2014

19 Case Study: Switzerland Swiss statutory accounting is based on a book-value basis However, is not a major driver of company behaviour Swiss Solvency Test ( SST ) Key driver of management decisions Used by regulators to ensure capital available at 99% confidence level over 1 year horizon. All balance sheet items on a mark-to-market basis Valuation of liabilities incorporate all options and guarantees. Guarantees valued using the Swiss government yield curve November 2014

20 Case Study: Switzerland Drivers for development of SST Product pricing in 1990 s assumed high reinvestment rates Low interest rates in Switzerland in early 2000 s. Considered a safe haven economy. Statutory financials (on a book-value basis) did not highlight strain of under pricing guarantees Losses accumulated as reinvestment earnings were well short of pricing assumptions Lead to many companies being economically insolvent November 2014

21 Case Study: Switzerland Impact of SST on Swiss life insurance industry Sale of insurance products with long-term guarantees almost disappeared Given insurers asset investment in risk-free bonds (to hedge guarantees), long-duration contracts became very expensive. Risk products (mortality, disability) were made popular in the sales channels However, every took this step and so profit margins were squeezed. Sales of unit-linked products were encouraged However, insurers do not have a unique selling proposition November 2014

22 Case Study: Switzerland Impact of SST on Swiss life insurance industry November 2014

23 Case Study: Netherlands WFT 2007 Adequacy Test Is the key test used by regulators to analyze sufficiency of assets backing liabilities Assets and liabilities are valued under a market consistent framework Has strong similarities to MCEV TSC Regulatory Capital for Dutch insurers Implemented 2014; Similar to Solvency II At high level, TSC required capital is calculated by applying tail event shocks to market value of assets and liabilities (e.g., 1/200 event) MCEV Is a market-value based framework Common reported to investors by Dutch (and European) insurers November 2014

24 Case Study: Netherlands Impact of market consistent framework Many Dutch insurers (Achmea, Real) have put blocks into run-off Noted, e.g., compressed profit margins under MCEV for lifetime immediate annuities Prolonged low interest rates have exacerbated the situation Immediate annuities Sales have been negatively impacted since introduction of WFT 2007 Adequacy Test / MCEV (products have become more expensive) However, demand continues due to regulatory requirement Banks are taking advantage of regulatory arbitrage November 2014

25 Macroeconomic Consequences Life insurers may reduce or eliminate long-duration product offerings Who would fill the societal needs for annuities/pensions? Impact on credit markets If long-duration product sales decline: Decreased investment in long-duration bonds Switzerland: according to BIS in 2011, SST led to the inverted yield curve for gov t bonds between maturities of 15 and 30 years November 2014

26 Macroeconomic Consequences Life Insurer Investment in Long-Duration Corporate Bonds $ Billions Year Corp Bonds 20+ Year Corp Bonds Source: American Council of Life Insurers, Life Insurers Fact Books data adjusted from that published in the Life Insurers Fact Books based on additional information provided by the American Council of Life Insurers to include mortgage-backed securities November 2014

27 Agenda 1. Introduction (PC) FSB/IAIS Proposed International Capital Standards: BCR, HLA, ICS 2. Implications of use of Market-Based Capital Standards (PC) Modelling illustrations (EA) Real world case studies: Switzerland and Netherlands (PC) Macroeconomic consequences (PC) 3. Alternatives to using Market-Based Frameworks for Capital (EA) November 2014

28 Alternatives to using Market-Based Frameworks for Capital 1. Adjustments/accommodations to market-based accounting 2. Anchor to local accounting standards (i.e., local GAAP) 3. Cash flow stress testing (not balance sheet-based) November 2014

29 Accommodations to Market-Based Accounting Solvency II includes several accommodations, such as: Volatility adjustment: include 65% of credit spread (net of expected defaults) in liability discount rate Matching adjustment: under some circumstances, include 100% of credit spread (net of expected defaults) in liability discount rate BCR includes a modest accommodation: 40% of credit spread included in liability discount rate Significant balance sheet volatility remains, even with 40% adjustment Credit spread based on a reference portfolio rather than company s own portfolio Neither Solvency II nor BCR includes accommodations for very long duration products where asset-liability matching is not possible November 2014

30 Anchor to Local Accounting Standards Anchoring to general purpose financial statements has strong appeal Audited provides comfort to supervisors Company executives familiar with local accounting standards Local accounting standards generally did not arise by historical accident tend to be tailored to be appropriate for the types of insurance products that a jurisdiction seeks to incentivize (e.g., long-duration insurance products in U.S.) Main concern with global solvency framework that is anchored to local accounting: Comparability BCR is based on a common global balance sheet that is a new accounting standard Not a carbon copy of any particular regime s accounting standard Yet, clearly closer to IFRS than to U.S. GAAP or statutory accounting November 2014

31 Cash Flow Stress Testing Cash flow stress testing starts with the key question at the heart of an appropriate capital standard: will insurers have the necessary cash flows to satisfy liabilities and safeguard financial stability during periods of stress? Insurers stress test asset and liability cash flows under a set of prescribed scenarios One year stresses and multi-year stresses Economic stresses and insurance stresses If it is deemed necessary to develop a capital ratio in order to rank well-capitalized companies, the results of cash flow stress testing can be used to calculate a ratio of available capital to required capital November 2014

32 Advantages of Cash Flow Stress Testing Provide regulators with an effective means to understand and evaluate the risks faced by insurers and the adequacy of the reserves and capital held to manage those risks Ensure solvency and financial stability in a globally consistent manner, without imposing a single system of accounting across different jurisdictions (cash flows are accounting agnostic ) Reflect major risk categories and explicitly demonstrate resilience to stress Avoid the pro-cyclical outcomes of a market-based accounting basis Preserve appropriate incentives for insurers to continue offering sound, long-duration products that provide security to consumers November 2014

33 Comparison of 3 Approaches Market-based framework Local accounting framework Cash flow stress testing Appropriate for US products Likely No unless strong accommodations made for longduration products Yes Allows for global comparability Yes Likely No unless comparability is defined in a broad, directional sense Balance sheet anchor Yes Yes Yes Yes No but does this truly matter? November 2014

34 Questions? November 2014

35 Contact Information Erik Anderson Prannoy Chaudhury November 2014