I’ve been working with a few insurers and reinsurers on credit risk recently. We’ve had plenty of reasons to think about it, what with new regulations (SAM, Basel III) and South African government downgrades. However, sometimes I get the impression that credit risk is viewed as an academic risk, as something that happens to others, micro lenders and maybe banks.
In South Africa, we’ve had incredibly few corporate bond defaults and most market participants don’t even know that the South African government “restructured” some of its debt in 1984 and so has, in fact, defaulted on contractual bond obligations.
In a recent credit risk and capital workshop, I raised the issue of Russia defaulting on Ruble-denominated debt in 1998, a big part of what led to the collapse of LTCM. Again, these events are often figured as “exceptionally unlikely” and not even worth holding capital.
Well, in the news, Argentina is about to default. Again. They have been one of the most regular defaulters on sovereign debt in the last couple of centuries. They’re also an example I often use of “currency pegs” doing precious little to mitigate currency risk except on a day to day basis.
More on that in another post (yes, I’m hoping to post a little more regularly in the coming months.)
A client recently mentioned that they were concerned about the implication that the adoption of Solvency Assessment and Management (SAM) would have on insurance accounting under current IFRS4.
The apparent concern was that measurement of policyholder liabilities for IFRS reporting would change to follow SAM automatically.
Let me start out by saying this is categorically not the case. The adoption of SAM should not change IFRS measurement of insurance liabilities. In this post I’ll cover some of the technical details and common misconceptions of IFRS4 to demonstrate why this conclusion is so clear. Continue reading “The Perfect Storm Part 1 – IFRS reporting under SAM”
The world of financial reporting for insurers has never been this close to the edge.
There is more change brewing now even than when Europe adopted “European Embedded Values” and later “Market Consistent Embedded Values”. The irony is that Embedded Values may well fall away as a result of the latest change.
So what is changing?
- Solvency Assessment and Management (SAM) is still planned for 2015 in South Africa. SAM will change the calculation of actuarial reserves, or Technical Provisions as they are now known, for regulatory reporting purposes. Solvency II in Europe is now likely to follow rather than precede SAM by a few year, but with nearly identical implications.
- IFRS4, the accounting standard covering insurance contracts, is due for a radical change effective in 2016/2017, although this is years later than originally planned. IFRS4 “Phase 2” as it is referred to throws out most of what we’re used to in terms of profit recognition, financial impact of assumption changes, impacts of asset and liability mismatches and may very well push insurers to value their assets on a different basis.
- IFRS9, a new standard replacing IAS39 and covering financial instruments, whether these are assets or liabilities, will poke and prod insurers into different decisions now and possibly before knowing exactly how IFRS4 will pan out.
- Finally, although this part is still speculative, Embedded Value reporting may fall away as SAM and Solvency II achieve much of the objections of Embedded Value.
This post is the first in a series covering important aspects if the change in financial reporting standards, covering news of the developments as it emerges as well as the likely implications for financial reporting, product design, ALM, financial reinsurance and others. I’d encourage you to post comments or questions on this or later posts and I’ll try to answer those through the series.
- Part 1 – IFRS reporting under SAM
- Part 2 – EV in a SAM/Solvency II world
- Part 3 – Apocalypse! – SAM as the tax basis
- Part 4 – Acquisition accounting under IFRS4 Phase II – a little speculation
The Technical Provisions Task Group and KPMG ran a workshop for industry participation on risk-free rates recently. The idea was to see whether we could improve the extent and quality of industry comment on key, controversial areas of the proposed SAM regime.
Turnout was good, but not great, but the discussion and points raised were all fantastic. Plenty more to do from here onwards, but I thought it might be useful to include the presentations somewhere publicly available.
Some of the concepts that were on the agenda
- Swaps vs Bonds, the theory as well as practical implications for insurers, banks and the capital markets
- Extrapolation methods and what challenges this creates for practitioners
- Identifying and measuring illiquidity premiums, credit spreads and the difference between Expected Default Loss and Credit Risk Premiums
- European developments on Matching Adjustments and Countercyclical Premiums. Should we follow their path? Is bottom-up or top-down more practical?
- Do we need a methodology for nominal and/or real yield curves?
- Non-South African countries – what is the practical answer to requiring multiple yield curves?
- Reducing regulatory arbitrage between banks and insurers for credit and market risk on swaps and bonds
- David Kirk
- Ian Marshall
- Philip Harrison
- Brian Kipps
- Lance Osburn
- Lindy Schmaman
- Louis Scheepers
Presentations (reproduced with permission from the authors)
Risk free rate workshop outline November 2012
Position Paper 40 (v 3)
Philip Harrison – Risk Free SAM Workshop
Risk free yield curves Brian Kipps
Risk-free rate workshop_LSchmaman
SAM Risk Free 29 Nov012 Louis Scheepers
SAM Workshop 20121129 Lance Osburn
I haven’t posted in ages – plenty happening on the work front, which is mostly good news. I also don’t really have time to comment properly on this article but Wits academic, Robert Vivian, but it’s interesting reading all the same.
Read Vivian’s letter first and then come back to my comments.
I can’t help but feel Vivian doesn’t actually understand the rationale for the proposed system and therefore gets a little frothy at the mouth about how awful it is. That’s not to say his criticisms shouldn’t be taken seriously – there are flaws in the proposed approach but it’s not clear to me that these are worse than a system that moves at the pace of continental drift because of exceptionally slow Parliamentary processes.
This maybe reflects a imperfectly functioning legislative process, which is a separate issue to discuss entirely.
It also reflects the reality that very few in Parliament (our country and most others I would imagine) have the time or technical knowledge to influence many of these laws anyway. Requiring a parliamentary process may not actually change the law-making function.
The final point here is that there is precedent here from a European perspective, so we’re not totally out on a limb in South Africa.
Maybe Vivian could rather suggest some tweaks that put his mind at ease about sentencing individuals to death by law without returning us to a stagnating world of too-slow legislative changes?
A client was asking about the key changes coming up for SAM Interim Measures. This document (from the FSB) is about the best summary I’ve seen: Interim Measures Update (Governance)
My take on this is that the FSB is basically expecting compliance or a pretty concerted effort and reasonable compliance with these requirements NOW. The original plan was for these to go live in 2012. That was for good reason – it will take a while to polish these up and there is plenty more required before full implementation of Pillar Two requirements.
Apparently the Insurance Laws Amendment Bill is still with National Treasury and is unlikely to be passed by Parliament this year. So breathing space if you’re not currently compliant, but also time to get a move on and get these things in place.
Maybe it doesn’t feel like a brave prediction, but the official word is still Jan 2014. But this is me sticking my pole in the sand – there’s too much uncertainty, too much politics going on to get this right in time.
Lots on this topic to come over the next few months.