SAM Risk-free Rate Workshop

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

Panel Members:

  • 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

 

IASB re-exposing IFRS 4 Phase 2

So, as I expected given the fundamental changes to IFRS 4 in recent months, the IASB is doing the grown-up thing and is re-exposing the latest version of the insurance accounting standard later this year early next year.

They are restricting questions to areas that have changed or where final decisions haven’t been made, which I suppose is also fair enough and ensures focus is on the key new areas.

Re-exposure for a period, analysis of comments, reworking of any sections as a result of those comments… There is still a fair amount of work to be done!

Implementation 2016 / 2017 is most likely.

Greek default?

So European politicians have more or less agreed a deal which may, more or less, push some of their problems to one side for a period. Yes, I’m not madly optimistic about this as a cure-all.  This is not the end of the Euro problems.

Part of the deal is a “50% loss for private investors”. Which is part true and part nonsense but will be an effective Greek default when enacted / agreed. (I don’t care how “voluntary” it may be, it’s a default and almost all definitions of default include restructuring of debt in any way that isn’t what was originally promised.)

Why is it only partly true? Well it’s not necessarily a “loss” for private investors. The probability of default on Greek bonds has been just about 100% for a while now. This probability of default is derived from market prices for Greek bonds and market spreads on Greek Credit Default Swaps (CDS) and an assumed Loss Given Default or Recovery Rate for investors when the bonds do default. Actual Recovery Rates vary widely, but often analysts plug in the average Recovery Rate over most of this century on unsecured debt which is around 40%.

So if market prices for Greek bonds assumed 100% default probability and a 40% recovery, then a 50% recovery doesn’t sound so bad. The potential downside is that Greece may still (need to) default on these written-down bonds at some point in the next two decades.

So the real question is what will the new probability of default be? Then we will know whether investors “took a loss” and perhaps gain the market’s view on how successful the deal really will be.