Moderator: Eric Michel Fournier ASA,MAAA. Presenters: Eric Michel Fournier ASA,MAAA Jean-Frederic Breton Aymeric Kalife Phil Weeber

Transcription

1 Session 17: ERM Considerations Related to Hedging Program and Derivative use Plan Moderator: Eric Michel Fournier ASA,MAAA Presenters: Eric Michel Fournier ASA,MAAA Jean-Frederic Breton Aymeric Kalife Phil Weeber SOA Antitrust Disclaimer SOA Presentation Disclaimer

2 ERM and Hedging Aymeric Kalife, Head of Savings & Variable Annuities, AXA Group Risk Management Rony Sleiman, Head of Risk Management, National Life Group Michel Fournier, AVP Hedging Solutions, National Life Group April 19, 2018

3 Size and complexity matters! Large and complex companies have a greater need for comprehensive ERM Framework. You can t rely on hallway conversations when there are locations in multiple countries, time zones and languages! Smaller sized, less complex companies may focus on Risk Culture and key individuals. Hedging programs have specific requirements that may be challenging for smaller companies. What are the differences between ERM and Hedging programs for smaller vs larger companies?

4 AXA Overview AXA was founded in The takeover of the American insurance company The Equitable, came in 1991 S&P Financial Strength rating of AA- and Moody s Rating of Aa3 Approximately employees in 64 countries ~$ 113bn AuM ($ 61bn with living benefits) 3rd in VA sales in 2017 ($9.6bn, ~10% market share) Introduced its first line of individual variable annuity in 1970 Innovative individual life insurance and annuities (GMIB, Structured Capital Strategies, Managed Volatility funds w/o guarantees) Diversified relationship-based distribution: Independent Channel 4 th, Bank Channel 2 nd, Retail 2 nd ) with strong tied agents network Focus on middle-income, emerging affluent, and payroll deduction markets Built hedging platform 2003, introduced managed volatility mechanism in 2009 & Target Volatility funds and 2011, introduced Variable guaranteed rate in

5 DRAFT National Life Insurance Company (NLIC) was founded in Life Insurance Company of the Southwest (LSW) was chartered in S&P Financial Strength rating of A+, A.M. Best Rating of A and Moody s Rating of A2. Approximately 1000 employees Innovative individual life insurance and annuities Diversified relationship-based distribution Focused on long-term responsible growth Focus on middle-income, emerging affluent, and payroll deduction markets

6 Questions and Answers Moderator Questions Audience Questions 5

7 Financial Risk Management: The Role of the Derivative Use Plan April

8 Disclaimer CHATHAM HEDGING ADVISORS, LLC (CHA) IS A SUBSIDIARY OF CHATHAM FINANCIAL CORP. AND PROVIDES HEDGE ADVISORY, ACCOUNTING AND EXECUTION SERVICES RELATED TO SWAP TRANSACTIONS IN THE UNITED STATES. CHA IS REGISTERED WITH THE COMMODITY FUTURES TRADING COMMISSION (CFTC) AS A COMMODITY TRADING ADVISOR AND IS A MEMBER OF THE NATIONAL FUTURES ASSOCIATION (NFA); HOWEVER, NEITHER THE CFTC NOR THE NFA HAVE PASSED UPON THE MERITS OF PARTICIPATING IN ANY ADVISORY SERVICES OFFERED BY CHA. FOR FURTHER INFORMATION, PLEASE VISIT TRANSACTIONS IN OVER-THE-COUNTER DERIVATIVES (OR SWAPS ) HAVE SIGNIFICANT RISKS, INCLUDING, BUT NOT LIMITED TO, SUBSTANTIAL RISK OF LOSS. YOU SHOULD CONSULT YOUR OWN BUSINESS, LEGAL, TAX AND ACCOUNTING ADVISERS WITH RESPECT TO PROPOSED SWAP TRANSACTION AND YOU SHOULD REFRAIN FROM ENTERING INTO ANY SWAP TRANSACTION UNLESS YOU HAVE FULLY UNDERSTOOD THE TERMS AND RISKS OF THE TRANSACTION, INCLUDING THE EXTENT OF YOUR POTENTIAL RISK OF LOSS. THIS MATERIAL HAS BEEN PREPARED BY A SALES OR TRADING EMPLOYEE OR AGENT OF CHATHAM HEDGING ADVISORS AND COULD BE DEEMED A SOLICITATION FOR ENTERING INTO A DERIVATIVES TRANSACTION. THIS MATERIAL IS NOT A RESEARCH REPORT PREPARED BY CHATHAM HEDGING ADVISORS. IF YOU ARE NOT AN EXPERIENCED USER OF THE DERIVATIVES MARKETS, CAPABLE OF MAKING INDEPENDENT TRADING DECISIONS, THEN YOU SHOULD NOT RELY SOLELY ON THIS COMMUNICATION IN MAKING TRADING DECISIONS. 2

9 Chatham Financial 2,000+ Clients Both public and private corporations rely on Chatham for end-to-end economic and hedge accounting advisory, hedge execution, and technology solutions 500+ Hedge Accounting Clients Clients rely on Chatham for accounting and/or valuations all supported by the ChathamDirect Platform 500+ Employees Treasury practitioners, hedge accountants, regulatory experts, software engineers 6 Global Offices KSQ Denver London Krakow Singapore Melbourne $500 Billion Annual transaction notional volume 3

10 Today s Agenda 1 2 Financial Risk Management Objectives Derivative Use Plans 3 Best Practices 4

11 1 2 Financial Risk Management Objectives Derivative Use Plans 3 Best Practices 5

12 Five Key Elements to a Hedging Program 1 Identify and Quantify Risks 2 Determine Strategy 3 Execute Strategy 4 Reporting and Valuations 5 Review and Reassessment 6

13 Identify Risks and Determine Strategy Risk management considerations 7

14 Execute Strategy Understanding key cost drivers High Profile Beneath the Surface Market Rates or Option Cost Bid/Ask Spread Exposure Aggregation Credit Charges Gain or Loss on Trades Hedge Accounting Process Maintenance Developing People and Expertise Regulatory Compliance Lack of correlation/effectiveness 8

15 Review and Reassessment An approved hedging policy provides the standards for subsequent reviews Purpose and Objectives Purpose Objectives Thresholds / Risk Tolerances Definitions Types of Risks Types of Hedging Programs Hedge Products Sources of Exposure Hedging Strategy and Products Strategy Allowable Hedge Products Cost Considerations Metrics Measurement Compliance with the Dodd-Frank Act Institutional Suitability Controls Mandatory Clearing Reporting and Recordkeeping Compliance with EMIR Monitoring Clearing Thresholds Portfolio Reconciliation Reporting Monitoring Performance Monitoring Policy and Program Review Counterparty Risk Management Roles and Responsibilities Responsibilities and Qualifications Trading Limits / Controls External Advisors 9

16 1 2 Financial Risk Management Objectives Derivative Use Plans 3 Best Practices 10

17 Derivative Use Plans Risk management via derivatives for insurance companies is mandated Background In 1999, the State of New York passed Regulation 163 which governs the use of derivatives by insurance entities. Each state has followed with similar regulations. Intent of legislation was threefold: Allow prudent flexibility in uses of derivatives for hedging Modernize regulations Establish consistent governance and controls As one result of the legislation, any insurance firm desiring to use derivatives must have an approved Derivatives Use Plan 11

18 Derivative Use Plans State regulations specify the requirements for an approved plan Guidelines specifying: Type of derivatives Counterparty exposures Limitations on use of derivatives ALM practices Liquidity needs Capital constraints Derivative strategies Oversight Internal controls and reporting Documentation Definitions Defined acceptable level of: Basis risk Credit risk FX risk IR risk Market risk Operational risk Option risk Annual review by audit firm Plan must be submitted to State Plan must be authorized by Board 12

19 Derivative Use Plans Applying risk management frameworks specifically to insurance companies Recommended but not required Include purposes and objectives Be thorough without being prescriptive Valuation procedures Hedging strategies Include accounting policy and tax policy Reference to internal policy documents which can be updated with internal approvals but do not require resubmitting DUP to State 13

20 Derivative Use Plans Applying risk management frameworks specifically to insurance companies Counterparty credit ratings Improvement areas Example language: The company will only enter into derivative transactions with a bank or broker-dealer which is rated A- or better or the equivalent thereof by at least one of the recognized rating agencies Intent: To protect the insurance company and their related policyholders from counterparty credit risk Improvement areas: Monitor CDS of counterparties with policy to reduce exposure in event of worsening credit 14

21 Derivative Use Plans Applying risk management frameworks specifically to insurance companies Improvement areas The Dodd-Frank Act Required amended trading documentation in order to comply with these new rules. Requirements for initial margin and variation margin. External Business Conduct Standards Swap Trading Relationship Documentation End-User Exception, Clearing & SEF Trading Reporting and Recordkeeping EMIR European entities (or counterparties to EU dealers) must make representations regarding their regulatory status. Non-EU entities that transact with EU counterparties will also be impacted. Entity Classification and Clearing Risk Mitigation (Timely Confirmation, et al.) Portfolio Reconciliation Reporting and Recordkeeping 15

22 1 2 Financial Risk Management Objectives Derivative Use Plans 3 Best Practices 16

23 Best Practices Checklist 1. OBJECTIVES Specify risk management objectives Quantify tolerance levels 2. DEFINITIONS Use defintions that are relevant to stakeholders Clarify differences in financial and regulatory definitions Define applicable tax and accounting terms 4. EVALUATE COST OF HEDGING Quantify trading and operations costs Benchmark against peers 5. MONITORING AND REPORTING Valuation reporting using consistent models and market data One page actionable management report Limited ad hoc report requests 3. GUIDELINES Permitted strategies Counterparty management Asset/liability and collateral management 6. ROLES AND RESPONSIBILITIES Segregation of duties Specify outsourcing needs and scope Rythme of review and improvement Accounting policy Remediation/correction plan 17

24 Common Pitfalls Misalignment of Goals Parent risk vs. sub-team risk Lack of communication across divisions Technically Correct Hedging delta, rho, gamma and vega because the model said to Set it and Forget it We are hedging per our policy Waiting Until the House is on Fire Holding out for the best price 18

25 Contact Information The SOA believes that this event may be suitable for fulfilling continuing professional development (CPD) requirements. Phil Weeber Executive Director T: Phil leads Chatham s Financial Services Practice, providing insights and transparency to companies facing front, middle and back office challenges related to the financial hedging of annuities and the general account. Since joining Chatham in 2003, Phil has worked across asset classes advising clients with risk strategy, hedging implementation and execution. Previously, he led the Commodity Risk Practice, advising corporations in various industries. Phil also headed Chatham s structured finance team and led business development efforts, working with public and private real estate companies. Phil holds a MBA from Emory (Goizueta) University, a Masters in Engineering from the University of North Carolina, and a BS in Engineering from the University of Michigan. 19 Kennett Square 235 Whitehorse Lane Kennett Square, PA Denver 7926 South Platte Canyon Road Littleton, CO United States London Burdett House, 4th Floor Buckingham Street London WC2N 6DU United Kingdom +44 (0) Krakow ul. Kotlarska Kraków Poland Singapore 20 Cross Street China Square Central #02-16/17 Singapore, Melbourne L8, 101 Collins Street Melbourne, Australia,