Converging Diverging. Jiang Bin Lai HSBC Insurance. 2 nd August The Actuarial Society of Hong Kong

Transcription

1 Converging Diverging Jiang Bin Lai HSBC Insurance 2 nd August 2017 The Actuarial Society of Hong Kong

2 Converging AGENDA Diverging Converging to what?

3 Converging The story thus far

4 Something a little familiar

5 Evolution of the regulation To aid the Appointed Actuaries in Hong Kong to interpret the ICO, an additional guidance note was issued by the Actuarial Society of Hong Kong (ASHK) specifically to give guidance on the practical application when determining the level of valuation interest rate To further enhance consistency across industry practice in respect of Chapter 41E of the Insurance Companies Ordinance, a supplement to the AGN3 was issued by ASHK. This document lists out 42 Q&A and help further converge the practice amongst insurers in HK on VIR setting 2002 AGN3 Additional Guidance For Appointed Actuaries AGN3 Supplement Chapter 41E of the insurance companies ordinance 2008 Notice for Appointed Actuaries: Chapter 41E Reinvestment Yield for Reserving 2014 Additional Guidance for Determination of the Valuation Interest Rate The original chapter 41E of the ICO is the foundation for the determination of the long term liabilities for insurance companies. In particular, section 8 (rate of interest) is the key section on the requirements of VIR, and section 16 (nature and term of assets) set out the resilience requirement. However, as a regulation written 20 years ago, the wordings are not specific enough and can lead to different interpretations of the law In light of the drastic changes in the financial market at the time, which drove the interest rates to a record low level, the ASHK has issued this notice to propose a sampling approach on the quantification of the reinvestment yield. This was adopted across Hong Kong insurers and continue to be effective today The low interest rate environment has sustained and continued to prove challenging for insurance companies. An additional Guidance Note was issued by the ASHK to suggest a way to blend the Portfolio Yield and the Reinvestment Yield, in an attempt to help insurers arrive at a higher VIR yet remains within the boundary of the regulation as set out in Chapter 41E.

6 Evolution of the regulation HKD 10-yr EFN AGN3 additional guidance 2008 Notice for Appointed Actuaries: Chapter 41E Reinvestment Yield for Reserving 2013 AGN3 Supplement 2014Additional Guidance for Determination of the Valuation Interest Rate Jan-97 Jul-97 Jan-98 Jul-98 Jan-99 Jul-99 Jan-00 Jul-00 Jan-01 Jul-01 Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

7 Converging on the VIR setting

8 Converging on the VIR setting Example of Calculation of Blending the Rates: For example, consider a five year product issued one year before the valuation date that is supported equally by two bonds with remaining terms to maturity of 3 years and 5 years both yielding 4%. The Portfolio Rate is therefore 4%. Assuming an initial reserve of 36,031 and Reinvestment Rate is 3% in year 3.. The sums to be invested in the future can be derived as Policy Duration Years from Valuation Date Increase in Policy Liability Existing Asset Portfolio Sums to be invested in the Future Policy Liability Principal Repayments Investment Yield ,031-36, % ,165 33,134 36,031-33, % ,285 30,120 36,031-30, % ,272 26,987 18,015 18,015 45,002 3% (126,272) 18,015 - (126,272) The Maximum VIR (R) is then the rate which satisfy the equation of Policy 5 Year 3 Year New Money New Money New Money Weighted Years from Valuation Date Liability Bond t=3 Yield Investment Yield 4.00% 4.00% 3.67% 3.33% 3.00% NPV of Investment * 65,956 50,340 92,587 57,106 43, ,031 18,015 18,015 4% 1 69,165 18,015 18,015 33, % 2 99,285 18,015 18,015 33,134 30, % 3 126,272 18,015 33,134 30,120 45, % 4 - * Net Present Value of Investment cashflow discounted by Max VIR (R)

9 Diverging Challenges from Upcoming regulation and accounting regime changes

10 The need to revamp Hong Kong s regulatory regime Solvency I Increased focus to align capital and risk Solvency II and RBC Hong Kong Japan EU Solvency II Indonesia Thailand US RBC Australia Vietnam Korea China C-ROSS India Singapore RBC2 Malaysia RBC

11 Influence from IAIS ICPs and IFRS 17 The IAIS s Insurance Core Principles requires the valuation of assets and liabilities to be an economic valuation (ICP 14 para 14.4) ICP 14 para gives the definition of an economic valuation: An economic valuation is a valuation such that the resulting assessment of an insurer s financial position is not obscured by hidden or inherent conservatism or optimism in the valuation. Such an approach is appropriate in the context of risk-based solvency requirements which satisfy these ICPs and standards and shares their objectives of transparency and comparability. In the development of the HKRBC regime, there is a strong desire to align with the final IFRS 17 standard. The IFRS 17 standard was finalized and published in May Para 36 requires the discount rate to be consistent with observable current market prices (if any) for financial instruments with cash flows whose characteristics are consistent with those of the insurance contracts, in terms of, for example, timing, currency and liquidity Although the exact interpretation of ICP s requirements and those of IFRS 17 are still under discussion in the context of HKRBC development, it is not unreasonable to predict that we will see increased volatility in HK insurers solvency position as well as the IFRS reported profits

12 Key areas of potential divergence Investment return and discount rate assumptions 4.50% 4.00% 3.50% 3.00% 2 Construction of forward discount rates Risk free rate (HKD) Risk free rate plus LP (HKD) HK bond market is not deep enough with longest swap rate observable being 15 years, i.e. LLP is 15 years Unsmoothed curve caused by illiquidity of swap rates at some tenor leading to the need to exclude certain tenors and a decision for interpolation in between How to derive haircut for credit default risk for HK swap rates 2.50% 2.00% 3 4 How long to assume before fully merge to the Ultimate Forward Rate level 1.50% Approach in extrapolation 1.00% 0.50% Market observable Extrapolation UFR 6 Method for derivation of liquidity premium and how to apply this 0.00% Level of the UFR

13 4.50% 4.00% 3.50% 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% Key areas of potential divergence Investment return and discount rate assumptions HKD Market observable Comparison of HKD and USD forward curves USD Market observable Risk free rate (HKD) Risk free rate (USD) The USD observable swap rates are much longer. Since the HKD is pegged to the USD, should insurers take an approach to use USD rates as proxy beyond HKD s LLP? This is an area where views might diverge Approach taken need to be internally consistent

14 Key areas of potential divergence Management actions, policyholder behavior and TVOG Management actions Unlike the current regulatory regime, all future policyholder dividends need to be allowed for. It is thus important to model the sharing between the policyholders and the shareholders in a realistic matter What is considered realistic is a subjective matter. Strong governance through With Profit Committee would help, but different companies committee may have different interpretation of fairness Defer the dividend adjustment with application of smoothing Immediately share gains/losses Other management actions such as hedging, derisking strategy and reinsurance may lead to further divergence in practice Dynamic policyholder behavior Relevant to interest sensitive products such as Universal Life products Experience at the tail end of the distribution is very limited, so approach and assumption behind this would rely on expert judgment, which would be a source of diverging practices amongst insurers Product features differences also contribute to the diverging approaches TVOG Different approaches in management actions and dynamic policyholder behavior would lead to differences in TVOG Difficulty in achieving true market consistent valuation of TVOG in HKD market, i.e. lack of deep and liquid HKD swaption market. This leads to the need for bespoke model for derivation of required implied volatility surface

15 Key areas of potential divergence Treatment of Alternative Asset / Credit Rating Treatment of Alternative Investments The prolonged low interest rate environment has driven the insurance sector to increase the exposure to riskier assets as well as diversify into alternative investment strategies in an aim to drive up investment returns No longer a simple portfolio of bonds and equities. Unless there is clear guidance from regulation, there would be different views in the treatment of non-conventional asset classes Asset look-through might yield benefit in terms of capital treatment but this requires very detailed specification to avoid rule abuses Look-through is very resource intensive and it might open up more complex issues that is not justified by the potential benefit in capital saving Accept only rating by established agencies? Global and Regional regulatory regimes typically rely on internationally established rating agencies for the assessment of credit and default risks These regimes do not know how to handle potential good and safe investments that are not rated by these established rating agencies, e.g. investments with some Chinese corporations This may limit investment choice in today s world where China s stock and bond markets are continuing to open up to Hong Kong as well as global investors

16 Source: xe.com Key areas of potential divergence Risk of de-peg The HKD/USD peg is unique to insurance sector in Hong Kong HKD has weakened significantly during the first half of this year, which has prompted the debate on the possibility of HKD de-peg Foreign exchange reserves in Hong Kong has increased to a new historic high level at USD 408bn as of June 2017 Opposing views on De-peg risk would influence companies decision on a number of areas in practical implementation: - Construction of HKD yield curve - Credit spread beyond HKD LLP - Currency risk demand - Treatment of Cross Currency Swap and underlying bonds - Sharing between HKD and USD policyholders Source: HKMA

17 Converging to what? Finding Hong Kong s identity in Insurance Regulation

18 Follow the footstep of Solvency II? UK pushed for allowance of liquidity premium due to large annuity portfolio in UK market UK, Netherland and Denmark were pushing for market consistent basis as their existing regulatory regimes were already on this basis France wanted counter cyclical premium such that insurers bear less risk in market downturn German insurer wanted higher extrapolated discount rates beyond 20 years Most Southern Europe wanted longer transition period for the adoption

19 Or to align with regulation in Mainland China?

20 Market Consistent or Market Consistent? Objective of regulatory reform Enhance comparability across the market Ensure level-playing field for all market participants Enhance policyholder protection Encourage the appropriate behavior for market participants Divert fund to support the long term prosperity of Hong Kong, e.g. preferential treatment for infrastructure projects type investment under the One Belt One Road initiative?

21 Any questions?