UK Pensions Got Margin Calls

Mary Pat Campbell

Link: https://www.bloomberg.com/opinion/articles/2022-09-29/uk-pensions-got-margin-calls

Excerpt:

I said above that pension funds are unusually insensitive to short-term market moves: Nobody in the pension can ask for their money back for 30 years, so if the pension fund has a bad year it won’t face withdrawals and have to dump assets. Still, pension managers are sensitive to accounting. If your job is to manage a pension, you want to go to your bosses at the end of the year and say “this pension is now 5% less underfunded than it was last year.” And if you have to instead say “this pension is now 5% more underfunded than it was last year,” you are sad and maybe fired; if the pension gets too underfunded your regulator will step in. You want to avoid that.

And so the way you will approach your job is something like:

  1. You will try to beat your benchmark, buying stocks and higher-yielding bonds to try to grow the value of your assets.
  2. You will hedge the risk of rates going down. If rates go down, your liabilities will rise (faster than your assets); you are short gilts. You want to do something to minimize this risk.

The way to do that hedging is basically to get really long gilts in a leveraged way. If you have £29 of assets, you might invest them like this:

  1. £24 in gilts,
  2. £5 in stocks, and
  3. borrow another £24 and put that in gilts too.[5] [5] No science to this number, and you’d probably do a bit less if your stocks are correlated with rates.

That way, if rates go down, the value of your portfolio goes up to match the increasing value of your liabilities. So you are hedged. You were short gilts, as an accounting matter, and you’ve solved that by borrowing money to buy more gilts. In practice, the way you have borrowed this money is probably not by actually getting a loan and buying gilts but by doing some sort of derivative (interest-rate swap, etc.) with a bank, where the bank pays you if rates go down and you pay the bank if rates go up. And you have posted some collateral with the bank, and as interest rates move up or down you post more or less collateral. 

This all makes total sense, in its way. But notice that you now have borrowed short-term money to buy volatile financial assets. The thing that was so good about pension funds — their structural long-termism, the fact that you can’t have a run on a pension fund: You’ve ruined that! Now, if interest rates go up (gilts go down), your bank will call you up and say “you used our money to buy assets, and the assets went down, so you need to give us some money back.” And then you have to sell a bunch of your assets — the gilts and stocks that you own — to pay off those margin calls. Through the magic of derivatives you have transformed your safe boring long-term pension fund into a risky leveraged vehicle that could get blown up by market moves.

I know this is bad but I find something aesthetically beautiful about it. If you have a pot of money that is immune to bank runs, over time, modern finance will find a way to make it vulnerable to bank runs. That is an emergent property of modern finance. No one sits down and says “let’s make pension funds vulnerable to bank runs!” Finance, as an abstract entity, just sort of does that on its own.

Anyway, as I said above, 30-year UK gilt rates were about 2.5% this summer. They got to nearly 5% this week, and were at about 3.9% at 9 a.m. New York time today. You can fill in the rest.

Author(s): Matt Levine

Publication Date: 29 Sept 2022

Publication Site: Bloomberg

Insurers brace for hit from Florida’s costliest storm since 1992

Mary Pat Campbell

Link: https://www.aol.com/insurers-brace-hit-floridas-costliest-120339135-182213253.html

Excerpt:

Insurers are bracing for a hit of between $28 billion and $47 billion from Hurricane Ian, in what could be the costliest Florida storm since Hurricane Andrew in 1992, according to U.S. property data and analytics company CoreLogic.

Wind losses for residential and commercial properties in Florida are expected to be between $22 billion and $32 billion, while insured storm surge losses are expected to be an additional $6 billion to $15 billion, according to CoreLogic.

“This is the costliest Florida storm since Hurricane Andrew made landfall in 1992 and a record number of homes and properties were lost,” said Tom Larsen, associate vice president, hazard & risk management, CoreLogic.

Author(s): Noor Zainab Hussain

Publication Date: 30 Sept 2022

Publication Site: Aol (Reuters)

Rising Rates Make Life Insurance Funded With Debt More Costly

Mary Pat Campbell

Link: https://www.wsj.com/articles/rising-rates-make-life-insurance-funded-with-debt-more-costly-11663849907?st

Excerpt:

Rising interest rates and a falling stock market are putting new pressure on a popular strategy of borrowing to fund the purchase of multimillion-dollar life-insurance policies.

Even before rates started to rise, consumers were being forced to make big payments when strategies failed to deliver the promised returns. Many sued their agents and insurers.

So-called premium financing has been around for decades. It was mostly used by the super rich to fund large policies that act as tax shelters and offer death benefits worth tens of millions of dollars. When interest rates hit zero, many more people borrowed to fund their policies.

The lawsuits claim that agents misled them about the strategy’s risks. The policies are supposed to generate enough income to repay the loans, which can also be repaid through the death benefit. People often take out one- to five-year loans, with interest rates that reset annually. They also face risk of loans not being renewed.

….

In court filings, the agents and insurers, Pacific Life and Lincoln National, deny the allegations, which include misrepresentation. Chad Weaver, an attorney for Wayne L. Weaver, one of the agents, said “the premium-financing strategy was implemented after numerous meetings and disclosures, and was completely consistent with [Mr. Marenzi’s] objectives and financial situation at the time of purchase.”

….

Insurers don’t release information on the use of premium financing. The Life Product Review, an industry publication, said a 2021 survey of about 60% of the premium-financing market identified $800 million of loans at those firms to pay for policies taken out in 2020.

Author(s): Leslie Scism

Publication Date: 22 Sept 2022

Publication Site: WSJ

Introduction to Credit Risk Exposure of Life Insurers

Mary Pat Campbell

Link: https://www.soa.org/sections/joint-risk-mgmt/joint-risk-mgmt-newsletter/2022/september/rm-2022-09-fritz/

Graphic:

Excerpt:

Under the old regime, the impairment was the incurred credit losses, in determining which only past events and current conditions are used. Credit losses were booked after a credit event had taken place, thus the name “incurred.” ECL and CECL require the incorporation of forward-looking information in addition to the past/current info in the calculation of impairment. There will be an allowance for credit losses since initial recognition regardless of the creditworthiness of the investment asset. The allowance can be perceived as the reserve or capital for credit risks. In practice, the allowance could be zero if there are no expected default losses for the instrument, US Treasury bonds, US Agency MBS, just to name a few.

ECL under IFRS 9 is typically calculated as a probability weighted estimate of the present value of cash shortfalls over the expected life of the financial instrument. It Is an unbiased best estimate with all cash shortfalls taking into consideration the collaterals or other credit enhancement. Four typical parameters underlying its calculation are: Probability of default (PD), loss given default (LGD, i.e., 1-Recovery Rate), exposure at default (EAD) and discounting factor (DF). Prepayments, usage given default (UGD) and other parameters can also play a role in the calculations. In the general approach the loss allowance for a financial instrument is 12-month ECL regardless of credit risk at the reporting date, unless there has been a significant increase in credit risk since initial recognition: The PD is only considered for the next 12 months while the cash shortfalls are predicted over the full lifetime; as the creditworthiness deteriorates significantly, the loss allowance is increased to full lifetime ECL in Stage 2, which should always precede stage 3 (credit impairment). Even without change of stages, any credit condition changes should be flowing into the credit loss allowance via updates in some of the underlying parameters. Exhibit 1 has an illustrative comparison between ECL, CECL, and incurred loss model.

CECL is similar to ECL except FASBs doesn’t have so-called staging as IFRS 9, which requires that only 12-month ECL is calculated in stage 1 (in the general model). In other words, CECL requires a full lifetime ECL from Day 1. There are also other differences: IFRS 9 requires certain consideration of time value of money, multiple scenarios, etc., in measurement of ECL while US GAAP CECL doesn’t.

Under US GAAP, different from CECL, currently the impairment for AFS assets, while also recorded as an allowance (with a couple exceptions), is only needed for those whose fair value is less than the amortized cost. Once it is triggered, the credit losses are then measured as the excess of the amortized cost basis over the probability weighted estimate of the present value of cash flows expected to be collected. Only the fair value change related to credit is considered in the calculation of AFS impairment. The quantitative calculation behind the probability weighted best estimate is like CECL/ECL. Both can use discounted cash flow methods with parameters such as PD although one is calculating expected cash shortfalls directly in CECL and the other is calculating the expected collectible cash payments and then is used to back out the impairment.

Author(s): Jing Fritz

Publication Date: September 2022

Publication Site: Risk Management newsletter, SOA

Forward Thinking on talent, state capacity, and being hopeful with Tyler Cowen

Mary Pat Campbell

Link: https://www.mckinsey.com/capabilities/people-and-organizational-performance/our-insights/forward-thinking-on-talent-state-capacity-and-being-hopeful-with-tyler-cowen

Graphic:

Excerpt:

Michael Chui: Fascinating. You mentioned talent. You recently coauthored a book with Daniel Gross entitled Talent: How to Identify Energizers, Creatives, and Winners Around the World. What was the central thesis of this book?

Tyler Cowen: That talent is remarkably important. That we’re doing a poor job, misallocating talent. And there are a variety of ways, outlined in the book, we can do better. This book tries to be “the” talent book: a one-stop shopping guide to how to think about identifying talent.

Michael Chui: What are the macro implications of [the] lack of good matching? Is this a potential for accelerating productivity, for instance?

Tyler Cowen: We have slower economic growth when we don’t match talent well. We have a lower level of per capita income. When a recession comes, as was the case in 2008, labor markets adjust much more slowly. The consequences for human welfare are considerable.

Author(s): Michael Chui, Tyler Cowen

Publication Date: 28 Sept 2022

Publication Site: McKinsey

$50 to drive to Manhattan. $100 to come into N.J. How a fight over traffic cameras could prove costly.

Mary Pat Campbell

Link: https://www.nj.com/news/2022/10/50-to-drive-to-manhattan-100-to-come-into-nj-how-a-fight-over-traffic-cameras-could-prove-costly.html

Excerpt:

A war of words between New York and New Jersey legislators over red light cameras could prove costly to commuters who could be slapped with hefty fees to travel between New York City and the Garden State.

New York lawmakers want to slap Jersey drivers with a $50 “non-cooperation fee” when they drive into New York City, in response to a bill that would bar the state Motor Vehicle Commission from helping New York enforce red light and speed camera tickets against Garden State drivers.

If passed by New York State’s senate and assembly, that charge would be on top of the $16 cash toll to cross the Hudson into Manhattan, and could be added to proposed congestion pricing fees for driving south of 60th Street, that might take effect in 2024.

….

O’Scanlon reiterated his long standing opposition to automated enforcement, citing his analysis of National Highway Traffic Safety administration statistics that showed red light camera and other automated enforcement did not translate in to lower death rates in states that had them.

“There is no correlation to safety benefits. Every unbiased assessment showed no benefit,” he said. “It’s a demonstrable fact that automated enforcement and red light camera systems don’t improve safety.”

Author(s): Larry Higgs

Publication Date: 1 Oct 2022

Publication Site: NJ.com

Kentucky Retirement Systems Lawsuit Targets New York Fixer Regina Calcaterra for Alleged Bid Fixing

Mary Pat Campbell

Link: https://www.nakedcapitalism.com/2022/09/kentucky-retirement-systems-lawsuit-targets-new-york-fixer-regina-calcaterra-for-alleged-bid-fixing.html

Excerpt:

Regina Calcaterra, partner in the law firm Calcaterra Pollack and a notorious New York State fixer is charged with bid rigging. The New York Times published an investigative series about the Moreland Commission, an anti-corruption probe. Calcaterra was its executive director. The commission was disbanded early. The Times reported that Calcaterra harassed investigators, interfered repeatedly in the report drafting process, improperly blocked subpoenas and communicated with Governor Cuomo, with the aim of squashing any findings that might embarrass Cuomo. The New York Board of Elections sued Calcaterra several times for violating campaign finance laws. She was barred from running for office for lying about her residency. To the extent she knows anything about public pension funds, she learned it from her one-time boss, state controller Alan Hevesi, who went to prison in a pay-to-play scandal (note Calcaterra worked for him his earlier role as New York City controller; in that capacity Hevesi was also responsible for the pension investments).

As you can see below, the tenacious legal team that originally represented the so-called Mayberry eight in Mayberry v. KKR has Calcaterra and an alleged co-conspirator at Kentucky Retirements Systems, its now general counsel Vicky Hale, in its cross-hairs for alleged violations of Kentucky procurement statutes, breach of trust and fiduciary duty, and conspiracy claims. A new group of so-called Tier 3 (defined contribution) plaintiffs are seeking to sue the KKR, Blackstone et al for selling overpriced, misrepresented customized hedge funds that underperformed stocks and even cash. The suit against Calcaterra, members of her firm, and Kentucky Retirement Systems’ Hale is a side but nevertheless revealing action.

The filing below perfects allegations previously made against Calcaterra and her apparent partners in misconduct. The first time the Tier 3 attorneys, led by Michelle Lerach, covered much of the same ground in an early 2021 filing and asked for the so-called Calcaterra Report to be released. Judge Philip Shepherd reacted harshly, as if the point of the filing was primarily to dirty up Calcaterra. He also discounted the New York Times investigation, saying more or less than anyone who has held an important job has been on the receiving end of bad stories.

Author(s): Yves Smith

Publication Date: 22 Sept 2022

Publication Site: naked capitalism

S&P Global’s Proposed Capital Model Changes and its Implication to U.S. Life Insurance Companies

Mary Pat Campbell

Link: https://www.soa.org/sections/financial-reporting/financial-reporting-newsletter/2022/september/fr-2022-09-sun/

Graphic:

Excerpt:

Life technical risks measure the possible losses from deviations from the best estimate assumptions relating to life expectancy, policyholder behavior, and expenses. The life technical risks are captured through mortality, longevity, morbidity, and other risks. The methodology for calculating the capital adequacy for these four risk categories remains unchanged under the proposed method, apart from the recalibration of capital charges or the consolidation of defining categories within each risk. Comparing to the current GAAP based model, charges have materially increased across all categories partly due to higher confidence intervals, with notable exceptions of longevity risk, with reduced charges across all stress levels (changes applicable to U.S. life insurers are illustrated in Tables A2 to A5 in the Appendix linked at the end of this article). Please note that S&P’s current capital model under U.S. statutory basis does not have an explicit longevity risk charge. However, this article focuses on comparison to current GAAP capital model[1] that is closer to the new capital methodology framework.

For mortality risk, lower rates are charged for smaller exposures (net amount at risk (NAR) $5 billion or less) with the consolidation of size categories, but higher rates are charged for NAR between $5 billion and $250 billion, with an average increase of 49 percent for businesses under $400 billion NAR. A new pandemic risk charge (Table A3 in the Appendix linked at the end of this article) will further increase mortality related risk charges to be 109 percent higher than original mortality charges under confidence level for company rating of AA, and 93 percent higher for confidence level for company rating of A, respectively, on average (Figure 1). The disability risk charge rates increased moderately for most products, across all eight product types such that the increase of disability premium risk charges is 6 percent under confidence level for AA, and 2 percent for A, respectively. In addition, the proposed model introduced a new charge on disability claims reserve, ranging from 13.7 percent of total disability claims reserves for AAA, to 9.6 percent for BBB. However, the proposed model provides lower capital charge rates in longevity risk and lapse risk.

Author(s): Yiru (Eve) Sun, John Choi, and Seong-Weon Park

Publication Date: September 2022

Publication Site: Financial Reporting newsletter of the SOA

Embedded Bias: How Medical Records Sow Discrimination

Mary Pat Campbell

Link: https://khn.org/news/article/electronic-medical-records-doctor-bias-open-notes-treatment-discrimination/

Excerpt:

Narrow or prejudiced thinking is simple to write down and easy to copy and paste over and over. Descriptions such as “difficult” and “disruptive” can become hard to escape. Once so labeled, patients can experience “downstream effects,” said Dr. Hardeep Singh, an expert in misdiagnosis who works at the Michael E. DeBakey Veterans Affairs Medical Center in Houston. He estimates misdiagnosis affects 12 million patients a year.

Conveying bias can be as simple as a pair of quotation marks. One team of researchers found that Black patients, in particular, were quoted in their records more frequently than other patients when physicians were characterizing their symptoms or health issues. The quotation mark patterns detected by researchers could be a sign of disrespect, used to communicate irony or sarcasm to future clinical readers. Among the types of phrases the researchers spotlighted were colloquial language or statements made in Black or ethnic slang.

“Black patients may be subject to systematic bias in physicians’ perceptions of their credibility,” the authors of the paper wrote.

That’s just one study in an incoming tide focused on the variations in the language that clinicians use to describe patients of different races and genders. In many ways, the research is just catching up to what patients and doctors knew already, that discrimination can be conveyed and furthered by partial accounts.

Author(s): Darius Tahir

Publication Date: 26 Sept 2022

Publication Site: Kaiser Health News

Bank of England in £65bn scramble to avert financial crisis

Mary Pat Campbell

Link: https://www.theguardian.com/business/2022/sep/28/bank-of-england-in-65bn-scramble-to-avert-financial-crisis

Graphic:

Excerpt:

The Bank of England has been forced into emergency action to halt a run on Britain’s pension funds after the impact of Kwasi Kwarteng’s ill-received mini budget prompted fears of a 2008-style financial crisis.

Threadneedle Street said the fallout from a dramatic rise in government borrowing costs since the chancellor’s statement had left it with no choice but to intervene to protect the UK’s financial system.

City sources said the surprise move, less than a week after Kwarteng’s unfunded tax giveaways, was needed to halt a “doom loop” in the bond markets that risked draining pension funds of cash and leaving them at risk of insolvency.

….

Interest rates on government bonds, or gilts, have risen sharply since the chancellor’s £45bn package of tax cuts – making it punitively expensive for thousands of pensions funds to fund their hedging activities.

Officials in the Financial Services Group of the Treasury were at an away day – said to have been held at the Oval cricket ground in London – on Wednesday, but returned to their desks that afternoon. A source said they were not working on the response to the Bank of England’s announcement.

The Bank’s action helped provide Kwarteng with some respite from the financial markets after three days of turmoil that has seen sterling hit its lowest ever level against the dollar, strong criticism of the mini-budget from the International Monetary Fund, about 1,000 mortgage products pulled and interest rates on UK government bonds hit their highest level since 2008. Bond yields fell while the pound recovered in the currency markets after Threadneedle Street’s announcement.

Author(s): Larry Elliott, Pippa Crerar and Richard Partington

Publication Date: 28 Sep 2022

Publication Site: Guardian