The unwinding has rippled to holders of the Credit Suisse funds, German municipalities that deposited money with Greensill’s bank, and a high-profile duo of venture-capital investors.
Greensill specialized in supply-chain finance, a type of short-term cash advance to companies to stretch out the time they have to pay their bills. The firm was once worth $4 billion based on investments from SoftBank Group Corp.’s Vision Fund. The collapse marks a high-profile blow for the mammoth Japanese investor.
During the early part of the eighteenth century, the French government issued a series of bonds to help raise money. With the decline of the French economy in the 1720s, they were forced to cut the interest rates on the bonds, which drastically diminished the market value of said bonds. This resulted in the French government having considerable difficulty in raising money via new bond sales.
One Michel Robert Le Pelletier-Desforts, Deputy Finance Minister for France, had a “brilliant” idea as to how to raise the value of existing bonds, encourage the sale of new bonds, and earn some money for the government- a trifecta. His idea was to allow bond owners to buy a lottery ticket linked to the value of their bonds (each ticket costing 1/1000th of the bond’s value). The winner would get the face value of their bond, which was more than what they could get on the market at this point, plus a ‘jackpot’ of 500,000 livres, which would make the winner instantly wealthy.
Unfortunately for the government, and fortunate for those of you who enjoy Voltaire’s work, the mathematics behind this new government fundraising scheme was fundamentally flawed. You see, if you owned a bond worth a relatively small amount, with the lotto ticket for the bond costing just 1/1000th of the value, you could buy the lotto tickets cheaply, yet your lotto ticket had just as much of a chance of winning as someone who owned a bond for, say, 100,000 livres and had to buy their ticket for 100 livres.
Thus, when La Condamine crunched the numbers, he realized that if he was able to buy up a certain percentage of the existing small bonds, he could then acquire the necessary entrees in the lotto to reasonably ensure he’d win, all while spending significantly less than the jackpot and also making a profit on the bonds themselves when he ultimately won and the government had to pay face value for them.
I expect some big institutional changes to be coming our way soon. One favorite debate, at least according to the editorial page of the Financial Times, is the trade-off between efficiency and resilience. Buying all your goods from China, including PPE, may be efficient—but if you have a global pandemic, then it means that you’re not so resilient. Or, if you live in Texas, cheap energy is great when you blast your air-conditioning every August when it’s 110 degrees outside, but if there’s a crazy cold snap and your power gets shut off, you see that your system is actually not that resilient at all.
We already see the Biden administration taking on resiliency, as he is trying to revive domestic manufacturing. And we can expect some soul searching in Texas as well. But I’m not convinced that we’ll get the big overhaul, because the problem with resiliency is that it can be extremely expensive, and once we forget about the shock, we don’t want to pay for it anymore. It’s expensive if you define resiliency as the ability to seamlessly handle a once-in-a-lifetime tail risk that you never saw coming. People like cheap power and goods, and those things help the economy grow.
Five key fallacies and pitfalls have affected public-health messaging, as well as media coverage, and have played an outsize role in derailing an effective pandemic response. These problems were deepened by the ways that we—the public—developed to cope with a dreadful situation under great uncertainty. And now, even as vaccines offer brilliant hope, and even though, at least in the United States, we no longer have to deal with the problem of a misinformer in chief, some officials and media outlets are repeating many of the same mistakes in handling the vaccine rollout.
Amidst all the mistrust and the scolding, a crucial public-health concept fell by the wayside. Harm reduction is the recognition that if there is an unmet and yet crucial human need, we cannot simply wish it away; we need to advise people on how to do what they seek to do more safely. Risk can never be completely eliminated; life requires more than futile attempts to bring risk down to zero. Pretending we can will away complexities and trade-offs with absolutism is counterproductive. Consider abstinence-only education: Not letting teenagers know about ways to have safer sex results in more of them having sex with no protections.
The current design of the SII risk margin is too interest-rate sensitive and too high, particularly in the current low-interest rate environment. We believe reform, and an overall reduction, in the risk margin is desirable and can be done whilst keeping an appropriate balance between policyholder protection and cost.
The Matching Adjustment (MA) is vitally important to UK insurers, UK pension schemes and individuals. Without it, annuity prices would increase, and it would simply not be affordable for many pension schemes to buy-out with an insurance company. The IFoA fully supports the continued inclusion of the MA; the MA has successfully helped reduced procyclical investment behaviour, such as during the stressed conditions in early 2020. However, we believe that the MA framework needs to incorporate more pragmatic flexibility, without a lowering of regulatory standards.
We favour incentivisation of ‘green’ investment rather than overly penal disincentives for ‘brown’ asset classes, noting that sectors considered ‘brown’ must also be part of the solution to the challenges of climate change.
Author(s): Institute and Faculty of Actuaries
Publication Date: 19 February 2021
Publication Site: Institute and Faculty of Actuaries
Solvency II is the regime that governs the prudential regulation of insurance firms in the UK. This call for evidence is the first stage of the review of Solvency II.
The review is underpinned by three objectives:
to spur a vibrant, innovative, and internationally competitive insurance sector
to protect policyholders and ensure the safety and soundness of firms
to support insurance firms to provide long-term capital to support growth, including investment in infrastructure, venture capital and growth equity, and other long-term productive assets, as well as investment consistent with the government’s climate change objectives.
The government seeks views on how to tailor the prudential regulatory regime to support the unique features of the insurance sector and regulatory approach in the UK.
Solvency II sets strict requirements over what kinds of liabilities and assets are eligible for the MA [matching adjustment], and the governance of them. In the UK’s Solvency II consultation, respondents have argued a looser regime would be good for insurers – and good for the country.
Many of these suggestions have been previously floated in industry circles, some since even before Solvency II came into effect in 2016. But there are a growing number of experts calling for a much more dramatic rethink of the MA – and whether it should even exist.
Dean Buckner, a former regulator at the Bank of England who worked on the MA, and Kevin Dowd, professor of finance and economics at Durham University, have been at the forefront of arguing the MA creates “fake capital” and puts annuity payments at risk.
In their submission to the consultation, they write: “The MA allows firms to recognise some anticipated risky future profits as if they were certain, thereby allowing them to be distributed before being realised. If the risky future profits are not realised – bear in mind that they are called ‘risky’ for a reason – then the capital created by MA will vanish, and policyholders will be at risk.”
But the whole thing is being framed in an odd way—i.e., that the individual retail investor is rising up against the big, bad hedge funds. This is a compelling narrative, and that’s why it’s all anyone is talking about. And I suppose that could be the takeaway after a single day of trading. But making money in markets requires knowing when to get out (or having power friends who will lend you money when you need it), and I worry about some people betting money they don’t have without realizing the risks that they’re taking on. Taking down a hedge fund is only fun when you make money at it, and we don’t know whether these day traders care so much about taking down big whales until they actually lose money while doing so. And these funds have much deeper pockets and access to a lot more capital. It’s sad to say, but the game is rigged in their favor. So, as satisfying as it may be in the short run, I don’t see it ending well.
It feels like all of these discussions about risk, class, and fairness are dancing around the real question here, a question few will dare to ask: Should retail investors be able to buy individual stocks? Or should we only be able to buy mutual funds?
Investing in individual stocks is risky, and most people would be better off owning an index fund. If they did, they’d make more money on average and face less risk at the same time. Day-trading options are even riskier. So is shorting. My mentor, Robert Merton, has likened owning an individual stock to buying a single piece of car—it’s pretty useless, especially if you don’t know what you are doing. After all, a security’s value is largely about how it contributes to your entire portfolio as a whole.
Vaccination drives hold out the promise of curbing Covid-19, but governments and businesses are increasingly accepting what epidemiologists have long warned: The pathogen will circulate for years, or even decades, leaving society to coexist with Covid-19 much as it does with other endemic diseases like flu, measles, and HIV.
The ease with which the coronavirus spreads, the emergence of new strains and poor access to vaccines in large parts of the world mean Covid-19 could shift from a pandemic disease to an endemic one, implying lasting modifications to personal and societal behavior, epidemiologists say.
“Going through the five phases of grief, we need to come to the acceptance phase that our lives are not going to be the same,” said Thomas Frieden, former director of the U.S. Centers for Disease Control and Prevention. “I don’t think the world has really absorbed the fact that these are long-term changes.”
The Casualty Actuarial Society, Canadian Institute of Actuaries, and the Society of Actuaries are pleased to make available results from the 2020 Emerging Risks Survey, the fourteenth in the series. Conducted by Max J. Rudolph of Rudolph Financial Consulting LLC, the survey incorporated a set of Emerging Risks defined by the World Economic Forum as the basis for several of the questions. The survey also included questions related to current risk management topics.
Now available is a report presenting the major findings from the study. The full report will be released later in the year.