Volatility of Fair Value Accounting from a Reinsurer's Perspective


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At the October 2012 Society of Actuaries annual meeting, Michael Frings gave a presentation entitled “Volatility of Fair Value Accounting from a Reinsurer’s Perspective”. He described the sources of fair value volatility on income statement and balance sheets both in US GAAP and IFRS frameworks. He described the assumptions and interpretations which can lead to increased volatility. He outlined where volatility is viewed more or less favorably by financial analysts. He proposed solutions to the fair value volatility problem emphasizing that while there is no silver bullet, astute setup of the hedges, accounting, and reinsurance can reduce fair value accounting volatility. Michael’s presentation was well-received and he will present it again at a future SOA webcast on Fair Value Accounting Volatility planned for early 2013.

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Volatility of Fair Value Accounting from a Reinsurer's Perspective

  1. 1. Volatility of Fair Value AccountingReinsurance PerspectiveMichael Frings FSA, CFA, MAAAVice President and Senior ActuaryGlobal Financial SolutionsRGA Reinsurance Company2012 SOA Annual Meeting-#71 PD Fair Value Volatility | October 16, 2012
  2. 2. Presentation TopicsA reinsurance perspective of ceding company fair value volatility Sources of Fair Value Volatility Solutions to Reduce Volatility 2
  3. 3. Sources of Fair Value Volatility 3
  4. 4. Reasons for Fair Value Volatilitymovement due to … Assumptions  Market inputs: interest rates, volatility, strike prices, etc.  Company inputs: policy holder behavior, mortality, morbidity, etc. Models Company structure Accounting Interpretations  US GAAP  US Statutory  IFRS  MCEV Need to know your sources of fair value volatility 4
  5. 5. Accounting Sources of Fair Value Volatilitygeography of volatility—some places better than others…  Income Statement  Operating Earnings vs. Non-Operating Income  Net Income  Balance Sheet  Equity / Other Comprehensive Income  Assets  Liabilities  Disclosure Only Fair value disclosed as required 5
  6. 6. Accounting Sources of Fair Value Volatilityselected from common accounting pronouncements… US GAAP  ASC 820 (FAS 157) – Fair Value Measurement  ASC 815 (FAS 133/FAS 155) – Derivatives & Hedging  Guaranteed withdrawal benefits guarantees in variable & indexed annuities  Excess indexed benefits in indexed annuities  Stable value wrap contracts  Financial guarantees  DIG B36 – funds withheld coinsurance and mod-co  ASC 320 (FAS 115) Investments – Debt & Equity Securities  Designation: Trading (IS & BS effects); AFS (BS/OCI only)  Other than Temporary Impairment (IS & BS effects)  ASC 944 (FAS 97/120) – Shadow DAC Asset  ASC 825 (FAS 107/159) – Fair Value Disclosure  ASC 250 (FAS 155) – Designating Fair Value of Liabilities 6
  7. 7. Accounting Sources of Fair Value Volatilityselected from common accounting pronouncements… US Stat  SAP 43R/99 – Other Than Temporary Impairments  SAP 86 – Accounting for Derivative Instruments & Hedging Activities  SAP 100 – Fair Value Measurements  Actuarial Guidelines 35 & 43 IFRS  IAS 7 – Financial Instruments: Disclosures  IFRS 9 – Financial Instruments  IFRS 13 – Fair Value Measurement (effective 1 Jan 2013) MCEV  Supplementary embedded value reporting for EU companies  European Embedded Value (EEV) principles and European Insurance Market Consistent Embedded Value (MCEV) principles published by CFO Forum 7
  8. 8. Solutions to Fair Value Volatility 8
  9. 9. What Can Insurers Dosome solutions… Hedge, Hedge, Hedge…is there a perfect hedge? Clearly interpret and define Fair Value  Develop fair value calculation with clear, consistent assumptions  Can explain it better to management  Using ‘book value’ rather than ‘fair value’ Find Another View of the Business  Another  Reinsurer(s)  Buyer(s)  View  Are in a different accounting regime  Likes the risk better than you 9
  10. 10. Some Reinsurance Solutions for Fair Value Risksincludes variable annuities, indexed annuities, etc… Reinsure mortality/longevity risk only  YRT net amount at risk  Doesn’t address fair value issues Coinsure business  Straight co/mod-co structures which are akin to selling the business Structure reinsurance to carve out risks  Use capital markets and reinsurance solutions to carve out market, mortality and policyholder behavior risks  Difficult to find those willing to take each of the risks…concentration of risks!  Parent of insurer may wind up keeping some of the risk 10
  11. 11. Challenges with Reinsuring Riskoften begin with differing views on measurement of risk… Counter-party risk present Complicated structured finance solutions Volatile fair value marks unpopular with analysts Reinsurer and ceding company have different view of risk  Draw conclusion that base contract + rider are under priced.  Real world v. risk neutral Market capacity is low Lack of secondary market  lack of opportunity to make money? Reinsurers also want profitable business, too! 11
  12. 12. Thank you for your attention. 12