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. Volatility of Fair Value Accounting
Reinsurance Perspective
Michael Frings FSA, CFA, MAAA
Vice President and Senior Actuary
Global Financial Solutions
RGA Reinsurance Company
2012 SOA Annual Meeting-#71 PD Fair Value Volatility | October 16, 2012
2. Presentation Topics
A reinsurance perspective of ceding company fair value volatility
Sources of Fair Value Volatility
Solutions to Reduce Volatility
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4. Reasons for Fair Value Volatility
movement 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
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5. Accounting Sources of Fair Value Volatility
geography 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
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6. Accounting Sources of Fair Value Volatility
selected 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
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7. Accounting Sources of Fair Value Volatility
selected 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
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9. What Can Insurers Do
some 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
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10. Some Reinsurance Solutions for Fair Value Risks
includes 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
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11. Challenges with Reinsuring Risk
often 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!
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