Wednesday, May 27, 2009

RBC Mortgage Factors for '09 Advanced, Derivatives Discussed

A mortgage adjustment factor for life risk-based capital calculations was adopted by the Life Risk-based Capital “E” working group of the National Association of Insurance Commissioners, Kansas City, Mo. The mortgage factor is for year-end 2009. The factor is narrowed to a range of 75%-125% from a current range of 50% to 350%. It will be advanced only for 2009 while regulators and life insurers attempt to develop a more permanent change to calculating RBC for mortgages. The proposal will now be considered by the Capital Adequacy Task Force at the summer NAIC meeting in Minneapolis next month. California and New York abstained from the working group vote.

During the discussion, California regulator Sheldon Summers asked if the proposal will address a situation in which troubled mortgage loans are transferred to an insurer’s affiliate so it doesn’t get counted. John Bruins, a life actuary with the American Council of Life Insurers, Washington, responded that the group would look at the issue.

The ACLI also discussed a paper one of its subgroups consisting of 9 company representatives and two ACLI staff members developed. The companies included Lincoln National, Met Life, Northwestern Mutual Life and TIAA. It looks at how the use of derivatives to hedge can help manage risk. Consequently, industry representatives argued to regulators that RBC should reflect this managed risk when appropriate.
These presenters of the paper posed the question of ‘Why should RBC be adjusted to reflect hedging and observation that “it is important to recognize reduced risk from “purchased credit protection” when those insurers are “similarly situated.”
Derivatives also allow for more flexibility and protection at a cheaper price, according to the presentation to regulators. For example, derivatives can offer protection in a single transaction if many cash bond portfolios are involved rather than having to sell multiple pieces of bonds with different yields.

Hedging with derivatives can offer short-term protection against an event but still allow for a long-term yield. So, for example, if there was a short-term threat to a company’s bonds because the company is being sued, derivatives could protect the company’s bonds. If the suit is settled and the issue cleared, the company’s securities would have been protected and there would not be an impact on economic cost and asset-liability management.

The representatives of the ACLI subgroup said that any RBC credit should be proportionate to the risk that is reduced.

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