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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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Reinsurance Perspective
Volatility of Fair Value Accounting
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
Sources of Fair Value Volatility Solutions to Reduce Volatility
Presentation Topics
A reinsurance perspective of ceding company fair value volatility
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Sources of Fair Value Volatility
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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
Reasons for Fair Value Volatility
movement due to …
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Need to know your sources of fair value volatility
Income Statement Operating Earnings vs. Non-Operating Income Net Income
Balance Sheet Equity / Other Comprehensive Income Assets Liabilities Disclosure Only
Accounting Sources of Fair Value Volatility
geography of volatility—some places better than others…
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Fair value disclosed as required
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
Accounting Sources of Fair Value Volatility
selected from common accounting pronouncements…
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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
Accounting Sources of Fair Value Volatility
selected from common accounting pronouncements…
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Solutions to Fair Value Volatility
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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
What Can Insurers Do
some solutions…
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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
Some Reinsurance Solutions for Fair Value Risks
includes variable annuities, indexed annuities, etc…
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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?
Challenges with Reinsuring Risk
often begin with differing views on measurement of risk…
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Reinsurers also want profitable business, too!
Thank you for your attention.
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