Swedish insurers warn of manipulation threat to new discount curve

Swedish insurers have welcomed a proposal for a Solvency II-based discount curve, but there are concerns that the curve could be distorted by speculators.

The Swedish Financial Supervisory Authority (FSA) is consulting on the methodology for determining the discount curve. Under the proposals, liabilities will be discounted primarily using swap rates up to the 10-year last-liquid point (LLP), after which the curve will be extrapolated to an ultimate forward rate of 4.2% at the 20-year point.

Jakob Carlsson, chief financial officer of Lansforsakringar Liv in Stockholm, says the proposals would improve the company’s capital requirements by 3–4% and would reduce the overall interest rate sensitivity of liabilities by 35–45%, reducing the need for hedges. “We welcome the change. Now we have a curve that is more hedgeable,” he says.

But there are concerns about the ALM implications of the new curve and the potential for it to be distorted by speculative traders such as hedge funds.

Interest rate sensitivity is focused around the 10-year LLP, meaning the preferred hedge for the curve will be 10-year swaps. There has been a surge in the purchasing of 10-year contracts and speculative positioning by hedge funds for tighter long-end swap spreads since the plans were first announced in February, bankers say.

The speculative trading activity has already had an influence on shape the yield curve and is a potential cause for concern, say insurers. Håkan Ljung, group chief risk officer at Skandia Liv, says: “We will look further into the sensitivity of the suggested extrapolation method to potential market manipulation. As we see it, robustness to market manipulation should be a key requirement on the discount rate.”

While the new curve will be based on swap rates rather than the average of covered bond zero coupon rates – which will make it easier to hedge – insurers are also working out how to effectively hedge the curve between the 10- and 20-year points, which is not determined by market rates.

Johan Jonsson, senior manager in charge of the Swedish capital modelling and risk quantification team at PwC in Stockholm, says: “To my knowledge, no-one has a good solution of how to hedge the Swedish solvency curve. You could hedge the market rate between 10 and 20 years, but you need a hedgeable bond to do so. The market is in a bit of limbo at the moment, figuring out how to do this.”

The new discount rate curve, which will apply from January 1, 2014, is being introduced to counter the threat to insurers’ solvency from low interest rates and the delays to Solvency II. The Swedish FSA said the curve makes the discount rate “less sensitive to market fluctuations since it is based on both market and model assumptions”.


This article was first published on Risk

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