A panel of senior insurance asset-liability management (ALM) professionals from a range of UK-based life insurance firms joined Milliman in mid-June 2024 to exchange views on various current themes in ALM and capital management.

This discussion was conducted under the Chatham House rule (comments are anonymous and non-attributable) and below we summarise key points from the hour-long call. We’d like to thank all those who took part for their time.

Participants

Joe Cannavan – Head of Capital Management at Royal London
Andrew Hague – Head of Financial Risk and Chief Actuary (Life) at NFU Mutual
Alex Kaitcer – Head of Group ALM at L&G
Jonathan Lim – Head of ALM Strategy and Hedging at Canada Life UK
Brendan McMaster – Director of Capital Management at Just
James Pratt – Lead Actuarial Manager, Capital Efficiency and ALM at LV=
Mauritz Strydom – Head of Capital Management and ALM at Lloyds Banking Group
Patrick Van Beek – Head of ALM, UK Life Finance at Aviva
ShuoShen Zhang – Head of ALM at Just

Moderated by Russell Ward, John Jenkins, Florin Ginghină and Peter Lin of Milliman

Notes

Do you have a view on the medium-term interest rates and short-term inflation rates by year-end?¹

While the general expectation was that the two rates will stay at a broadly similar level if not slightly lower, the participants all agreed the focus was not on the precise level of the rates but making sure the company balance sheet is robust to withstand the higher levels of market volatility seen in recent years.

What are some of the top challenges for you in 2024?

One common theme the participants expressed was balancing different objectives in optimising hedging strategies, e.g., Solvency II metrics versus International Financial Reporting Standard (IFRS) 17 metrics, and liquidity versus solvency. In particular, interest rate hedging was noted as more difficult in recent more volatile markets, balancing the solvency priority in a scenario where interest rates fall against the liquidity priority in a scenario where interest rates rise. Interest rate swaptions could be bought to address the volatility point. However, this was countered by the high up-front premium and the difficulty in conveying the benefit of swaptions to other stakeholders, who hold deterministic views of future interest rates. One practical way to address this was to prioritise the biting scenario or metric without holding a specific directional view. There were also further challenges of balancing these hedging metrics with other stakeholders’ expectations, for example challenge from board members who may hold strong directional views on rates, and analysts’ expectations on the short-term stability of coverage ratios.

Liquidity risk was highlighted during the stressed market environment from the fallout of the UK mini-budget event in September 2022. We have also seen the Prudential Regulation Authority (PRA) putting more emphasis in this area.² Is liquidity management becoming more challenging recently?

The participants agreed that there was now more focus on liquidity within the ALM framework. It was commented that a good liquidity framework needs to provide a list of management actions to cover a wide range of stressed scenarios. One challenge observed was managing liquidity monitoring and collateral requirements from different departments (e.g., actuarial, treasury, investment and reinsurance) within the company. This requires consideration of asset eligibility for collateral posting and bringing together a holistic view of collateral availability versus diverse demands for collateral and a need for the efficient deployment of the collateral pool during stressed scenarios.

The scale of the interest rate stress observed in the immediate aftermath of the mini-budget event was unprecedented, the 30-year gilt yield rose by more than 80 basis points the day after the budget announcement,³ before the Bank of England’s intervention. In light of this, have you recalibrated the “1-in-X” scenario in your monitoring metrics?

The participants noted that the large interest rate movement from the mini-budget event was automatically fed through into the risk calibration process and had an immediate impact on the level of stress testing scenarios. To increase the number of extreme data points in the calibration process, one suggestion was to reconsider the calibration data period to include more data from historical periods with higher interest rates. One participant emphasised the need to communicate clearly with stakeholders on the absolute stress levels being used for monitoring and their impacts.

We have seen large new business flows recently, especially in the pension risk transfer (PRT) arena. Do you see challenges in hedging for these transactions?

The participants noted insurers as having some risk appetite to take on pricing spread risks for small deals (for example a deal backed by inflation-linked bonds but priced on inflation swaps). Also mentioned were transaction gap risks between the deal completion date and asset receiving date, and risks from market movements (for example credit spreads) during this gap period affecting the value of received assets. Insurers have considered hedging the gap risk using correlated assets such as credit default index swaps, total return swaps, and exchanged-traded funds (ETFs). However, these new assets could introduce challenges, for example basis risks, and they may not be eligible for inclusion within a Matching Adjustment (MA) portfolio. On a particularly topical note, participants indicated that, while insurers would factor in possible volatility from upcoming election events when considering new business, this was not a major hindrance to signing deals. One other challenge discussed was on premium deferral, where part of the premium for some deals is to be received in the future. This can help manage the challenge of illiquid assets within pension schemes but creates reinvestment risk and challenges around the purchase of assets today to hedge future premium receipts.

We have seen insurance regulatory changes that could affect ALM considerations, for example the recent PRA policy statement on Matching Adjustment reform.⁴ What do you see as some of the challenges they could pose?

There was limited time to cover this topic, but one potential new challenge was the management of callable securities, which are now potentially eligible within Matching Adjustment portfolios as assets with highly predictable cash flows. The risk of early repayment would pose reinvestment risk and add complexity to rate hedges, and companies would need to factor in the likelihood of repayment under different economic conditions.

To summarise, Milliman notes that:

• There was a broad consensus on the main challenges when optimising an ALM hedging strategy in the current volatile market and in balancing competing metrics.
• The discussions also highlighted the critical role of liquidity management, and the new challenges posed by the recent new business flows and regulatory reforms.

¹ At the time of the discussion the 10-year gilt rate and UK inflation (CPIH) were circa 4.1% and 2.8%, respectively.

² For example, PRA’s letter setting out 2024 insurance supervisory priorities, available at https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/letter/2024/insurance-supervision-2024-priorities.pdf.

³ Read further on Bank of England’s intervention at https://committees.parliament.uk/publications/30136/documents/174584/default/.

⁴ See PS10/24 – Review of Solvency II: Reform of the Matching Adjustment | Bank of England at https://edu.bankofengland.co.uk/prudential-regulation/publication/2024/june/review-of-solvency-ii-reform-of-the-matching-adjustment-policy-statement..

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