New York State Insurance Department
Capital Markets Bureau
New York State Insurance Department
Stress Testing
&
Other regulatory investment issues
*
NYIA Educational Seminar
2/12/09
Matti Peltonen
Bureau Chief
1
New York State Insurance Department
Capital Markets Bureau
•Capital Markets Bureau
–Assists in regulation and monitoring of capital markets & risk
management activities of New York licensed insurers
–Insurance companies’ capital markets activities:
•investments
•derivative use
•Borrowing & securities lending
•Securitization
•Asset allocation
–Risk management: measuring, managing, and controlling
(capital market) risks – including stress testing
–Enterprise Risk Management: how market, credit, and
operational risk are incorporated into the insurer’s corporate
structure & culture
2
New York State Insurance Department
Capital Markets Bureau
CMB activities:
 Provide examination support
Insurance companies
Public retirement systems




Review special transactions, valuation
Approve and monitor derivative activity
Assess asset & liability management
Train staff in capital markets issues
 Assess solvency & identify problems through financial analysis
 Evaluate corporate governance
 Review use of third party investment management
 Monitor securitization of insurance risk
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New York State Insurance Department
Capital Markets Bureau
Current Critical Issues & Initiatives:
•Credit Crisis
•Financial Guarantee Insurers
•Stress Testing
•Enterprise Risk Management
•Securities Lending
•Subprime and other structured securities
•Valuation
•Derivatives
•Rating Agencies
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New York State Insurance Department
Capital Markets Bureau
•Stress Testing
•After the turmoil in many sectors of investments, we considered
it prudent to meet with companies on how they conduct stress
testing, and how the stress testing has changed in 2008
•CL #25(2008) was issued 11/18/08
•All companies are expected to have scenario stress testing
process in place as part of prudent management
•Stress testing: how different economic scenarios are analyzed
•First round of reviews completed – focus on large NY domestics
•Second round starts – probably - during spring 09
5
New York State Insurance Department
Capital Markets Bureau
•Stress Testing Questions
•Governance and Operations
•Details of risk management structure
•Stress testing methodology, market shocks
•Reporting
•Disaster recovery
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New York State Insurance Department
Capital Markets Bureau
•Stress Testing – Market Shocks
a. Interest rate shocks
b. Basis spreads
c. Credit spreads and swap spreads.
d. Equity market shocks
e. Changes in volatility in relevant inputs.
f. price shifts (such as equities, commodities, currencies, real estate, etc)
g. Yield curve shifts
h. Changes in credit quality
i. Changes in liquidity
j. Rating agency downgrades
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New York State Insurance Department
Capital Markets Bureau
•Stress Testing – Market Shocks
k. increases in inflationary pressures
l. deflation
m. continued fall in equity markets and falls in real estate
n. increased default rates leading to counterparty failures, including collateral
arrangements in hedging, securities lending or other arrangements
o. Effect of increased defaults on value of collateral (RMBS, credit card
receivables, student loans, etc).
p. changes in lapse rates
q. Collateral calls
r. natural catastrophes (hurricane, flood, earthquake)
-what are the extreme scenarios used
-what is the technology used to run reports and analyses
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New York State Insurance Department
Capital Markets Bureau
•Credit Crisis
•Mortgage-backed securities
•Residential: subprime, Alt-A, home equity
•Commercial real estate
•Other structured securities (e.g CDOs, CDO^2)
•Borrow short & lend long (SIVs, banks, securities lending)
•Corporate bonds (Bloomberg story – up to $1 trillion in losses)
•FGIs, including impact on municipal debt
•Monitor insurance industry exposures
•Monitor how different asset classes perform (illiquidity, credit, price):
•Municipal auction-rate securities
•Subordinated/hybrid debt issued by financial firms
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New York State Insurance Department
Capital Markets Bureau
•Financial Guarantee Insurers
•Analysis of risk exposures/solvency, modeling capabilities, risk
management
•Examinations
•Impact on municipal securities market
•Ensure adequate financial guarantee capacity
•Restructuring of old companies
•Capital
•New capacity
•Structured securities
•New legislation / regulation / circular letter
•ACA, AG, AMBAC, CIFG, FSA, FGIC, MBIA, Syncora (Berkshire)
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New York State Insurance Department
Capital Markets Bureau
•Financial Guarantee Insurers/Structured securities
CDO Squared
Mortgages
RMBS
Inner CDO
CDO Squared
Bondholders
Mortgage
Mortgage
Mortgage
FGI:
Senior
(AAA)
CDS guarantees
payments
AAA
Mortgage
AAA
Mezzanine
(A)
Mortgage
Mortgage
AA
Mortgage
A
Mortgage
BBB
Mortgage
Junior
(BBB)
BBB
Equity
Control rights
•Theory: by subordination, you can create AAA security from subprime
•Underestimated the value erosion caused by the rise in delinquencies and defaults
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New York State Insurance Department
Capital Markets Bureau
•Structured Securities: CPDO
•Constant Proportion Debt Obligation
•Structured security leveraged up to 15 times with CDS off iTRAXX
•CDSs rolled on the exchange every 3/6 months
•Dependent on spreads, contract liquidity, max leverage
•If spreads widen, leverage goes up
•Initially rated AAA, as the probability that interest and principal would be paid was
estimated to be 99.2%
•Coupon LIBOR+2%
•Initiated re-formation of NAIC Invested Assets Working Group
•Euromoney’s “Obituary” in November 2008 for the 600 billion issued
$$$
Money mkt
LIBOR
$$$
Arranger
(CDS c/p)
Premium
CDS G/L
Libor+premium
$$$
SPV
CDS G/L
Investors
Libor+premium
sell protection
CDS
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New York State Insurance Department
Capital Markets Bureau
• Enterprise Risk Management (“ERM”)
• ERM: capability to consistently identify, measure, aggregate and
manage risk exposures within predetermined tolerance
guidelines
• The ERM structure: combines market risk, credit risk,
operational risk and insurance risk, economic capital, and
disaster planning
• Oversight by Chief Risk Officer
• Insurance companies’ ERM is at various stages of development
• Capital Markets Bureau:
• Establish evaluation criteria
• Develop an audit&examination program to assess ERM
• Incorporate assessment of ERM into examination process
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New York State Insurance Department
Capital Markets Bureau
• Enterprise Risk Management (“ERM”) / Risk-Focused Exams
Modeling/analyzing insurance companies’ portfolios
•
•
traditional approach: verification of balance sheet
risk-based approach - portfolio analysis:
-using the filed statutory information on investments
-upload portfolio (into Excel & Bloomberg) for analysis
-enables a more dynamic risk assessment, using (for example):
-bonds: duration, Value-at-Risk, rating distribution
-sector exposures (telecommunications, energy)
-equities: P/E, beta, etc.
-scenario testing
•
•
•
Metrics
Problem: understanding liability structure (on duration basis)
IAWG: improve information in the annual statement + “database symmetry”
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New York State Insurance Department
Capital Markets Bureau
•Securities Lending
•Insurance companies enhance income by lending securities to
broker/dealers, banks, hedge funds
•Lender receives cash as collateral (typically 102% of value)
•Problem: some insurers have reinvested the cash collateral in
subprime and other structured securities, which have
significantly fallen in market value – and as a result, the
collateral is no longer adequate
•The Department issued a Circular Letter (16/2008) indicating an
enhanced review of the activity in upcoming examinations
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New York State Insurance Department
Capital Markets Bureau
•Securities Lending
The problem; short-term securities lending program was used to finance
long-term investments in securities (to leverage balance sheet)
Market value fell either on both sides, or for the securities where the
borrowed money was invested
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New York State Insurance Department
Capital Markets Bureau
Derivatives
•Regulation of CDS
•Derivatives Working Group (NAIC)
•Update Derivatives Model Regulation (282)
•Prior approval
•Update Annual Statement Schedule DB (Derivatives)
•Transparency
•Hedge effectiveness
•Permitted uses:
•Hedging
•Income generation
•Replications
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New York State Insurance Department
Capital Markets Bureau
Valuation
•Problem: market value (what another counterparty pays) is far
from the discounted cash flow value, which can be far from
amortized cost
•Annual Statement
•Pricing proposal (VOS), effective 12/08 for Schedule D
•Company can select the source (instead of SVO Unit Price)
•Pricing source needs to be disclosed
•Same method for derivatives (Schedule DB)
•Eventually, both D and DB likely to follow FASB Levels 1,2,3
•SSAP 43 ->SSAP 98&99 Other Than Temporary Impairment
•Change (98): written down to fair value (instead of undisc. cashflows)
•99: discount can be amortized if principal unimpaired
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New York State Insurance Department
Capital Markets Bureau
Rating Agencies
•Unrated securities are filed with the SVO (assigns NAIC 1-6)
•Rated Securities, NAIC relies on the NRSROs (“AROs”) for about
$2.6 trillion of rated securities
•Rating translated into NAIC 1-6
•SVO Initiatives WG -> SVO-NRSRO
•NAIC continues to rely on NRSROs (RBC, statement value)
•A review of the FE process, and reliance on the NRSRO ratings?
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New York State Insurance Department
Capital Markets Bureau
NAIC Work
In addition to developing and enhancing securities and derivatives
regulation in New York State, New York is at the forefront of work
that is done on those areas in the NAIC:
•Valuation of Securities Task Force (Chair)
•Derivatives Study Working Group (Chair)
•Invested Assets Working Group (Vice Chair)
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New York State Insurance Department
Capital Markets Bureau
Asset Allocation
% of inv. assets
Bonds
Preferred Stocks
Common Stocks
Mortgages&real estate
Other inv assets (BA)
Cash & short term inv.
Affiliated investments
Life
74.8
2.2
4.6
10.5
2.8
2.7
5.3
P&C
65.8
1.3
26.2
0.4
4.1
6.8
16.1
% of bonds
NAIC 1
NAIC 2
NAIC 3
NAIC 4
NAIC 5
NAIC 6
Life
69.3
25.1
3.3
2.0
0.4
0.1
P&C
91.8
5.9
1.1
0.9
0.2
0.0
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