latest developments in risk management, hedging ... · latest developments in risk management,...
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Latest Developments in Risk Management, Hedging andManagement, Hedging and Capital Markets for Insurers
Victor Huang, Milliman &Danny Wong, MillimanDanny Wong, Milliman
© 2012 Milliman
AgendaAgenda• Market update, hedging overviewMarket update, hedging overview• Key developments in risk management
f ifor insurers• Control framework evolution• Trends/implications for products
AgendaAgenda• Market update, hedging overviewMarket update, hedging overview• Key developments in risk management
f ifor insurers• Control framework evolution• Trends/implications for products
Market ThemesMarket Themes• European crisis and austerities• Central Bank’s balance sheet expansionp• China’s less aggressive easing• Increase in overall market volatility
Source: VIX Index (Bloomberg)
Source: US Federal Reserve, ECB (Bloomberg) Source: EuroStat (Bloomberg)
Market ActivityMarket Activity
Source: Bloomberg
Source: Bloomberg
Hedging OverviewHedging Overview• Liability: where does the risk lie?
– GuaranteesProtection– Protection
Source: Milliman MG-HedgeTM
Translating to Market RiskTranslating to Market RiskAccount Currency I t t R tValue> Delta
Currency> Delta
Interest Rate> Rho
Delta
V l tilit C it Basis RiskVolatility> Vega
Convexity> Gamma
Basis Risk> Hedge StrategyStrategy
Derivative Hedge InstrumentsDerivative Hedge InstrumentsInstrument Delta Rho Vega Gamma / Convexity
Equity Index Futures / Total Return Swaps Total Return SwapsCurrency Futures / Forwards Interest Rate Swaps / Bond Futures
Interest Rate Swaptions Variance Swaps / Volatility Futures Equity Options Equity Options (ETO & OTC)
Dynamic Hybrid Static
Milliman Hedge Cost IndexMilliman Hedge Cost Index
Source: Milliman Hedge Cost Index for Variable Annuity Guarantees (Bloomberg: MLHC Index)
New Exchange Traded ProductsNew Exchange Traded Products• SGX China A50 Futures• 10 Year French Govt Bond Futures• S&P500 Super LEAPS Options• VIX Futures
– Nikkei Volatility IndexH S V l tilit I d– Hang Seng Volatility Index
– Emerging Markets ETF Volatility Index– Brazil ETF Volatility IndexBrazil ETF Volatility Index
• ASX Property Index
Impacts of Regulatory p g yDevelopments on Hedging
Regulation ImpactDodd-Frank • Exchange clearing IRS and CDS
• Upfront margin requirement
European Market Infrastructure Regulation (EMIR)
• Exchange clearing for IRS and CDS• Upfront margin requirement
Basel III • Hedge cost likely to increase• Pricing for uncollateralised transactions• More intensive usage of capital
Life and General Insurance Capital • Risk based capital requirementsLife and General Insurance Capital (LAGIC)
• Risk based capital requirements
OTC Trading DevelopmentsOTC Trading Developments• Collateral Posting for OTC Transactions
Credit Support Annex (CSA)– Credit Support Annex (CSA)– Overnight Index Swap (OIS)– Currency– Upfront Margin RequirementsUpfront Margin Requirements
• Disruption Clauses on ISDA Confirmations– Hedging Disruption– Increased Cost of HedgingIncreased Cost of Hedging– Loss of Stock Borrow– Increased Cost of Stock– Optional Termination ProvisionOptional Termination Provision
AgendaAgenda• Market update, hedging overviewMarket update, hedging overview• Key developments in risk management
f ifor insurers• Control framework evolution• Trends/implications for products
Vega Rho Hedging TrendsVega, Rho - Hedging Trends• Volatility Management
– Opportunistic Vega hedging– Variance swaps
R H d i• Rates Hedging– More granular duration
More Active Hedge ProgramsMore Active Hedge Programs• Client demands:
– 24hr real-time coverage of risk positions• Recent market events and industry best practice
driving this demanddriving this demand– Eurozone debt, Fukushima, GFC
• Benefits– Better management of gap risk through minimising periods
where risk thresholds are breached– Approaching the ‘continuous rebalancing’ assumption of modelspp g g p
Operationally how is it implemented?Operationally, how is it implemented?Typical approach previously used by insurers, most basic use of a Global DeskPrimary approach clients are adopting ‐ Makes use of extended futures trading hour
ASXNIKKEIEurostoxx 50FTSE 100S&P 500
ASXNIKKEIEurostoxx 50FTSE 100S&P 500S&P 500Time: 0. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23.S&P 500Time: 0. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23.
A step further ‐ Makes use of proxies when liquidity isn't available
ASXNIKKEIEurostoxx 50FTSE 100
SPX ProxySPX Proxy
Possible need for SPX Proxy
S&P 500Time: 0. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23.
No TradingNormal Trading Reduced liquidity Limited Trading
Models how are they changing?Models, how are they changing?Most current market data, inforce data used for full valuations
Greeks #1 #2
Time: 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 0. 1. 2. 3. 4. 5. 6. 7.
Valuation #1 + real‐time market data =real‐time Greeks used for 24hr hedging
Valuation #2 + real‐time market data =real‐time Greeks used for 24hr hedging
• Move towards more precise intra-day estimation of Greeks– Full Taylor series implementation
F ll D lt fil t dd l k t t– Full Delta profile to address larger market movements– GPU assisted real-time valuation of Greeks
• Smarter, tighter trading thresholds– Risk adjusted thresholds– Thresholds for overall position
Evolving Operational Best PracticesEvolving Operational Best Practices
TradersHedge Assets Database
Pre-filled Trade Execution Broker/
ExchangeFIXTrading
ModelLiability
Valuations System Exchange
F t fi &
Model
R l ti
Valuations
Fat-finger & Security checks Hedge policyReal-time
Market data
AgendaAgenda• Market update, hedging overviewMarket update, hedging overview• Key developments in risk management
f ifor insurers• Control framework evolution• Trends/implications for products
Identifyingand Specifying
the Problem
The eControl Cycle
Developing and Monitor and
Implementing the
solutionresponding to
experience
Performance Attribution
Note: Numbers are illustrative
Sample Real-time Snapshot
Note: Numbers are illustrative
AgendaAgenda• Market update, hedging overviewMarket update, hedging overview• Key developments in risk management
f ifor insurers• Control framework evolution• Trends/implications for products
Product Implications/Emerging TrendsProduct Implications/Emerging Trends• Shift in the product landscape
• Traditional guaranteed products less feasible• Increasing demand for protection amid market uncertainty
E b d l t t i k t• Embed latest risk management technologies into funds directly
• Volatility management provides a stabilised level of risk exposurestabilised level of risk exposure
• Capital protection provides a layer of option-like protection
Source: Milliman
ExamplesExamples• Locally, Fortnum/Wealthsurey
have launched/are launching funds with embedded risk management.
• In the US, Lincoln, Ohio national, etc.
• TOPSTM Protected ETF Portfolios