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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?

    – Guarantees Protection– Protection

    Source: Milliman MG-HedgeTM

  • Translating to Market RiskTranslating to Market Risk Account 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 Instruments Instrument Delta Rho Vega Gamma / Convexity

    Equity Index Futures / Total Return Swaps Total Return Swaps Currency 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 Index H 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 y Developments on Hedging

    Regulation Impact Dodd-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

    ASX NIKKEI Eurostoxx 50 FTSE 100 S&P 500

    ASX NIKKEI Eurostoxx 50 FTSE 100 S&P 500S&P 500 Time: 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 500 Time: 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

    ASX NIKKEI Eurostoxx 50 FTSE 100

    SPX Proxy SPX Proxy

    Possible need for SPX Proxy

    S&P 500 Time: 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/ ExchangeFIX

    Trading Model

    Liability Valuations System Exchange

    F t fi &

    Model

    R l ti

    Valuations

    Fat-finger & Security checks Hedge policy

    Real-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

  • Identifying and Specifying

    the Problem

    The e Control Cycle

    Developing and Monitor and

    Implementing the

    solution responding 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

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