A team of insurance regulators is seeking public comments on an American Council of Life Insurers proposal concerning the effects of derivatives-based hedging programs on life insurer risk-based capital calculations.
The Life Risk-Based Capital Working Group, part of the National Association of Insurance Commissioners, Kansas City, Mo., has posted a draft of a proposed hedging program RBC worksheet, draft worksheet instructions, and a response to questions about the proposal, on its section of the NAIC website.
Comments are due Dec. 1.
In the questions and answers, for example, the ACLI, Washington, notes regulators have asked about mismatches between derivatives durations and the liabilities hedged.
“Regulators expressed concern that a 5-year credit default swap (CDS) should not hedge 100% of a 30-year bond simply because current RBC calculations do not take maturity into account,” the ACLI says. “The value of the CDS versus the cash instrument will not move in close correlation when the maturities aren’t the same.”
The ACLI understands the importance of differentiating hedge programs with varying degrees of maturity mismatches, but it believes that “insurers should get 100% RBC credit for hedging based on certain market dynamics,” the ACLI says.
The ACLI has responded to that concerning by suggesting that insurers should reduce the amount of credit they get for a hedge if there is mismatch between the maturity of the derivative and the underlying bond.
The proposal does not deal with adjusting for the risk that a counterparty – the party in a CDS transaction that is supposed to pay up if a bond defaults – will fail to meet its CDS obligations.
The ACLI left that matter out of the derivatives proposal because the NAIC already incorporates derivatives counterparty risk in RBC calculations, the ACLI says.
“We feel the approach to counterparty risk currently in place is thorough and sufficient,” the ACLI says.
But the ACLI believes RBC should reflect the protection that a CDS that works properly does provide against a default event, the ACLI says.