Market risk and ALM

At Black Horse Life (1990-98) I managed the team responsible for monitoring all the life company’s investments.  This included:
• Monitoring the performance of the unit linked funds against agreed performance targets.
• Monitoring the use of derivatives within the unit linked funds for legality.
• Monitoring the split of funds by asset class, credit rating, industry sector, etc against agreed limits.
• Membership of the Investment Steering Group, which would discuss the ongoing appropriateness of the investment strategy, the ongoing compliance of the fund managers with the strategy and the investment performance of the unity linked funds.

I also:
• Checked the valuation of OTC derivatives within the unit funds.
• Provided advice to the actuaries developing unit trusts that used derivatives to provide investment guarantees.
• Derived cash switching schedules for unit linked mortgage endowments approaching maturity.

At Gen Re (1999-2000) I would discuss with potential clients the use of swaptions to hedge guaranteed annuity options and the use of swaps to avoid duration mismatches while maximising returns on bonds backing annuities.

At PwC (2000-06) my knowledge of derivative pricing theory left me well placed to become the practice’s subject matter expert on market consistent valuation.  This soon broadened out into all aspects of stochastic modelling (real world as well as market consistent) and on the use of derivatives.  I was frequently asked to review firms’ derivative strategies and to explain them to my colleagues.  I provided all the actuarial input to a project to build a real world stochastic model for a portfolio of shared appreciation mortgages.  I invested a lot of time in training the whole life insurance practice to understand derivatives, market consistent valuation and all aspects of stochastic modelling.

In 2004, the Actuarial Profession identified the need to provide a course and exam on financial economics for those actuaries looking to increase their knowledge of a number of topics that had only recently been incorporated into the actuarial exams.  A committee was appointed to develop the course and, after the first couple of meetings, identified the need for a derivative expert to join the team.  So I was invited to join and contributed all the course material on derivatives.

At Prudential (2008-2010) I spent all of my time on ALM and market risk.  The firm had decided that it needed to hedge some of the equity risk within the with profits fund and that, rather than buying options, it would delta hedge using futures.  I separated the problem into choosing a “benchmark option” and then delta hedging the benchmark option.
• To help senior management choose an appropriate benchmark option, I developed the concept of “solvency frontiers”.  The only data I had available was the impact on the fund’s solvency of a number of stresses to interest rates and/or equity prices.  I built a spreadsheet that would extrapolate these figures all over a two-dimensional plane with the FTSE and a particular interest rate as the axes.  I then allowed the spreadsheet user to specify a “benchmark option” and coded the spreadsheet to adjust the solvency levels all over the plane to allow for the payoffs from the option.  Finally, I coded the spreadsheet to output a graph with a single line on it: the solvency frontier, below which the fund would not cover its capital requirements.  I then used the spreadsheet to derive the benchmark option that would result in a solvency frontier lying in a position that senior management were comfortable with.  The position of the solvency frontier and the choice of benchmark option were reviewed on a regular basis.
• I agreed delta hedging procedures with the fund managers: we developed spreadsheets independently and, by using these independently, reduced some operational risks.  I developed a spreadsheet that would separate the profit/loss from futures into (i) the profit/loss that would have arisen from buying the benchmark option, and (ii) the profit/loss arising from the decision to delta hedge rather than buying the option.  I also broke down the delta hedging profit/loss into the separate mismatches for the key Greeks.  Despite the decision having already been made to delta hedge, I was also careful to explain the extra risks that this introduced.

In 2009, I was asked to join the team of examiners for ST6, the Actuarial Profession’s derivative exam.  I served on the team for five years, contributing about 40% of the exam questions for the 2010-14 sittings.  As well as setting exams the team was responsible for updating course material when this was thought to be necessary: I updated all the course material on securitisations.

With the FSA and PRA (2010-14) ALM issues would occasionally arise.  For example:
• I needed to understand a bulk annuity provider’s use of swaps (and their impact on the valuation interest rate).
• I supported the Policy division in recommending an FSA view on plans by a number of firms to introduce “liquidity swaps” to maximise profits on annuity books.
• In reviewing with profits runoff plans, I expected firms to be able to provide forward projections of a fund’s equity backing ratio.

While contracting with Pension Insurance Corporation (late 2015) I made changes to the counterparty risk module of the firm’s internal model, introducing functionality to model the impact of defaults under stock lending arrangements.

From April to November 2016 I helped Admin Re design and build an internal model for Solvency II.  This included the development of the methodology underlying the financial markets and credit modules. In particular, I designed and documented models for equity, gilt yield, swap spread, credit spread and default & migration risks. I also built spreadsheet-based t-copulas to experiment with & to help the client understand their properties. And I showed the client how to convert variances of monthly returns to variances appropriate to use with a model of annual returns and extended this to a methodology for annualising monthly correlations.

From January to July 2017 I helped Legal & General Retirement to understand the impact on their capital requirements of changes to the migration and default methodology within their internal model. This involved a deep dive into the mechanics of the model.

While contracting with Canada Life (July 2017 to May 2018), as well as documenting the data, assumptions and internal model methodology for determining capital requirements for the credit risks associated with mortgages, I also documented the internal mortgage credit rating methodology and the internal mortgage valuation methodology.  I designed and actioned test plans for the bond spread calibration model, the mortgage spread/migration model and the model that calculated the matching adjustment following stress (and portfolio rebalancing).  I designed a new approach to validating capping of mortgage spread stresses.