Grigory Spivak: Our business is in long-term reinsurance for life insurance companies. Our liabilities to clients have to be fully collateralised.
The collateral – the assets our counterparties can accept as collateral – depends greatly on the market. This means that what UK companies are able to accept as collateral is driven by their interaction with the Prudential Regulation Authority (PRA) and their regulatory requirements, which will be very different from what our clients in Japan are able to accept.
So far, most of the reinsurance transactions we have done have been in the UK. Our freedom in terms of using private assets as collateral to insurance counterparties was due to the PRA and their eligibility rules on the subject. The amount of private assets we’ve placed was fairly limited, but we are constantly looking at various opportunities.
Grigory: To the extent that private assets backing reinsurance are aligned with the assets UK clients are able to use themselves, we can have some allocation to private assets. For some of them, we have to restructure those private assets either using some repack vehicles or special purpose vehicles (SPV) or securitisations.
"We're regulated by the Bermuda Monetary Authority and their agenda regulatory
rules – which are similar to the PRA Solvency II rules but have differences."
The first step here is using some kind of vehicle to be able to post that as the collateral, and then we have to apply ‘look through’ when we're thinking about risk management, capital modelling, and all these things.
The second thing we have to consider is that it needs to work both for our UK clients under Solvency II and it needs, as collateral, to be acceptable quality for them.
Then it needs to work for us as a Bermudian reinsurer. We're regulated by the Bermuda Monetary Authority (BMA) and their agenda regulatory rules – which in many ways are similar to the PRA Solvency II rules but have some differences – so we have to think about a scenario-based approach (SBA), which is the Bermudian version of matching adjustment (MA), and we have to think about the BMA capital requirements.
Typically, for all the private assets, we consider all these vehicles that I've mentioned, we apply a look through, and we have in-house economic stress tests too.
On top of this, the BMA always requires us to form an internal view of what the capital requirements should be before they compare them to the standard factors that are used in Bermuda.
Grigory: We have so far not reinsured UK inflation in our transactions; our liabilities have not been impacted by higher inflation rates. The main impact on us is how the actions of the US and other central banks impact investment markets.
Our liabilities tend to be very long duration and we tend to originate very long duration debt in the capital markets to match those liabilities.
When the interest rates were low, we saw a lot of companies keen to issue 30- or 40-year debt in the capital markets to lock into the low interest rates in anticipation that interest rates would go up. Now, they have gone up. There was a period when there wasn't much new debt issuance going on, and it was difficult for us, as an investor and a lender, to originate long-term debt with attractive yield because the corporates were not raising debt at those levels.
"Last year, the yields on public debt went up much quicker than the private debt
on the private markets – and private markets are always a bit slow to follow."
But since October last year, interest rates have gone down quite a lot and, hopefully, conditions in capital markets will improve. These changes will impact both public and private markets.
Private markets have acted with a bit of a lag in terms of the yields on private assets. For instance, last year, the yields on public debt went up much quicker than the private debt on the private markets – and private markets are always a bit slow to follow. So, our strategy last year was to invest in public corporate bonds rather than private assets, which was quite an attractive strategy at one time.
But now we're seeing more attractive opportunities in private markets, and we are considering those structures and vehicles because we want to catch up on our access to private markets.
Grigory: The challenges we are facing are twofold; I've already mentioned regulatory restrictions on the collateral requirements. Although we’re in Bermuda (technically a subsidiary of the US company), which means we are not directly subject to those matching adjustment rules, the reinsurance collateral we're posting to our UK clients still has to be compliant with the Matching Adjustment, especially for the illiquid private assets.
"The types of structures we're considering are repack vehicles such
as SPIRE, which package assets together with derivatives."
In addition to that, the PRA has recently put out a consultation encouraging UK companies to have assets on the collateral in the same currency as their liabilities – so as not to rely on their ability to put currency hedges in place in case of a reinsurance recapture event.
So, the types of structures we're considering are repack vehicles such as Single Platform Investment Repackaging Entity (SPIRE), which package assets together with derivatives, such as currency swaps, and interest rates that make the currency and the shape of the underlying assets more in line with the underlying Sterling reinsured liabilities – therefore making it easy for companies to demonstrate MA compliance.
They are also helpful in the sense that we are able to match the collateral – for example, the reinsurance liabilities – with assets much more closely, to give clients more comfort that this collateral would protect them in case of insurance termination. We do this not just for the PRA but also for our internal sensible risk management policy.
That's one family of structures that we're considering, but there are other types of structures, too. For example, we could look at a portfolio of private assets, put them into an SPV that will issue notes, and then we would put the notes issued by the SPV into the collateral. That would allow passing the legal ownership and would give an external credit rating that would indicate which capital treatment should be applied to them.