The advent of "Living Benefits" in the UK has heralded much debate. Cazalet Consulting's report on Living Benefits described them as the "investment holy grail" by being able to provide exposure to the upside of equities, whilst at the same time limiting or even eliminating the downside and providing growth and lock-ins and/or guaranteed income.
Cazalet Consulting also pointed out that “there would appear to be considerable barriers to entry… because the concept demands cutting edge intellectual capital, as well as highly sophisticated management practices and controls supported by powerful computer technology.”
This article points out the highlights from Cazalet Consulting review of Risk Management for Living Benefits. For the full report please download the pdf at the bottom of this page.
“[There are] other players [that] are considering joining the fray with regard to ‘Living Benefits’ offerings in the UK, but there would appear to be considerable barriers to entry.”
Comparison with the UK.
In looking [at] the over-arching financial and risk management culture of The Hartford, and to understand the strategic direction of the group, we were impressed by the presence of a very strong risk management culture.
In examining The Hartford’s Living Benefits guarantees, were struck by the huge gulf between the approach adopted by The Hartford and what passes for financial management among the generality of UK life offices and with-profit funds.
Set against the best US financial and risk management practice (as exemplified by The Hartford), many UK with-profits funds simply do not compare when it comes to risk management.
“Many UK with-profits funds simply do not compare when it comes to risk management”.
We think that the vast difference in approach to risk management in relation to< life products with guarantees and options has a lot to do with the respective financial structures of US and UK providers.
Many UK life offices still seem to be some way off from employing modern capital market techniques to manage and mitigate the risks arising from policyholder options and guarantees.
[Therefore] we think that the contrast between US and UK life offices is very important for IFAs. When life offices “go wrong”, this can be calamitous for policyholders and embarrassing for advisers.
Risk Management for Living Benefits
The first thing that The Hartford does at the end of each and every trading day is to re-examine its entire portfolio of in-force Living Benefits and to assess the risks embedded in it and the market-consistent cost of the guarantees and options. This is done by running a daily market-consistent stochastic valuation.
In total, each daily stochastic model run for the Living Benefits book of business involves the assessment of approximately 300 sensitivities with each run through 4,000 random simulations, stretching out over the following 40 years.
Having undertaken the daily stochastic modelling and analysis overnight, The Hartford starts each day by re-assessing and re-balancing a portfolio of hedge assets that it holds with the aim of eliminating balance sheet risk.
In order to run a modelling and hedging programme of such magnitude, The Hartford requires very considerable computing power, robust internal risk management and reporting structures, a concentration of leading intellectual capital, and preferred access to and strong relationships as a counterparty on Wall Street and other capital market centres.
“We were very impressed by the presence of a very strong risk management culture.”
Comparison with typical UK with-profits funds.
It is worth noting that most UK life offices did not engage in any form of stochastic modelling until forced by the FSA to do so a couple of years ago and, even now, for many the stochastic model run is an annual and not a daily event.
Further, in our experience and opinion, stochastic modelling is primarily being used by UK life offices for regulatory reporting and is treated as something of a once-a-year chore (a bit like Christmas shopping), rather than being used
as a management tool to drive strategic direction, product development and financial management in real time.
“We were struck by the huge gulf between the approach adopted by The Hartford and what passes forfinancial management among the generality of UK life offices.”
Conclusion
The Hartford has embedded risk management across the organisation within
a robust structure that appears to spread responsibility without diluting it, which is positive for the financial strength and stability of the group as a whole as well as aiding the design of durable consumer investment propositions that are insulated from the kind of unforeseen market shocks and unintentional management mis-steps that have plagued substantial parts of the UK with-profits sector in recent times.
For the full Risk Management for Living Benefits report by Cazalet Consulting, download the pdf (PDF: 55Kb).
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