Rothesay Life's internal model cuts £411m from capital requirement

Published in: Risk, Risk management, Capital, Corporate strategy, Capital management, Financial results, Solvency II, Investment risk - strategy, Asset management, UK, SFCR

Companies: Rothesay Life

Adopting a partial internal model to calculate its Solvency II capital requirement (SCR) has saved Rothesay Life £411m ($538m), according to analysis by Insurance Risk Data (IRD), a database from the publisher of InsuranceERM.

IRD analysis shows Rothesay Life’s switch to a partial internal model also reduced its overall SCR by 16% to £2.16bn.

The UK annuity provider received regulatory approval to model credit and counterparty risk from 31 December 2018, according to disclosures in the company’s solvency and financial condition report.

This was the main factor in boosting Rothesay Life’s 2018 year-end solvency ratio to 180% from 163% a year earlier.

Other capital management actions taken during 2018 include the issue of equity and debt to support the acquisition of Prudential’s £12bn annuity book.

Rothesay Life’s shareholders – including GIC, Blackstone and MassMutual – provided £380m of new equity, while £350m of restricted tier 1 (RT1) notes were also sold to capital markets investors.

The company reported IFRS pre-tax profit for 2018 of £102m, down from £312m in 2017.

“While widening credit markets have dampened profits … they also present opportunities to invest at more attractive levels,” Rothesay Life reported.

Asset risk measured

Insurers usually apply to use an internal model when the Solvency II standard formula is not a good fit for the risks they have.

In Rothesay Life’s case, this is particularly around the assets it invests in, which includes a growing allocation to equity-release mortgages of £1.9bn at the 2018 year-end – an increase of more than £1.3bn over the year.

“The [partial internal model] means that the company’s bespoke models are used for calculation of credit and counterparty risk capital and ensures that the allocation of capital to investment is consistent with the low risk inherent in the types of highly secured and collateralised investments which are core to the company’s investment strategy,” the company reported.

Rothesay Life manages more than £36bn of assets across nine main asset classes:

  • 32% in UK and other sovereign bonds
  • 15% in secured residential property lending, which includes covered bonds, loans secured on ground rents and social housing
  • 11% in supranational and quasi sovereign debt
  • 10% in regulated infrastructure such as water, energy and transportation
  • 10% in other secured lending – loans secured against other collateral including commercial real estate
  • 9% in corporate bonds
  • 5% in equity release mortgages
  • 4% in other fixed interest investments including negative basis trades and loans to US and UK higher education and other non-profit organisations
  • 4% in cash

Matching adjustment

The changing asset mix and market conditions also led to changes in the matching adjustment (MA) benefit that Rothesay Life achieved.

At the 2018 year-end, the MA was approximately equal to 125 basis points, up from 105 basis points a year earlier.

Use of the MA had the impact of reducing the best estimate liabilities for the business in the matching adjustment fund by around 14%, Rothesay Life reported.

Capital add-on

For risks other than credit and counterparty, the company uses the standard formula to calculate regulatory capital.

However, where the standard formula is considered to be inappropriate and there is no internal approach to modelling the risk, an insurer will agree a capital add-on with the regulator.

Rothesay Life added £37m to its 2018 capital requirement to capture risks not covered by the standard formula: predominantly the risk that a higher proportion of pensioners than assumed have dependants and the inflation risk associated with inflation-linked liabilities.

Transitional recalculation

Rothesay Life employs the transitional measure on technical provisions (TMTP), which smooths the transition between Solvency I and Solvency II over 16 years.

Coinciding with the approval of the partial internal model, Rothesay Life applied to recalculate the TMTP. Without the TMTP, the group's own funds would reduce by £609m. In 2017, the TMTP benefit was just over £1bn.

All SFCRs and QRTs are available from Insurance Risk Data, a database from Field Gibson Media, the publisher of InsuranceERM.

This service combines European insurers' financial and regulatory filings, including Solvency II disclosures, into a single, comprehensive and user-friendly database ideal for market/peer analysis, research and benchmarking.

For more information or a free trial please email [email protected]

Christopher Cundy