New York State Insurance Department

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New York State Insurance DepartmentCapital
Markets Bureau

• New York State Insurance Department
• Stress Testing
• Other regulatory investment issues
• NYIA Educational Seminar
• 2/12/09
• Matti Peltonen
• Bureau Chief

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New York State Insurance DepartmentCapital
Markets Bureau

• Capital Markets Bureau
• Assists in regulation and monitoring of capital
  markets risk management activities of New York
  licensed insurers
• Insurance companies capital markets activities
• investments
• derivative use
• Borrowing securities lending
• Securitization
• Asset allocation
• Risk management measuring, managing, and
  controlling (capital market) risks including
  stress testing
• Enterprise Risk Management how market, credit,
  and operational risk are incorporated into the
  insurers corporate structure culture

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New York State Insurance DepartmentCapital
Markets Bureau

• CMB activities
• Provide examination support
• Insurance companies
• Public retirement systems
• Review special transactions, valuation
• Approve and monitor derivative activity
• Assess asset liability management
• Train staff in capital markets issues
• Assess solvency identify problems through
  financial analysis
• Evaluate corporate governance
• Review use of third party investment management
• Monitor securitization of insurance risk

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New York State Insurance DepartmentCapital
Markets Bureau

• Current Critical Issues Initiatives
• Credit Crisis
• Financial Guarantee Insurers
• Stress Testing
• Enterprise Risk Management
• Securities Lending
• Subprime and other structured securities
• Valuation
• Derivatives
• Rating Agencies

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New York State Insurance DepartmentCapital
Markets Bureau

• Stress Testing
• After the turmoil in many sectors of investments,
  we considered it prudent to meet with companies
  on how they conduct stress testing, and how the
  stress testing has changed in 2008
• CL 25(2008) was issued 11/18/08
• All companies are expected to have scenario
  stress testing process in place as part of
  prudent management
• Stress testing how different economic scenarios
  are analyzed
• First round of reviews completed focus on large
  NY domestics
• Second round starts probably - during spring 09

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New York State Insurance DepartmentCapital
Markets Bureau

• Stress Testing Questions
• Governance and Operations
• Details of risk management structure
• Stress testing methodology, market shocks
• Reporting
• Disaster recovery

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New York State Insurance DepartmentCapital
Markets Bureau

• Stress Testing Market Shocks
• a. Interest rate shocks
• b. Basis spreads
• c. Credit spreads and swap spreads.
• d. Equity market shocks
• e. Changes in volatility in relevant inputs.
• f. price shifts (such as equities, commodities,
  currencies, real estate, etc)
• g. Yield curve shifts
• h. Changes in credit quality
• i. Changes in liquidity
• j. Rating agency downgrades

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New York State Insurance DepartmentCapital
Markets Bureau

• Stress Testing Market Shocks
• k. increases in inflationary pressures
• l. deflation
• m. continued fall in equity markets and falls
  in real estate
• n. increased default rates leading to
  counterparty failures, including collateral
  arrangements in hedging, securities lending or
  other arrangements
• o. Effect of increased defaults on value of
  collateral (RMBS, credit card receivables,
  student loans, etc).
• p. changes in lapse rates
• q. Collateral calls
• r. natural catastrophes (hurricane, flood,
  earthquake)
• -what are the extreme scenarios used
• -what is the technology used to run reports and
  analyses

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New York State Insurance DepartmentCapital
Markets Bureau

• Credit Crisis
• Mortgage-backed securities
• Residential subprime, Alt-A, home equity
• Commercial real estate
• Other structured securities (e.g CDOs, CDO2)
• Borrow short lend long (SIVs, banks,
  securities lending)
• Corporate bonds (Bloomberg story up to 1
  trillion in losses)
• FGIs, including impact on municipal debt
• Monitor insurance industry exposures
• Monitor how different asset classes perform
  (illiquidity, credit, price)
• Municipal auction-rate securities
• Subordinated/hybrid debt issued by financial
  firms

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New York State Insurance DepartmentCapital
Markets Bureau

• Financial Guarantee Insurers
• Analysis of risk exposures/solvency, modeling
  capabilities, risk management
• Examinations
• Impact on municipal securities market
• Ensure adequate financial guarantee capacity
• Restructuring of old companies
• Capital
• New capacity
• Structured securities
• New legislation / regulation / circular letter
• ACA, AG, AMBAC, CIFG, FSA, FGIC, MBIA, Syncora
  (Berkshire)

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New York State Insurance DepartmentCapital
Markets Bureau

• Financial Guarantee Insurers/Structured
  securities CDO
  Squared

• Theory by subordination, you can create AAA
  security from subprime
• Underestimated the value erosion caused by the
  rise in delinquencies and defaults

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New York State Insurance DepartmentCapital
Markets Bureau

• Structured Securities CPDO
• Constant Proportion Debt Obligation
• Structured security leveraged up to 15 times with
  CDS off iTRAXX
• CDSs rolled on the exchange every 3/6 months
• Dependent on spreads, contract liquidity, max
  leverage
• If spreads widen, leverage goes up
• Initially rated AAA, as the probability that
  interest and principal would be paid was
  estimated to be 99.2
• Coupon LIBOR2
• Initiated re-formation of NAIC Invested Assets
  Working Group
• Euromoneys Obituary in November 2008 for the
  600 billion issued

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New York State Insurance DepartmentCapital
Markets Bureau

• Enterprise Risk Management (ERM)
• ERM capability to consistently identify,
  measure, aggregate and manage risk exposures
  within predetermined tolerance guidelines
• The ERM structure combines market risk, credit
  risk, operational risk and insurance risk,
  economic capital, and disaster planning
• Oversight by Chief Risk Officer
• Insurance companies ERM is at various stages of
  development
• Capital Markets Bureau
• Establish evaluation criteria
• Develop an auditexamination program to assess
  ERM
• Incorporate assessment of ERM into examination
  process

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New York State Insurance DepartmentCapital
Markets Bureau

• Enterprise Risk Management (ERM) / Risk-Focused
  Exams
• Modeling/analyzing insurance companies
  portfolios
• traditional approach verification of balance
  sheet
• risk-based approach - portfolio analysis
• -using the filed statutory information on
  investments
• -upload portfolio (into Excel Bloomberg) for
  analysis
• -enables a more dynamic risk assessment, using
  (for example)
• -bonds duration, Value-at-Risk, rating
  distribution
• -sector exposures (telecommunications, energy)
• -equities P/E, beta, etc.
• -scenario testing
• Metrics
• Problem understanding liability structure (on
  duration basis)
• IAWG improve information in the annual statement
  database symmetry

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New York State Insurance DepartmentCapital
Markets Bureau

• Securities Lending
• Insurance companies enhance income by lending
  securities to broker/dealers, banks, hedge funds
• Lender receives cash as collateral (typically
  102 of value)
• Problem some insurers have reinvested the cash
  collateral in subprime and other structured
  securities, which have significantly fallen in
  market value and as a result, the collateral is
  no longer adequate
• The Department issued a Circular Letter (16/2008)
  indicating an enhanced review of the activity in
  upcoming examinations

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New York State Insurance DepartmentCapital
Markets Bureau

• Securities Lending

The problem short-term securities lending
program was used to finance long-term investments
in securities (to leverage balance sheet) Market
value fell either on both sides, or for the
securities where the borrowed money was invested
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New York State Insurance DepartmentCapital
Markets Bureau

• Derivatives
• Regulation of CDS
• Derivatives Working Group (NAIC)
• Update Derivatives Model Regulation (282)
• Prior approval
• Update Annual Statement Schedule DB (Derivatives)
• Transparency
• Hedge effectiveness
• Permitted uses
• Hedging
• Income generation
• Replications

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New York State Insurance DepartmentCapital
Markets Bureau

• Valuation
• Problem market value (what another counterparty
  pays) is far from the discounted cash flow value,
  which can be far from amortized cost
• Annual Statement
• Pricing proposal (VOS), effective 12/08 for
  Schedule D
• Company can select the source (instead of SVO
  Unit Price)
• Pricing source needs to be disclosed
• Same method for derivatives (Schedule DB)
• Eventually, both D and DB likely to follow FASB
  Levels 1,2,3
• SSAP 43 -gtSSAP 9899 Other Than Temporary
  Impairment
• Change (98) written down to fair value (instead
  of undisc. cashflows)
• 99 discount can be amortized if principal
  unimpaired

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New York State Insurance DepartmentCapital
Markets Bureau

• Rating Agencies
• Unrated securities are filed with the SVO
  (assigns NAIC 1-6)
• Rated Securities, NAIC relies on the NRSROs
  (AROs) for about 2.6 trillion of rated
  securities
• Rating translated into NAIC 1-6
• SVO Initiatives WG -gt SVO-NRSRO
• NAIC continues to rely on NRSROs (RBC, statement
  value)
• A review of the FE process, and reliance on the
  NRSRO ratings?

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New York State Insurance DepartmentCapital
Markets Bureau

• NAIC Work
• In addition to developing and enhancing
  securities and derivatives regulation in New York
  State, New York is at the forefront of work that
  is done on those areas in the NAIC
• Valuation of Securities Task Force (Chair)
• Derivatives Study Working Group (Chair)
• Invested Assets Working Group (Vice Chair)

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New York State Insurance DepartmentCapital
Markets Bureau
Asset Allocation