Hi DoY;

With regard to the Deutsche table quoted in the Alphaville article, would you be willing to answer SteadyAim's query, which puts into words my own puzzled reaction to the article?

and from SteadyAim's post:

So they hold a load of structured holdings. But the total assets figures are multiples of the minimum solvency requirement. I presume the figures are bad, but the article doesn't exactly go out of its way to explain why.

I'll see if I can help - but I agree, the table from the brokers note and the commentary in the Blog entry isn't the clearest, and I'm not sure I fully understand.

What they seem to be saying is that 100% would be the minimum statutory solvency level - i.e. anthing below this and they need further capital; anything above is an excess capital buffer (and they seem to be measuring by using IGD as a measure of capital - which is a completely flawed method. For the sake of argument, you could make your reserving policy less prudent - i.e. value your liabilities at a lesser value by changing your assumptions - and lo and behold your solvency ratio would improve (and hence a group's IGD would improve) - despite the fact that you're now being less prudent than previously. Flawed, n'est-ce pas?)

So they're looking at asset classes as a % of IGD, and coming up with ratios of how these asset classes compare to the IGD level. They seem to be saying that the bigger a % of assets that exist above the 100% IGD solvency level, the bigger the risk. However, what they don't seem to be commenting on is

- what levels of surplus capital do all these companies have over and above the IGD minimum levels?
- what are the absolute actual sizes of the books of business that are being considered in each of the Groups? (%s are pretty meaningless without actual numbers to put them in perspective)
- what levels of defaults are already being assumed by the companies and are included in their solvency figures as stated?
- when are these 'solvency figures' from? Companies publish year end returns 3 or 4 months after their year ends - so have they used up to date figures, or rolls forward from last year?

I think that their point is that the bigger a % of assets that a Group has over and above the 100% 'statutory minimum', the bigger sensitivity a group would have to defaults (remember - changes in value don't really affect as a business model would be to hold to maturity). So, if Aviva has a total corporate bond exposure of 467%; make the assumption that 10% of this defaults (i.e. 46%) and then they recover 50p in the pound on that amount (i.e. 23%). My (possibly flawed) reading is that this is the kind of correlation that they're trying to put across - using this example, a 10% default on corporate bonds with a subsequent 50% recovery rate would affect their IGD solvency by 23%.

There's loads of holes that can be picked in this reasoning - Insurance co's have minimum credit rating levels across their portfolios; it's rare for a co to default from investment grade (they almost always get downgraded to junk first of all); IGD is an imperfect measure that analysts have latched onto under the oversimplification that it's "one number" measure that's comparable across Groups - it isn't. But I think what they're trying to say is that these Groups have exposure to asset defaults. That's obvious. But I don't agree with the conclusions drawn in the blog post. They seemed to have jumped from analysis towards armageddon without explaining how they've got there. Maybe the brokers note itself has more, but from what's been presented, I remain to be convinced they've actually 'got there' without the reasoning behind the conclusion being published so that it could be critically examined.

Solvency and defaults are of course a worry, as they should be. But insurers hit a capital and solvency crunch in the early part of this decade and had to take remedial action then (see Standard Life's equity sell-off and demututalisation, rights issues, etc etc) - in that sense, they're one step ahead of the banks already.

Rgds
K