U.K. life insurance companies are likely to increase their use of over-the-counter derivatives next year if a proposed regulation change comes into force. The Financial Services Authority in the U.K. plans to publish a policy statement at the end of the month detailing the new capital requirements for life companies and these should come into effect at year end, according to Sarah Varney, in the prudential standards division in London. The rules, currently laid out in consultation paper 195, are expected to require life funds to put up more margin for longer-dated assets.
"With CP195 in mind, we are looking at buying very short-dated assets, and matching longer liabilities with a swap overlay," said Robert Barnard-Smith, a fund manager in the bond team at Legal & General Investment Management in London, which has around GBP141 billion under management. Barnard-Smith is considering adding interest rate and inflation swaps to the life funds, instruments the fund manager already uses in its pension funds. He added, "Life companies haven't really touched on derivatives."
This new source of derivatives buyers, however, is raising concern in some areas of the market. Traders think the size of the life funds in the U.K. means they could move the market when they buy or sell options. "There could be a rush by life companies to buy [equity] put protection," noted Tom Wills, derivatives fund manager at Morley Fund Management in London, owned by Aviva, the U.K. life company with around GBP240 billion under management. Life companies would likely buy index options, which have no natural suppliers, added one analyst. Wills suggested there could be a parallel with the white-hot demand for interest rate swaps and swaptions after insurance companies started hedging their guaranteed annuity policies in the wake of Equitable Life Assurance Society closing its doors to new business.
