Portfolio Bonds and SIPP’s can include individualised funds where a wide range of investments may be held. Recent years of market turmoil have forced us all to examine what is investment risk, and who actually carries this risk. In this session we will discuss the nature of default risk and counterparty risk with these particular products in mind.
As speakers we have the advantage of knowing who plans to attend our session. We expect this will be an interactive session as we will present a range of open issues and dare to suggest our own personal opinions on each one. We look forward to the debate.
I have been thinking about sovereign bonds a lot recently. Ten year Irish government bonds were yielding 9.2% on the last day of 2010 when UK yields were 3.2% and Italian were 4.9%. As at 8 November 2011 the latest yields were 8.3% for Ireland, 2.2% for the UK and 6.7% for Italy.
So we agree that the market believes not all government bonds are risk free. As actuaries we have to try to quantify how much of this spread is credit (default) risk. The Society of Actuaries in Ireland produced a useful paper in May 2011 that summarised a range of approaches to try to quantify this credit component. The full paper (and presentation and podcast!) is here:
The interesting table is included in the Appendix to the paper:
Irish government bonds, as at 31 December 2010:
|Approach to estimating credit risk
||% of the excess spread that can be considered credit risk
|Credit default swaps
|Market based metrics
||75% – 90%*
|Solvency II illiquidity premium
|Historical experience approach
|Bank of England’s analysis on corporate bonds
* Based on data at 15 February 2011
** Depends on the analysis of historical experience.
I’m looking forward to discussion of this at the life convention in Liverpool. I expect (and hope) the International Actuarial Association attendees will bring an interesting international viewpoint to the debate.