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Insurers holding fixed receiver swaps entered into when interest rates were high have seen the mark-to-market value of these positions rocket in recent years as rates have plummeted. At the same time, falling rates have reduced the yield insurers can achieve on the asset portfolio.
To realise the cash value tied up in their swaps, insurers can unwind the in-the-money hedges in exchange for a lump sum from the counterparty. This can then be invested in higher-yielding assets. The insurer can then enter into a new swap struck at current market rates to retain their interest rate protection in a process known as recouponing.
But there are limits to the amount of yield enhancement to be gained on the back of recouponing, say bankers. David Prieul, head of the insurance and pensions solutions group in Europe at Credit Suisse in London, says insurers will need to hold back some of the cash to use as collateral for servicing the new at-the-money swaps they enter into. "Nevertheless, one can save a portion of that and reinvest into assets that earn a spread over the implied rate of return of the derivative collateral", Prieul adds.
Some insurers, such as Aegon UK, are recouponing their swaps to reduce the cost of servicing the collateral posted by their counterparties. Colin Black, Edinburgh-based market and credit risk director at Aegon UK, says the insurer was receiving significant amounts of collateral from the banks as its swaps turned in-the-money. "The collateral was in the form of cash and we had to pay the banks a target interest rate on that by investing in the money markets. Through that process we were adding counterparty exposure to our balance sheet", Black says. "By turning the clock back to zero by recouponing, the risk and burden of servicing that collateral was eased."
The windfall from recouponing can also be used to pay for changes to the credit support annexes (CSAs) of derivatives contracts as counterparties look to align with new rules around the central clearing of derivatives.
More and more firms are electing to set up so-called clean CSAs that accept only cash and gilts as collateral in a single currency to bring them in line with new clearing requirements.
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