DENMARK - The Danish Financial Supervisory Authority (DFSA) has said that rate increases constitute the "worst scenario" for the life and non-occupational pension funds.
A Nykredit report quoting the DFSA said that the regulator found that 44 or two-thirds of the 65 companies have reported an yield rise as the worst-case event in the “red” scenario.
In comparison, the sector appears to be adequately hedged in case of yield falls up to 100bp from end-2004 levels. However, this does not rule out the possibility of some companies in the sector being worse off in case of an yield fall, Nykredit noted.
Since the turn of the year, yield levels have dropped by 60-70bp in terms of 10Y yields and this according to Nykredit has increased the need for higher duration.
“Recent months’ development in yields is therefore assumed to have aggravated the situation for one third of the companies that are most sensitive to yield falls,” said the report. At the turn of the year, six companies were in the were in the “yellow”, while no one was in the “red”.
The report said that while interest rate of the overall liabilities side is “positive convex” i.e. the interest rate sensitivity of liabilities is higher in an yield decrease than in an yield increase scenario, on the assets side, overall interest rate sensitivity is slightly “negative convex”.
“At first glance, it may seem odd that the negative convexity of the bond portfolios is not more pronounced. It is furthermore worth noticing that 11% of the bond portfolios at end 2004 was made up of index-linked bonds denominated in DKK and 28% in bonds in foreign currencies. The remaining 61% of the bond portfolios was made up of nominal DKK-denominated bonds including callable mortgage bonds,” the report added.
The DFSA’s traffic light tests work on two basic scenarios: a “red light” under which pension funds must be able to take a 12% decline in equity prices and a 0.7% change in interest rates; and a “yellow light” where pension funds must cope with a 30% fall in equities and a 1% change in interest rates.
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