Document ID: chunk:federal_register_of_legislation:F2023L00673:body:0:p11
Version: federal_register_of_legislation:F2023L00673
Segment Type: other
Provision Reference: 
Character Range: 26945–30063

amount for a statutory fund with liabilities for variable annuities:
(a)          the uncertainty associated with the company's ability to implement any required hedging strategy in a timely and effective manner;
(b)          the effectiveness of hedging arrangements;
(c)          the ability to access suitable hedge instruments in the future;
(d)          whether a matched asset and liability profile within 12 months can be achieved for this type of product, particularly given the risks that exist for these type of products beyond 12 months, e.g. ratchets and path dependencies;
(e)          allowance for any discretions available; and
(f)           allowance for management corrective action to achieve a matched asset and liability profile within 12 months.
6.             The prescribed capital amount (before addition of the Asset Concentration Risk Charge and the Operational Risk Charge) for a statutory fund with liabilities for variable annuity business must be determined via the following formula:
where:
(a)          Capital (including hedging) = the capital requirement for asset and insurance risks calculated assuming that dynamic hedging is included in the model;
(b)          Capital (excluding hedging) = the capital requirement for asset and insurance risks assuming there is no dynamic hedging but allowance can be made for hedge positions that exist at the valuation date; and
(c)          E = an effectiveness factor that reflects the level of sophistication of the dynamic hedging in the model.
    A dynamic hedging strategy is a hedging strategy that requires frequent rebalancing of the asset portfolio. The Capital (including hedging) and Capital (excluding hedging) may allow for diversification between asset and insurance risks but must not attribute any value to tax benefits that cannot be netted against deferred tax liabilities.
7.             In determining E, the following points must be taken into account:
(a)          E cannot be greater than 0.70 because most models would include at least some approximations or idealistic assumptions;
(b)          if certain economic risks are not hedged, yet the model does not generate scenarios that sufficiently capture those risks, E must be in the lower end of the range of 0.0 to 0.7;
(c)          a life company that does not have 12 months of experience to date must set E to a value no greater than 0.30[7]; and
(d)          the ultimate effect of the current hedging strategy (including currently held hedge positions) needs to recognise all:
(i)            risks;
(ii)         associated costs;
(iii)       imperfections in the hedges; and
(iv)        hedging mismatch tolerances associated with the hedging strategy.
8.             The risks referred to in subparagraph 7(d)(i) above include, but are not limited to:
(a)          basis;
(b)          gap;
(c)          price;
(d)          parameter estimation; and
(e)          variation in any assumptions (mortality, lapses, annuitisation, etc.).
9.             The costs referred to in paragraph 7(d)(ii) above include, but are not limited to:
(a)          transaction,