Investment Symposium April I7: The Evolution of Insurance Companies Investment Strategy: Survey Results. Moderator Max Rudolph

Transcription

1 Investment Symposium April 2011 I7: The Evolution of Insurance Companies Investment Strategy: Survey Results Max Rudolph Marc Tourville Moderator Max Rudolph

2 I7: The Evolution of Insurance Companies Investment Strategy: Survey Results April am 12:15 pm Max J. Rudolph, FSA CFA CERA Rudolph Financial Consulting, LLC Research Project Ongoing research sponsored by Society of Actuaries Online survey Follow up phone discussion Literature search Conclusions 2

3 Survey Large/small companies Companies P/C Life Health 3 Preliminary Results Investment Policy Statements (IPS) are common Most are formally approved by board 75% have updated their IPS Not due to financial crisis Often minor issues like renaming benchmarks 4

4 Preliminary Results Most think insurers weathered the storm better than others Conservative investment strategy Limited leverage Focus on core offerings Recurring premiums 5 Preliminary Results Investment risk tolerance metrics are board approved Statutory equity Rating Duration Statutory earnings Stress tests added post crisis 6

5 Preliminary Results Portfolio changes Avoided/reduced specific asset classes Sought out specific asset classes Some slow to rebalance due to fear/anticipated meltdown 7 Preliminary Results Outsourcing Many insurers use outsourcing Small firms outsource all assets Large firms outsource satellite classes Continues to evolve 8

6 Preliminary Results Additional learnings Securities lending stopped by many Operating cash flows provided buffer FHLB programs relied on Some for the first time 9 Follow up Questions What should we ask? What asset classes are you worried about now? Do capital requirements provide good incentives in a low interest rate environment? How does the dynamic nature of liabilities impact an IPS? 10

7 Follow up Questions What should we ask? If an IPS does not need to be updated after a severe stress period, does this mean It was effective It was too broad Should metrics be tied to exposures? 11 What have we learned recently? Slides were due in March Research is continuing i Literature search Financial trends of the industry Outsourcing trend Discussions 12

8 Question for the Audience Does the insurance industry pose a systemic risk? Why or why not? What are your biggest worries? How do emerging risks fit in? 13 Thanks! Max J. Rudolph, FSA CFA CERA Rudolph Financial Consulting, LLC Twitter - maxrudolph Thanks! Max J. Rudolph, FSA CFA CERA Rudolph Financial Consulting, LLC Max.rudolph@rudolphfinancialconsulting.com (402)

9 I7: The Evolution of Insurance Companies Investment Strategy: Survey Results April am 12:15 pm Marc A. Tourville, CFA, CIPM Cardinal Investment Advisors, LLC Discussion Topics Risk Appetite Risk Management Tactical vs. Strategic Financial Disaster Preparedness Checklist Rebalancing 2

10 Investment Risk Appetite Two pieces: Ability to assume risk Willingness to assume risk Many definitions and metrics for risk Meaningful and material to your business Be specific on how and where it impacts you Not always quantitative 3 Investment Risk Management Tactical Requires timing and conviction without restrictions 4

11 S&P 500 Put Options 20% 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% % of Portfolio Cost to Hedge Equity Market for.. S&P500 Value 6 months 12 months Lehman Credit Default Swap (CDS) 6

12 Morgan Stanley CDS 7 Investment Risk Management Tactical Requires timing and conviction without restrictions Strategic Requires time and construction Too late if hurricane is on the horizon 8

13 Disaster Preparedness Checklist Profitable operations Diversification Due diligence Risk control Investment guidelines and compliance Liquidity Lines of communication 9 Diversification Across asset classes Across capital structure Across borders Across managers No big bets Style or size over weights Sector strategies Balance diversification with excess return 10

14 Due Diligence Understand the asset class Expectations in different market conditions Who are the other investors in the asset class? Hedge funds, private investors, etc. Understand your managers Strengths and weaknesses Expectations in different market conditions Organizational Stability What % of a fund, partnership do you represent? What does enhanced mean? Beta becomes alpha Over engineering No free money. No such thing as a no-brainer 11 Due Diligence (example) Hedge fund impact on convertible bond market 100% 90% 80% 70% 60% 74% 73% 67% 60% 59% 53% 47% 53% 57% 50% 50% 40% 30% 20% 10% 26% 27% 33% 40% 41% 47% 53% 47% 43% 50% 0% 2008Q2 2008Q3 2008Q4 2009Q1 2009Q2 2009Q3 2009Q4 2010Q1 2010Q2 2010Q3 Outright Arbitrage Source: Barclays Capital, Tremont. 12

15 Risk Control Re-confirm risk tolerance Multiple definitions of risk Portfolio manager risk controls Don t overlook risk for return Enterprise exposures: Across accounts (including pension) Across capital structure Know your counterparties (from your due diligence) 1 st order: direct investments 2 nd order: indirect exposures 3 rd order: your business partners 13 Risk Control (example) Lehman Brothers 1 st Order Exposures 2 nd Order Exposures 3 rd Order Exposures Lehman Senior Debt Synthetic Convertible Rehypothecation Lehman Convertible Preferreds Securities Lending Borrower Reinsurer s Exposure to Lehman Brothers? Lehman Common Stock Money Market Fund Commercial Paper??????? Commodities Exchange Traded Note (ETN) 14

16 Risk Control (example) Lehman Senior Debt If you bought a credit default swap (CDS) on Lehman, who wrote it?...aig? 15 Investment Guidelines and Compliance Issuer limits (by quality) Sector limits Aggregate portfolio exposures Custodian capabilities Manager pre/post trade capabilities Create a loss budget for managers Create and adhere to a thoughtful impairment policy Balance constraints with manager flexibility 16

17 Investment Guidelines and Compliance What you can do with a smart finance employee and Microsoft Excel. % of Admitted Moodys Market Value Assets % of Admitted Comments Govt S&P Rating $ 131,456, Market Value 6.0% Assets Comments Agency $ 241,458, % % of Admitted Govt $ 131,456, % Aaa 20 Largest Issuers $ 138,532, Market Value 6.3% Assets Comments Agency $ 241,458, % Aa1 AAA FANNIE MAE $ 30,988, $ 180,678, $ 164,596, % 8.2% 7.5% Compliant no constraint on U.S. Agencies % of Admitted Aa2 FREDDIE MAC $ 18,198, $ 76,846, % 3.5% AA+ 20 Largest Issues $ 5,459, Market Value 0.2% Assets Comments Aa3 AA TSY INFL IX N/B $ 59,599, $ 27,298, $ 65,189, % 1.2% 3.0% EMC CORP SR NT CONV 1.75% 01 DEC 2011 $ 14,424, % A1 US TREASURY N/B $ 69,734, $ 57,884, AA- $ 65,002, % 2.6% FNMA PL # % 8/01/35 $ 13,516, % 0.6% A2 LEHMAN BROTHERS A+ $ 34,583, $ 32,264, $ 79,581, % 1.5% TRANSOCEAN INC SR NT CONV SER A 1.625% $ 12,613, % 0.6% A3 A JP MORGAN CHASE $ 65,664, $ 54,516, $ 29,148, % 2.5% 1.3% % of Admitted MERRILL Baa1 CITIGROUP INC Foreign LYNCH Bonds CONV VAR RATE 3/13/32 $ 11,949, A- $ 48,988, $ 26,254, Market Value 0.5% $ 84,981, % 1.2% Assets Comments GENZYME CORP $ 11,687, % 0.5% Total Baa 5.9% Baa2 BBB+ MERRILL LYNCH & CO $ 55,032, $ 95,655, $ 23,405, % 4.3% 1.1% 0.0% LOCKHEED MARTIN CORP $ 11,305, % S&P BBB exposure totals 6.6% Baa3 MORGAN STANLEY BBB $ 25,157, $ 22,056, $ 21,664, % 1.0% U.S. TREASURY 1.0% NR BANK OF AMERICA Total CORP Foreign BONDS Bonds 4.375% 12/15/10 $ 11,112, BBB- $ 151,153, $ 19,771, $ $ 28,207, % 1.3% All bonds 0.9% - 0.5% 0.0% U S TREASURY NOTES $ 10,551, not 0.5% rated by % Moody's, of Admitted but rated by S&P are at least BBB with the exception BB GNMA $ $ 262, ,503, % of Countrywide 0.8% ALZA CORP Sprint (12668AYP) Nextel (852060AJ) at Clover & (852061AD) rated AAA by at Fitch. Blackrock rated Baa3 by Moody's. Grand Total GOLDMAN SACHS GROUP 20 Largest INC Issues $ 10,132, NR $ 1,070,548, $ 15,675, Market $ 54,324, % 0.7% Value 0.5% % of Admitted Assets Comments INTEL CORP 2.5% All bonds are rated A3 or better by Moody's with the exception of Countrywide MEDTRONIC INC Foreign Exxon JR SUB Stocks Mobil DEB (Sep. Corporation CONV Account) $ 10,038, $ 15,094, Market $ Value 6,442, % 0.7% Assets 0.3% Comments FNMA POOL # % DUE 01 MAR 2034 $ 8,604, (12668AYP) 0.4% at Clover AAA by Fitch. Total Bonds PRUDENTIAL FINANCIAL General INC Electric $ 1,070,548, $ 14,970, $ 3,651, % 0.7% 0.0% 0.2% NEWMONT MINING NEM CONV 144A $ 8,441, % EMC CORP Total Microsoft Foreign Corporation Stocks $ 14,424, $ $ 3,009, % - 0.0% 0.1% % of Admitted MEDTRONIC INC CONV 1.5% 4/15/11 $ 8,072, % COUNTRYWIDE Chevron Corporation Equities $ 13,852, $ 2,834, % Market Value 0.1% Assets Comments MOLSON COORS CONV 2.500% 7/30/13 $ 8,068, % BEAR STEARNS CO AT INC & T Separate Inc Account (Northern, $ Converts) 13,603, $ 2,779, $ 0.6% 150,866, % of Admitted 0.1% 6.8% AMGEN INC CONV 0.125% 2/01/11 $ 8,061, % TRANSOCEAN INC Procter Mutual & Gamble Foreign Funds Company Mutual (Lord Funds Abbett, $ Vanguard) 13,069,781.25Market $ Value 2,553, $ 0.6% 75,666, Assets 0.1% 3.4% Comments U S TREAS J h f G J h % ALLERGAN INCEuropacific NTS Johnson Rabbi Growth & Johnson Trust 4.750(T Rowe Price) $ 7,965, % $ 11,803, $ $ 7,120, ,493, $ 0.5% 87,266, % % 01% 0.1% 4.0% % of Admitted BRISTOL MYERS SQUIBB CO $ 7,915, % GENZYME CORP Harbor IBM Corporation International Mutual Funds Equity $ (Harbor, 11,687, Mutual Europacific) Funds $ $ 7,461, ,240, $ 0.5% 14,581, Market 0.3% Value 0.1% 0.7% Assets Comments FNMA PL Total # ConocoPhillips Foreign Total 4.500% Funds Equity Europacific 8/01/20 Growth $ 7,893, $ $ 14,581, ,013, $ 328,381, % $ 7,120, % 0.1% 14.9% 0.3% U S TREASURY Apple NOTES Computer Harbor Incorporated International $ 7,747, $ 2,009, % $ 7,461, % 0.3% WYETH CONV Total Cisco Foreign FLTG Systems RATE Securities Inc Lord 1/15/2024 Abbett Small Cap $ 7,708, $ $ 14,581, ,909, % $ 26,821, % 0.1% 1.2% Wal-Mart Stores Vanguard Inc Mid Cap $ 1,815, $ 48,845, % 2.2% Schlumberger Limited T Rowe Price Equity Income $ 1,761, $ 40,582, % 1.8% Intel CorporationT Rowe Price Mid Cap Gr $ 1,701, $ 46,684, % 2.1% Google Inc Total Mutual Funds $ 1,673, $ 177,515, % 8.0% Pfizer Incorporated $ 1,615, % J P Morgan Chase & Co $ 1,603, % Hewlett Packard Company $ 1,489, % Bank Amer Corporation 144A $ 1,448, % Coca Cola $ 1,419, % 17 Liquidity Profitable operations Federal Home Loan Bank (FHLB) membership Lines of credit Separate account versus fund You should know: Notification and timing requirements at managers for redemptions Your share class in a partnership The % of a fund or partnership you represent How your securities lending program really works Markets can stay irrational longer than you can stay solvent 18

18 Liquidity (example) Hedge fund-of-fund share classes Committed class 3 year rolling lock Lower fees Standard class Quarterly liquidity, initial 1 time, 1 year lock Higher fees Slightly lower returns (due to increased redemptions) 370 days notice is needed to convert Committed class shares to Standard class shares 19 Liquidity (example) Hurricane Ike September 14 th 2008, hits Columbus Ohio Initial damage: $553M State Farm, Nationwide and Grange report that Hurricane Ike is the most costly Ohio storm in each company's history What if companies had to sell securities at the end of September to pay claims? 20

19 Lines of Communication Those who touch your money: Portfolio Managers Custodians Those who direct investment strategy: Senior management Committee and Board members NAIC Model Law Know the availability and frequency of information and pricing Confirm expectations and risk tolerances frequently 21 Lines of Communication (example) NAIC Model Law: Section 5. Prudence Evaluation Criteria The following factors shall be evaluated by the insurer and considered along with its business in determining whether an investment portfolio or investment policy is prudent; the commissioner shall consider the following factors prior to making a determination that an insurer's investment portfolio or investment policy is not prudent: A. General economic conditions; B. The possible effect of inflation or deflation; C. The expected tax consequences of investment decisions or strategies; D. The fairness and reasonableness of the terms of an investment considering its probable risk and reward characteristics and relationship to the investment portfolio as a whole; E. The extent of the diversification of the insurer's investments among: (1) Individual investments; (2) Classes of investments; (3) Industry concentrations; (4) Dates of maturity; and (5) Geographic areas; F. The quality and liquidity of investments in affiliates; 22

20 Lines of Communication (example) NAIC Model Law: Section 5. Prudence Evaluation Criteria G. The investment exposure to the following risks, quantified in a manner consistent with the insurer's acceptable risk level identified in Section 6H: (1) Liquidity; (2) Credit and default; (3) Systemic (market); (4) Interest rate; (5) Call, prepayment and extension; (6) Currency; and (7) Foreign sovereign; H. The amount of the insurer's assets, capital and surplus, premium writings, insurance in force, and other appropriate characteristics; I. The amount and adequacy of the insurer's reported liabilities; J. The relationship of the expected cash flows of the insurer's assets and liabilities, and the risk of adverse changes in the insurer's assets and liabilities; K. The adequacy of the insurer's capital and surplus to secure the risks and liabilities of the insurer; and L. Any other factors relevant to whether an investment is prudent. 23 Rebalancing Common behavior: Wait till markets calm down Start when the market has hit bottom Stick to your discipline Uncomfortable Pays off in the end 24

21 BEAR MARKETS AND REBOUNDS (S&P 500) Bear Markets and Rebounds 250% 239.6% 200% 150% Through 3/09/2011 (2 years) S&P 500 Price Returns (%) 100% 50% 0% 107.7% 100.2% 66.5% 60.8% 38.1% 9.4% 11.4% 105.1% 98.7% 58.3% 59.0% 33.0% 24.4% 8.4% 3.1% 95.1% 68.6% 39.3% Peak to Trough 3 Month Return 1 Year 3 Year 5 Years -50% -48.0% -27.0% -34.0% -49.0% -56.8% -100% : OPEC : Volcker : "Black : Tech bubble Current Bear Market embargo, Watergate, tackles inflation, "back Monday", program bursts followed by 9/11 (10/9/07-3/9/2011) collapse of Bretton to back" recessions trading, liquidity issues Woods System Source: T. Rowe Price, Russell Investments, Investworks, Cardinal Investment Advisors Analysis CURRENT RECOVERY (S&P 500, 2 YEARS THROUGH 3/9/2011) 120% 100% 95.1% Cumulative Return (%) 80% 60% 40% 20% 0% -20% 11.4% 34.4% 39.3% 30.5% 26.6% 21.6% 16.4% 69.5% 68.6% 48.9% 52.7% 58.4% 61.6% 62.0% 63.2% 58.2% -40% -60% -56.8% -80% Source: Google Finance, Cardinal Investment Advisors Analysis

22 MISSING THE TROUGH (S&P 500, 2 YEARS THROUGH 3/9/2011) ( g ) 100% 95.1% 90% 80% 75.1% 70% 67.6% Cumulative Return (%) C 60% 50% 40% 60.4% 54.1% 45.2% 40.1% 30% 27.7% 20% 15.7% 10% 0% Fully Invested 1 Week Late 2 Weeks Late 3 Weeks Late 1 Month Late 2 Months Late 3 Months Late 6 Months Late 1 Year Late Source: Google Finance, Cardinal Investment Advisors Analysis MISSING TRADING DAYS (12/31/ /31/2006) In the 17 year time period, there were (on average across countries) 4,283 trading days 10 days = 0.23% of total days 20 days = 0.47% of total days 100 days = 2.33% of total days Market Buy and Hold Best10 Best20 Best100 Worst10 Worst20 Worst100 Australia 7.5% 5.6% 4.2% 4.3% 10.2% 11.8% 21.9% Canada 7.2% 4.7% 2.8% 6.7% 10.5% 12.7% 25.9% France 6.5% 3.2% 0.8% 11.7% 10.0% 12.7% 30.1% Germany 8.0% 3.7% 0.5% 14.7% 12.5% 16.2% 39.4% Hong Kong 12.2% 6.5% 3.0% 14.3% 18.5% 22.9% 48.4% Italy 6.5% 3.3% 1.0% 12.0% 10.5% 13.7% 32.1% Japan 4.7% 8.6% 11.3% 25.1% 1.2% 1.7% 20.5% New Zealand 3.2% 0.5% 1.2% 10.6% 6.5% 8.5% 19.8% Singapore 4.2% 0.4% 2.1% 14.2% 8.2% 11.2% 27.4% Spain 10.2% 7.0% 4.5% 8.9% 14.3% 17.4% 35.0% Switzerland 9.4% 6.0% 3.6% 7.7% 7% 13.0% 15.9% 32.2% 2% Taiwan 1.2% 5.1% 8.6% 27.3% 3.0% 7.1% 38.5% Thailand 1.5% 6.9% 11.0% 28.7% 4.0% 8.3% 33.4% UK 6.0% 3.3% 1.3% 9.0% 8.8% 11.0% 24.5% USA 8.5% 5.5% 3.2% 8.4% 11.7% 14.0% 28.2% Average 5.5% 1.9% 0.6% 13.6% 9.4% 12.3% 30.5% Source: Journal of Investing, Fall 2008: Black Swans and Market Timing: How Not To Generate Alpha, Javier Estrada, Cardinal Investment Advisors Analysis

23 MARKET TIMING AND THE AVERAGE INVESTOR Note: Indexes used are as follows: REITS: NAREIT Equity REIT Index, EAFE: MSCI EAFE, Oil: WTI Index, Bonds: Barclays Capital U.S. Aggregate Index, Homes: median sales price of existing single family homes, Gold: USD/troy oz, Inflation: CPI. Average asset allocation investor return is based on an analysis by Dalbar Inc. which utilizes the net of aggregate mutual fund sales, redemptions and exchanges each month as a measure of investor behavior. Returns are annualized (and total return where applicable) and represent the 20 year period ending 12/31/09 to match Dalbar s most recent analysis. Source: JP Morgan Guide to the Markets Q Thanks! Marc A. Tourville, CFA, CIPM Managing Director Cardinal Investment Advisors, LLC mtourville@cia-llc.com (312)