Joint Regional Seminar 2013 Taking risks and winning

Transcription

1 Joint Regional Seminar 2013 Taking risks and winning Dynamic Asset Liability Management in Today s Complex Economic Development Keith Walter, South East Asia Market Leader & Director Risk Consulting and Software Philip Tso, Senior Consultant, Investments, Asia Pacific 26 Jul Towers Watson. All rights reserved.

2 Agenda Background and update on the economic environment Low interest rates and increased volatility - Implications on Insurance Managing New Business, Assets and Inforce Liabilities - in a Dynamic ALM Framework Building a Dynamic ALM Approach towerswatson.com 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

4 US continues to grow at a moderate pace A moderate recovery compared to past cycles impeded by housing and now Government sector contraction. Underlying economy no longer contracting. US real GDP growth 10 Forecast Year on year Source: Thomson Bloomberg LP, Towers Watson. 4

5 Percentage The Fed has switched targets 12 Expected to fall to 6.5% by midlate US unemployment rate NAIRU (OECD) Current Fed guidance consistent with structural unemployment estimate of c.6% Monthly data from Jan 1970 through Mar 2013 Source: Bloomberg LP, Towers Watson Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 5

6 Level of economic / market stress Eurozone scenarios anything from bad to badder The Eurozone is the world s second largest economy US EU total Euro Area 2012 GDP in USD China Japan UK Brazil India High Low Scenario Goldilocks: Euro survives with rapid resolution Base case: Euro survives Orderly small peripheral default and exit, residual bloc survives Indicative probability 0-5% 40-60% 20-30% Unilateral core exit 0-5% Worst case: Full dissolution 5-10% 6

7 In Asia there is a shifting focus on greater intra regional trade with a greater reliance on Chinese growth Korean export destinations 14,000 US dollars, millions Exports to China have grown considerably over the past 3 years, offsetting weakness in Europe 12,000 10,000 Exports to Europe Exports to China Exports to US 8,000 6,000 4,000 2, Source: Bloomberg, Towers Watson. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 7

8 But China is very difficult to forecast Certain indicators show improvement, while others are less favourable. Domestic Demand Indicators Period UPDATE Previous 3 month average Previous Latest Previous vs 3ma Latest vs previous month Retail Sales (% y/y) Jun stronger stronger Consumer Confidence Jun weaker weaker Macroeconomic Climate leading index May weaker similar Production and Trade NBS Mfg. PMI: New Orders Jun stronger weaker China Manufacturing PMI Jun stronger weaker Housing Existing Home sales, thous, sa Jun stronger weaker Housing Starts, thou, sa Jun weaker weaker Building permits, thous, sa Jun stronger weaker Employment Employment (thousands persons) Feb NA NA NA Credit M2 Growth (y/y) Jun stronger weaker Household Consumption Loans (% y/y) Jun stronger stronger Source: Thomson, Towers Watson 8

9 Emerging market growth overview Emerging Asian and Latin American GDP rebounds from low levels, China stabilises, and European-focused markets continue to suffer Year on year RGDP growth, weighted average* 12.0% 7.0% 2.0% China -3.0% Asia ex China Europe, middle-east & Africa -8.0% Source: Thomson, IMF, Towers Watson * Countries: India, Indonesia, Korea, Malaysia, Thailand; Poland, Russia, South Africa, Turkey; Brazil, Chile, Colombia, Mexico, Peru. Latin America 9

10 Index: Jan 31, 2005=100 It s working Ben Impact of Fed policy basis points 1000 Emerging Market spread to Treasuries %, OAS US IG Corporate Cap Rate US Real Estate S&P 500 price index MSCI World price index Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 10

12 Trends of government bond 10-year real yields since % US Govt 10-Year real yield Japan Govt 10-Year real yield Korea Govt 10-Year real yield Trend line of US Govt 10-Year real yield Trend line of Japan Govt 10-Year real yield Trend line of Korea Govt 10-Year real yield Source: Bloomberg, Towers Watson towerswatson.com 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

13 The world has changed, again Different market environments may demand different investment management techniques. We have moved from a low risk/high return environment to a high risk/low return environment. 20% 15% We have seen a regime change in markets Ten year rolling annual volatility Ten year returns annualised We may need to add to our skill sets as a result Market neutral hedge fund outperformance and VIX January 1993 to December 2011 VIX 10% 5% 0% -5% (Source: MSCI World Index) Source: MSCI, HFRI, Merrill Lynch Market neutral hedge fund returns over global equities Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 13

17 Life Insurance as a Short Straddle Due to guarantees and policyholder optionality on life insurance products, insurers are adversely affected by very low and very high interest rates (or a sharp spike in rates) Life insurers have taken a bet that interest rates might move by a little, but not by a lot towerswatson.com 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

18 Results from recent TW CFO Survey show the reason for concern What portion of your total interest-sensitive life insurance block (measured by account value) currently has the credited rate set to its minimum guaranteed rate? 24% Less than 20% 60% or more 56% 4% 20% 39% 16% 40% 59% Base: n = 25. towerswatson.com 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 18

19 Impact of changes in interest rates Low Interest rates Reduced bond returns Insurers lock-in unattractive rates Reinvestment risk is an issue for markets without a liquid long-term bond market Crediting rates may hit the minimum guarantee rate Eroded profit margins High Interest rates Increase crediting rates or face surrenders Higher crediting rates result in lower spread earned Surrenders result in negative cashflows and potentially market losses Convexity risk Liabilities increase (offset by rise in bond values) towerswatson.com 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

20 New Business Issues MANAGE RISK - Product design - Limitations of adjustment mechanisms - Client suitability - Benefit illustration - Risk appetite and product mix - Crediting strategies & investment of new business premiums MAKE IT Frequent review of pricing assumptions Timely response to market opportunities towerswatson.com 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

22 Asset-liability, not assets and liability Long-term investment strategy (strategic asset allocation) should be developed with a defined set of objectives in mind and based on the liability profile of the business. Assets Liabilities ALM Equity Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 22

23 Liability hedging Level of hedge NONE MODERATE FULL Asset-only Duration Matching PV01 Bucketing Cashflow Matching Dynamic Hedging Risk hedged Small, parallel shock to full yield curve Broadly hedge changes in shape of yield curve Broad range of shocks to interest rate Large shocks to yield curve Extreme shocks to yield curve Credit and spread risk Risk unhedged Changes in shape of yield curve (tilts, bends) Credit risk, uncertain cashflows Timing of uncertain cashflows Credit risk, uncertain cashflows Cost to implement and manage Cheap, simple A good compromise Costly, complex as may involve derivatives towerswatson.com 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

24 Balance Sheet View Liabilities Assets that hedge liabilities Assets Required Capital Assets that are a reasonable hedge or buffer for various risk charges Stability in investment performance from matched portfolio Free Surplus Assets to meet surplus distribution and investment return targets Flexibility to pursue opportunities for enhanced investment returns towerswatson.com 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 24

25 Strategic asset allocation for a life insurer can be viewed relative to a liability matching strategy ILLUSTRATIVE Market Value Balance Sheet Market Value Assets Market Value Liabilities + SH Investment Balance Sheet Insurance Balance Sheet Market Value Assets Matching Portfolio + SH Matching Portfolio Market Value Liabilities Investment Result Insurance Result Tactical Asset Allocation Strategic Asset Allocation Value of New Business In-Force Run-Off The strategic asset allocation needs to be aligned with and driven by the overall risk strategy and appetite Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 25

26 Additional Considerations UNDERSTAND YOUR RISK Understand the balance sheet (Economic basis vs Statutory basis) Impact of floors of reserves, optionality, and guarantees Risk Charges Contingent Liabilities Inflation risk Residual risk and basis risk MAKE IT What is the best liability hedging strategy? Feedback loops residual risk and economic risk charges MaIntaining the matching portfolio for rebalancing and ongoing management towerswatson.com 2013 Towers Watson. All rights reserved. Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

28 The Universe of Assets ERP Credit Term Inflation Illiquidity Currency Insurance Skill Large cap equity Small cap equity Emerging market equity Long-term long-only equity REITs Investment grade High yield MBS ABS Emerging market debt Secured loans (leveraged loans) Structured credit Nominal bonds Long duration bonds Gold Inflation linked bonds (e.g. TIPS) Inflation swaps Private equity Unlisted property Infrastructure Timber Farmland Emerging market currency Developed market currency carry The Strategic Asset Allocation is selected from the Asset Universe Commodity futures Catastrophe bonds Structured products (e.g. selling put options) Weather derivatives Fund of hedge funds Directional strategies (e.g. long/short equity, emerging markets) Relative value strategies (e.g. equity market neutral, convertible arbitrage) Event driven strategies (e.g. merger arbitrage, distressed) Trading strategies (e.g. Global Tactical Asset Allocation) Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 28

29 ways to make your portfolio work harder Govt. Bonds Balance Sheet SAA Corp Bonds Equity AI Medium Term Opportunities Temporal thematic positions Access niche beta / new asset class Liability matching assets vs. growth assets DSAA Allocations adjusted or Tilts between asset classes Exploit listed vs unlisted pricing Tilts within asset classes Exposure to macro trend Fund management approach Decisions on desired investment universe 4 Dynamic management of manager structure Active vs. passive In-house management vs. outsourcing / external managers Manager alpha expectations Changing views on particular styles Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 29

30 Risk Tolerance Risk Tolerance the acceptable level of deviations or uncertainty in meeting the objectives Risk Budgeting a quantitative approach to the allocation of risk Insurance risk Operational risk Total risk budget Market risk SAA DSAA Matching or Surplus Portfolio Asset Classes Position Sizing Active or Passive Active management Investment Manager Structure 30 Proprietary and Confidential. For Towers Watson and Towers Watson client use only.

31 Risk Monitoring Dashboard Regular monitoring of risk to ensure objectives are achieved for the business Balance Sheet Market Exposure New Business and Cash Flows Implementation Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 31

33 ALM should be a key process within the Risk Management Framework RISK MANAGEMENT FRAMEWORK COMPONENTS OF A RISK MANAGEMENT FRAMEWORK BUSINESS PROCESSES EIGHT BUSINESS PROCESSES THAT EITHER STEER THE BUSINESS OR MANAGE RISK AND REWARD Risk appetite and strategy Risk organisation Risk processes Strategy development Capital management Planning/ targeting Performance management Pricing/Product development ALM Reinsurance optimisation Incentive compensation Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 33

34 What is the right amount of risk and capital? And hence value creation? What type of company do you want to be? Return on MCEV Expected return 0 Volatility -100% Matched Mismatched Different strategies will create different risk / return profiles but they may not add value on day one. Proprietary and Confidential. For Towers Watson and Towers Watson client use only. 34

35 ALM MAKE IT NOT JUST A PROJECT, REQUIRES ONGOING MANAGEMENT Regular monitoring of dashboard Track financial position and risk profile Frequent rebalancing and review Risk limits and triggers for management action IT IS A JOURNEY Identify triggers for decision points Timing market opportunities Incorporate into business planning Identify new opportunities and incorporate into ALM Proprietary and Confidential. For Towers Watson and Towers Watson client use only.