Address Operational Impacts and Risks through Component Outsourcing Services

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1 whitepaper Address Operational Impacts and Risks through Component Outsourcing Services Seeking Higher Returns? Be Sure to Address All the Risks Institutional asset managers are constantly seeking opportunities to provide better returns for their clients portfolios by increasing yield and/or lowering risk. It is the most basic and never-ending challenge faced by asset managers, as this pursuit becomes more complex and competitive. In the quest to maximize portfolio returns in a sustained period of record low interest rates and yields, investments in complex or non-traditional asset classes syndicated bank loans, derivatives, foreign securities, commercial and residential mortgage backed securities or loans, private equity and hedge funds to name a few are gaining greater acceptance among insurers and the asset managers that serve the insurance industry. It is important to understand however that risk in this context extends beyond the impacts to the investment portfolio to include operational and accounting risk.

2 In the quest to maximize portfolio returns in a sustained period of record low interest rates and yields, investments in complex asset classes are gaining greater acceptance among insurers and the asset managers that serve the insurance industry. Even in the case of a relatively small number of holdings or positions in one or more of these complex asset classes, on a relative basis such complex investments can increase a firm s operational costs and risks several times over when compared to other less complex investment types. This is due not only to the accounting and operational complexities involved, and in many cases the related lack of uniformity in underlying structures, but also because the technical and operational expertise required is highly specialized and in very short supply. In the best instances where an asset manager is able to mitigate or contain the operational costs and risks, achieving any meaningful degree of scale or efficiency is nearly impossible for such unique or one-off investment types. In this paper, we discuss how to effectively administer complex or non-standard investments in a rapidly evolving landscape. Today, many institutional investors struggle to effectively manage the risk and operational impact of complex asset class investments. Organizations that are taking advantage of complex investments to garner higher yields are routinely forced to rely on inefficient and inherently risky manual processes in operations, accounting and reporting. Most middleand back-office solutions deployed by asset managers are not architected to deal with the complexities or transaction volumes associated with complex asset types, exposing asset managers and insurers to increased risk of errors, costs and related audit and compliance issues. On the opposite end of the spectrum, many insurers are not able to take full advantage of the higher relative returns due to concerns about the consequential operational and financial impacts of investing in these complex asset classes. The need for scalable solutions to capitalize on this accelerating asset class diversification is here to stay and accordingly, insurers and asset managers are increasingly looking to external service providers for cost-effective and scalable solutions to minimize the operational risks and costs. Address Operational Impacts and Risks through Component Outsourcing Services 2

3 Complications of New Investment Strategies The complexity of these alternative asset class investments is magnified for insurance companies that must maintain multiple accounting bases at a minimum GAAP, Statutory and Tax and deal with the corresponding reporting and disclosure requirements. The desire to maximize yield and returns by investing in these complex investment classes presents several unique challenges to all insurance companies: Reporting Requirement and Regulations Dealing with Statutory accounting and reporting, for example filing the Annual Statement Blanks with the NAIC, can be especially challenging for accounting and operations staff that have no or limited experience dealing with complex securities which fall out of the norms (and core competencies) of traditional asset types. Compounding the problem, the existing staff is often already stretched thin from an operational perspective. Regulations and reporting requirements change frequently as the NAIC hands down guidance on how to account for and report on different asset classes. For third party asset managers that are accustomed to maintaining GAAP-based records, the required Statutory accounting treatment required is often difficult or impossible to address for the insurers they serve. Beyond Statutory aspects, examples of requirements unique to insurance companies include recording book values and related amortization/accretion, pricing and valuation, risk management, and impairments. Regular changes to the reporting requirements for Schedule A, B, BA, D, and others, further compound the regulatory challenges and, in many cases, require specialized technical accounting expertise to address. Automation of Complex Processing Substandard or incomplete systems, processes and expertise are limiting insurance companies ability to diversify investments and are challenging their ability to accurately and efficiently report on diversified portfolios. Supporting these investment types with robust technology and expertise is critical. By automating multi-faceted processing that arises from investing in complex assets, insurers will not only improve operational efficiency but also systemically reduce or eliminate the risk and costs associated with manual processing. Technical Tax and Regulatory Expertise Skilled technical accounting, tax and regulatory expertise are also essential to investing in complex or non-traditional assets. U.S. GAAP involves complex accounting requirements and, from the Statutory perspective, Risk-Based Capital and AVR/IMR requirements are also critical concerns. In addition, the SEC, PCAOB and other overseers are becoming increasingly vigilant when it comes to the valuation, disclosure and risk assessment of non-traditional securities. Address Operational Impacts and Risks through Component Outsourcing Services 3

4 A Sustainable Approach through Component Outsourcing Initially, many insurance companies address operational and system challenges by using existing staff and systems along with manual processes and spreadsheets to make due, providing very limited operational and accounting support for these more complex asset classes. While spreadsheets can be a convenient and easy to use tool, they inherently lack the same level of sophistication and controls that a comprehensive accounting and operations solution provides. A less risky, more sustainable approach to dealing with complex assets is to leverage a software and service partner to support these complex asset classes with accurate and robust systems and operational expertise. That partner will understand the detailed accounting and Statutory reporting requirements, and the operational nuances of complex investments. For most firms, the quickest and most effective way to be business ready for the challenges faced by the addition or expansion of complex investments is to pursue a Component Outsourcing Model. Component Outsourcing services allow firms to choose precisely the services they need and how they are deployed spanning a wide spectrum of functions including middle office, investment accounting, reporting, reconciliation, risk analysis, performance, and Statutory requirements. The list of non-traditional asset classes that are candidates for Component Outsourcing services are vast, including: Private Equity/Partnerships Syndicated Bank Loans Collateralized Debt Hedge Funds Fund of Funds Asset- and Mortgage-Backed Securities Commercial Loans Global Fixed Income Residential Whole Loans Distressed Assets Derivatives REITs / Real Estate As new asset classes are introduced and continue to morph and evolve, it is the responsibility of the Component Outsourcing provider to correspondingly modify systems, accounting policy and business processes to proactively address the changing markets and regulations and be operationally ready to address these assets. Component services are middle- and back-office functions for complex asset classes, which may either be hosted by or entirely outsourced to a solution provider. Address Operational Impacts and Risks through Component Outsourcing Services 4

5 Component Outsourcing Operating Model Insurance Asset Management Operations & Accounting Traditional Assets Traditional Assets Complex Assets Financial Reporting Purchase GAAP Interco Transfers General Ledger Annual Statements Statutory Reporting Schedules B, BA, BD, D FX and Foreign Tax Performance & Attribution Custodian Settlements Income Cash GAAP Basis STAT Basis Component Outsourcing Accounting & Reporting Complex Assets Key Benefits of the Component Outsourcing Model Component outsourcing allows insurers and institutional asset managers to expand their middle- and back-office capabilities in order to support complex investments without disrupting or overburdening their already taxed internal systems and operations. The services are provided via private cloud-based SaaS models, enabling firms to invest in new asset classes quickly, efficiently, and cost-effectively. Operational and accounting risks are greatly reduced or eliminated by leveraging the Component Outsourcer s experience and expertise to service complex assets. Benefits of the Component Outsourcing Model include: Quick deployment because the infrastructure and readiness provided is already in place and there are no procedures to build, software to install, or staff to train Complete solution that encompasses the Component Outsourcer s depth and breadth of people, processes and technology Scalable model that can expand or contract as needed, and is on standby to be business ready to support peak volumes and other problematic aspects in the normal course of business processing Variable cost structure that is directly tied to the processing volume and operational complexities of the assets administered Address Operational Impacts and Risks through Component Outsourcing Services 5

6 Component Outsourcing with SS&C Partnering for Success Component Outsourcing is a logical, incremental approach to developing an outsourcing relationship, especially for organizations that have traditionally managed operations entirely in house. SS&C has invested significant amounts of time, expertise and resources creating the most comprehensive and robust arsenal of solutions in the insurance investment management industry including software and technology that complements our unrivaled expertise in front,middle, and back-office operations. We have the innovation and agility to service any new market, asset class or regulation in your future. Component services are provided via private cloud-based, Software-as-a- Service (SaaS) models, which allows firms to enter new asset classes quickly with no up-front software costs or infrastructure to build. 80 Lamberton Road Windsor, CT USA t: f: solution@sscinc.com 2015 SS&C Technologies Holdings, Inc.