SOA Annual Symposium Shanghai. November 5-6, Shanghai, China. Session 2a: Capital Market Drives Investment Strategy.

Transcription

1 SOA Annual Symposium Shanghai November 5-6, 2012 Shanghai, China Session 2a: Capital Market Drives Investment Strategy Genghui Wu

2 Capital Market Drives Investment Strategy Genghui Wu FSA, CFA, FRM, MAAA Senior Investment Vice President Prudential Financial

3 1. Market Volatility 2. Financial Business Lines & Investment Strategies 3. Asset Liability Management 4. Case Studies & Analytical Tools

4 Equity Volatility S&P Shanghai Composite Index Source: Bloomberg

5 Rate Volatility year U.S. Treasury year Corp. A spread Source: Bloomberg

6 5 Typical Financial Institution Balance Sheet Assets Liabilities Assets supporting product liabilities Cash Bonds Mortgages Stocks Other Deposits Reserves Life Insurance Annuities Long Term Care Structured Settlements Product Liabilities Assets = Surplus / Equity Solvency Insurance Value to Shareholders

7 6 Surplus Surplus is the net of assets less liabilities, or the net worth of the company. It is viewed as a measure of the financial strength of the company Insurance companies are required by state laws to hold a certain amount of funds in reserve to ensure they always have enough money on hand to pay claims and other obligations. Any amount over and above the required reserve level is Surplus. Surplus Creation Interest/dividends earned on investments Asset Management Fees Sales Fees Higher premiums than claims paid Surrender charges from cashed-in policies $ urplus Surplus Significance Sign of Profitability / Financial Strength Mechanism for paying dividends Used to lower premiums to attract new business and retain existing business Business growth via acquisitions

8 7 ALM Liability Driven Investment Portfolio construction is liability-driven. Asset Liability Management is strongly aligned with the business units it supports. Emphasizes a deep understanding of product liability structures Tight duration management with limited intentional exposure to interest rate risk Well-diversified across asset classes, industry sectors, geographic regions, and issuers There are meaningful risk mitigating factors in credit portfolio: Underweight in troubled sectors High Yield exposure weighted towards higher quality and asset-rich sectors; emphasis on allocations to private placements with strong covenant packages and ability to restructure Exposure to commercial mortgages: Diversification with strong overall debt service coverage and modest loan-to-value ratios Within structured securities, focus on the most highly rated tranches

9 How Does Annuities Make Money?- Earnings Driver ALM Earning Drivers Underwriting Earnings Earning$ Investment Spread Earnings Assuming Risks from Customers AUM Asset-based Fee Earnings Managing Expenses Managing Assets Fee Based Earnings: Primarily earnings from managing customer separate account assets along with other customer fees Investment Spread Earnings: Earnings from managing customer bond related investments in the general account/fixed Underwriting Earnings: Earnings from providing customer protection and managing customer risks (e.g. death and living benefit coverage) 8

10 9 How ALM Constructs Investment Policy Communicate Product Characteristics & Design Expected Cash Flows Client Options Pricing Strategy PROFIT CENTER Competitive Considerations Importance of Income vs. Capital Gains Recommended Duration ASSET / LIABILITY MANAGEMENT Asset Mix Income Impact Economic Return Surplus Volatility Capital Requirements Liquidity Interest Rate Risk Management Product Pricing Support Provide Market Intelligence Spreads Deal Flow Research Leverage Competitive Investment Strengths Credit Research Regional Presence Direct Origination Flexibility INVESTMENT UNITS Investment Policy A Policy Statement determines types of assets to include in portfolio and the level of risk.

11 Risk Management: Product Risks & Mitigating Features Risks and Mitigation RISK Exposure Mitigator Fee Income Asset Allocation Programs Living/Death Guarantees Equity Market Performance Deferred Acquisition Costs Hedge Program Capital Requirements Auto Rebalancing Features Interest Rate Credit Risk Default Risk Credit Markets Spread Income Minimum Guaranteed Rates Capital Losses Duration Matching Investment Policies/Hedging Credit Analysis Pricing/Crediting Rate Hedging Mortality Death Benefit Guarantees Reinsurance Persistency Profitability Deferred Acquisition Costs Client Service Product Features Surrender Charges 10

12 11 Best Practices Model - Asset / Liability Management Components of ALM and Investment Management Framework 1 Strategy Investment Objectives and Risk Appetite Capital and Risk Management Strategy ALM Policy 2 Execution Review of Asset Allocation Liability Measurement SAA TAA Asset Manager Selection Rebalancing Performance Monitoring and Reporting Risk Management 3 Organization 4 Systems Support Governance/Organization and Talent Management IT Tools, Performance Controlling, Settlement/Accounting

13 12 Investment Objectives and Constraints Goals Capital Preservation Minimize risk of real loss Capital Appreciation Growth of the portfolio in real terms to meet future needs (liabilities) Constraints Investment Policy Fiduciary Responsibility Regulatory Economic Current Income Focus on generating income rather than capital gains Liquidity Needs Geopolitical Total Return Increase portfolio value by capital gains and by reinvesting current income Maintain moderate risk exposure Generate surplus Time Horizon Tax Concerns

14 13 Case Studies & Analytical Tools

15 14 Impact to Retirement Savings and Annuity Products Defined Benefit Fixed Annuities Improved net investment spread reflects higher investment yields, reduced credited interest rates to policyholders and higher asset balances. Variable Annuities Low Interest Rate Environment Volatile Equity Market Interest crediting rate strategy Fee Income Less: Less: Investment Income Investment Expenses Interest Credited to Policyholders Net Investment Income

16 15 Disclosure These materials represent the views, opinions and recommendations of the author(s) regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced herein. Distribution of this information to any person other than the person to whom it was originally delivered is unauthorized, and any reproduction of these materials, in whole or in part, or the divulgence of any of the contents hereof, without prior consent of Prudential is prohibited. Certain information contained herein has been obtained from sources that the author believes to be reliable as of the date presented; however, we do cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. Prudential has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services and should not be used as the basis for any investment decision. Past performance is not a guarantee or a reliable indicator of future results. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this report. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients or prospects. No determination has been made regarding the suitability of any securities, financial instruments or strategies for particular clients or prospects. For any securities or financial instruments mentioned herein, the recipient(s) of this report must make its own independent decisions.