Investment Risk Management Under New Regulatory Framework. Steven Yang Yu Muqiu Liu Redington Ltd

Transcription

1 Investment Risk Management Under New Regulatory Framework Steven Yang Yu Muqiu Liu Redington Ltd 06 May 2015

2 Premiums written in billion RMB Dramatic growth of insurance market 2,500 Direct premium written in China 2,000 2,023 1,722 1,500 1,453 1,434 1,549 1, , Source: CIRC 06 May

3 Premiums written in billion U.S. dollars 4 th largest globally 1,400 1,200 1,259 Direct premium written by countries , Source: Statista Ping An Insurance is one of the 9 Globally Systematically Important Insurers (G-SIIs) in the world! 06 May

4 Opportunities but also challenges Weak risk management capability Low capital efficiency Long-term investment not performing well Customer complaints, mis-selling High expenses 06 May

5 Agenda for this workshop Regulations: C-ROSS Key investment risks Example strategies to manage risk Equities Credit Interest rate Conclusion: 4 key takeaways 06 May

6 C-ROSS Institutional Characteristics One Supervision Emerging Markets Risk-Oriented with Value Consideration Supervisory Pillars Pillar I Quantitative Capital Requirements Pillar II Qualitative Supervisory Requirements Pillar III Market Discipline Mechanism Supervisory Foundation Company Solvency Management 06 May

7 C-ROSS Quantifiable Risk Market Risk Interest Rate Risk Credit Risk Insurance Risk Investment Strategy 06 May

8 Multi-Dimensional Challenge Return on Capital Regulatory Capital Economic Capital Surplus Volatility Governance Liquidity 06 May

9 Investment Risk Management Framework Objective Measurement Quantification Action Return Expected return > Shareholder required return on capital Expected return on capital 13.5% Required return on capital 12.0% Margin (Expected return less required return) 1.5% - Risk / Capital Liquidity Asset allocation target benchmark Current capital > required capital The company should hold enough eligible assets to cover additional liquidity requirements in an adverse scenario The current asset allocation is to be kept within +/- 5% of the target benchmark allocation Economic basis Regulatory basis Current capital budget Required capital (VaR 99.5%) 1,150m 1,020m Current capital budget 1,300 Required capital (VaR 99.5%) 1,350 Available liquid asset 400m 5 year cashflows if lapse rate increases by 20% 250m Government bonds 20% 36.2% Corporate bonds 10% 10.5% Equity 35% 27.0% Property 5% 6.3% Other assets 30% 26.0% Bring current capital in line with required capital Allocate out of overweight assets into relatively underweight assets to bring in line with target benchmark allocations - - On track Within 10% of target Off track 06 May

10 Equity Risk Management 06 May 2015

11 Rationale UK Equity Total Return UK Gilts Total Return Inflation Source: Bloomberg, Redington Why investing in equities Offers a decent level of positive risk premiums over the long term Relatively liquid market Match certain type of liabilities for institutional investors 06 May

12 S&P 500 Drawdown from prior peak (%) Downside Risk 0% -10% -20% -30% -40% -50% -60% -70% -80% -90% -100% Source: Bloomberg, Redington Infrequent large drawdowns (>30%) Frequently enough to be a problem in a portfolio context 06 May

13 Shanghai Composite Index Daily Return (%) Volatilities 15.00% 10.00% 5.00% 0.00% -5.00% % % 115 days of higher than 5% loss Source: Bloomberg, Redington Chinese equity market could also suffer significant volatilities (if not larger than developed market) on a daily basis 06 May

14 Negative impact 240% 220% 200% 180% 160% 140% 120% 100% year periods Capital Drawdown >> Target Equity Return >> 8.0% 9.0% 10.0% -10% 10.3% 11.3% 12.3% -15% 11.5% 12.5% 13.6% -20% 12.8% 13.9% 14.9% -25% 14.3% 15.3% 16.4% 20 year periods Capital Drawdown >> Target Equity Return >> 8.0% 9.0% 10.0% -10% 8.6% 9.6% 10.6% -15% 8.9% 9.9% 10.9% -20% 9.2% 10.2% 11.2% -25% 9.5% 10.6% 11.6% 06 May

15 Solutions Risk Management should be put in place in the good times to have most effect in the bad times Downside protection Risk Control Diversification 06 May

16 EXpected Return 1. Diversification 8.00% 7.50% 7.00% 50% DM Equity 10% EM Equity 30% Alternatives Efficient Frontier 50% DM Equity 30% EM Equity 20% Alternatives 20% DM Equity 80% EM Equity 0% Alternatives 6.50% 6.00% 40% DM Equity 0% EM Equity 60% Alternatives Concentrated equity portfolio 5.50% 5.00% 1.5% 3.5% 5.5% 7.5% 9.5% 11.5% 13.5% 15.5% 17.5% 19.5% Risk (measured by standard deviation of annual returns) Source: Redington 06 May

17 2. Risk Control Volatility controlled equities provides greater exposure to equity markets at times of low volatility and reduces equity exposure at times when markets have higher volatility and in general: -Equity volatility rises when equities fall -Equity volatility falls when equities rise Equity volatility 15% 67% equity exposure (as equity vol is 15%) 15%*0.67 = 10% 160% % Allocation in Equity 140% 120% 100% 10% 100% exposure 80% 60% 40% 8% 125% equity exposure (as equity vol is 8%) 8%*1.25 = 10% Time 20% 0% Source: Bloomberg, Redington 06 May

18 Annual Percentage Return Annualized Volatility (%) 2. Risk Control 70% 60% 50% 40% 30% 20% 10% 0% MSCI World Index Daily Net TR Local MSCI World Volatility Controlled Index 40% 30% 20% 10% 0% -10% % -30% -40% Source: Bloomberg, Redington MSCI World MSCI World Volatility Controlled Index 06 May

19 Payoff 3. Downside Protection Equity value Equity Equity + 90% Put Source: Redington 06 May

20 Performance MSCI World Index MSCI World Vol Control (10% Vol) Index MSCI World Vol Control (10% Vol) with Put (90% strike) Source: Bloomberg, Redington 06 May

21 Credit Optimization 06 May 2015

22 Why credit optimization Liability Matching Economic Return Credit Optimization Valuation discount rate Capital Charges 06 May

23 RMB billion Chinese fixed income market The size of various sectors of the market Policy Bank Bonds Ministry of Finance Bonds Others Medium-Term Notes Enterprise Bonds Commercial Paper Local Gov't Bonds Corporate Bonds Central Bank Notes Source: Wind Primarily driven by government related bonds; Growing demand and supply of corporate and SME bonds. Diversity of ratings and maturities. 06 May

24 Credit Spread Credit Spread Dynamics within credit market Aaa Aa A Baa Maturity[1,3) Maturity[3,5) Maturity[5,7) Maturity[7,10) Maturity[10,15) Maturity[15,) Source: Barclays POINT, Redington 06 May

25 How to do credit optimization Return on Economic Capital Numerator Denominator Credit Risk Premium Capital Required Credit risk premium Maximise expected returns. Maximise implied illiquidity premium in bonds. Required capital Reduce regulatory capital requirement. Reduce economic risk i.e. Surplus at Risk 06 May

26 How to do credit optimization Capital Efficiency (Return on Economic Capital) 1-3 Years 3-5 Years 5-7 Years 7-10 Years Years > 15 Years AAA 0.3% 0.2% 2.1% 1.9% 0.4% 0.3% AA 3.2% 2.5% 3.6% 2.7% 5.4% 0.7% A 5.4% 3.6% 7.4% 5.3% 2.4% 0.8% BBB 5.9% 5.6% 5.5% 3.5% 2.8% 1.9% Source: Barclays POINT, Redington 06 May

27 How to do credit optimization Objective Before Optimization After Optimization Return Risk / Capital Liquidity Asset allocation target benchmark Expected return > Shareholder required return on capital Current capital > required capital Hold enough eligible assets to cover liquidity requirements in an adverse scenario The current asset allocation is to be kept within +/- 5% of the target benchmark allocation Credit spread 1.5% Credit spread 2.2% Minimum illiquidity premium required Credit spread after default allowance 1.0% 1.1% Minimum illiquidity premium required Credit spread after default allowance 1.0% 1.7% Economic basis 1,050 million Economic basis 1,070 million Regulatory basis 1,350 million Regulatory basis 1,280 million 1 year net cashflow 80 million 1 year net cashflow 80 million 1 year net cashflow under stress 20 million 1 year net cashflow under stress 20 million AAA 5% AAA 1% AA 30% AA 10% A 40% A 55% BBB 25% BBB 34% Non-Investment Grade 0% Non-Investment Grade 0% 06 May

28 Other fixed income investments Equity Release Mortgages Long dated cashflows Diversifier Exposure to residential property Infrastructure debt Return pick up Well collateralized Secured leases Inflation protection Return pick up Exposure to commercial property 06 May

29 Managing Interest Rate Risk 06 May 2015

30 Why Manage Interest Rate Risk? % 5% 100 (1 + Rate) time = Present Value Interest rates fall Today 10 years Liabilities PV increases Surplus falls 06 May

31 Why Manage Interest Rate Risk? Duration Mismatch Unrewarded Risk Interest Rate Risk Management Capital Requirement Surplus Volatility 06 May

32 Why Manage Interest Rate Risk? 7 Falling interest rate in major developed countries - 10Y swap rate /01/ /01/ /01/ /01/ /01/ /01/ /01/ /01/ /01/2015 JPY Swap USD Swap GBP Swap CNY Govt Source: Bloomberg, Redington 06 May

33 How Could You Manage it? PV01 ( m) Liabilities Government bonds Corporate bonds Swaps Maturity 06 May

34 Economic vs. Regulatory 3.50% Risk free Interest Rate 3.00% 2.50% 2.00% 1.50% 1.00% 0.50% 0.00% EUR Swap UFR Economic Regulatory Risk (VaR 99.5%) 70m 45m Risk Budget 75m 50m 06 May

35 Conclusion: 4 key takeaways Strong need of risk/capital management practices Investment strategy in the context of ALM People, system and process Constant learning and dynamically adapt to changes 06 May

36 Questions Comments Expressions of individual views by members of the Institute and Faculty of Actuaries and its staff are encouraged. The views expressed in this presentation are those of the presenter. 06 May