11
Introduction to Introduction to Managing Insurance AssetsManaging Insurance Assets
Peter Gunder, CFAPeter Gunder, CFAOctober 9October 9--10, 200710, 2007
The Harvard Club, New York CityThe Harvard Club, New York City
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Your ConferenceYour ConferenceModeratorModerator
Peter GunderPeter Gunder–– Cofounder and Managing Director, Cardinal Cofounder and Managing Director, Cardinal
Investment Advisors (Investment Advisors (““CardinalCardinal””).).–– Cardinal is a boutique investment consulting Cardinal is a boutique investment consulting
firm specializing in service to insurers. firm specializing in service to insurers. –– 32 relationships with $63 billion in invested 32 relationships with $63 billion in invested
assets, primarily P&C and health insurers.assets, primarily P&C and health insurers.
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OutlineOutline
Your ConferenceYour ConferenceCapital MarketsCapital MarketsInvestment StrategyInvestment Strategy–– Create, Implement and MonitorCreate, Implement and Monitor
OutsourcingOutsourcing
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Your ConferenceYour ConferenceSponsorsSponsors
GE Asset ManagementGE Asset ManagementGoldman Sachs Asset ManagementGoldman Sachs Asset ManagementMorgan Stanley Investment ManagementMorgan Stanley Investment ManagementPrime AdvisorsPrime AdvisorsState Street Global AdvisorsState Street Global Advisors
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Your ConferenceYour ConferenceParticipating FirmsParticipating Firms
AEGON USAAEGON USAAmerican Family InsuranceAmerican Family InsuranceAmerisureAmerisure CompaniesCompaniesChicago Hospital Risk Pooling ProgramChicago Hospital Risk Pooling ProgramChurch Mutual Insurance CompanyChurch Mutual Insurance CompanyColumbian Mutual Life Insurance CompanyColumbian Mutual Life Insurance CompanyCommunity Health Plan of WashingtonCommunity Health Plan of WashingtonEmployers Reassurance CorporationEmployers Reassurance CorporationEnduranceEnduranceExcellus BlueCross BlueShieldExcellus BlueCross BlueShieldFidelity Life AssociationFidelity Life AssociationFremont Insurance CompanyFremont Insurance CompanyGE Insurance GE Insurance -- L&HL&HGenworthGenworth FinancialFinancialGLOBAL Reinsurance Corporation of AmericaGLOBAL Reinsurance Corporation of AmericaGMAC InsuranceGMAC InsuranceHarleysville Group Inc.Harleysville Group Inc.Korea Life InvestmentKorea Life InvestmentLouisiana Workers' Compensation Louisiana Workers' Compensation CorporationCorporation
Main Street America GroupMain Street America GroupNew York Life Insurance CompanyNew York Life Insurance CompanyNew York State Insurance FundNew York State Insurance FundNGM Insurance CompanyNGM Insurance CompanyPartnerRePartnerRe Asset Management CorporationAsset Management CorporationPMSLIC Insurance CompanyPMSLIC Insurance CompanyR&Q Reinsurance CompanyR&Q Reinsurance CompanyRadian Group, Inc.Radian Group, Inc.SBLIUSASBLIUSASecuraSecura InsuranceInsuranceTriple S Management CorporationTriple S Management CorporationTrustmark InsuranceTrustmark InsuranceUnited Americas Insurance CompanyUnited Americas Insurance CompanyUnited Frontier Mutual Ins. Co.United Frontier Mutual Ins. Co.Utica Mutual Insurance CompanyUtica Mutual Insurance CompanyVantisLifeVantisLife Insurance CompanyInsurance CompanyWestern World InsuranceWestern World InsuranceWilton ReWilton ReWinterthur Investment Management Corp.Winterthur Investment Management Corp.Zurich GlobalZurich Global
Participant listing as of September 27, 2007
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Your ConferenceYour ConferenceInsurance LinesInsurance Lines
You are a diverse groupYou are a diverse group–– Lines of BusinessLines of Business
Life & HealthLife & HealthProperty & Casualty Property & Casualty MultiMulti--linelineReinsurerReinsurer
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Your ConferenceYour ConferenceFirm SizesFirm Sizes
<$1 Billion<$1 Billion–– 1,000 plus insurers1,000 plus insurers–– $450 billion in assets$450 billion in assets
$1$1--5 Billion5 Billion–– 100 insurers100 insurers–– $400 billion$400 billion
$5$5--25 Billion25 Billion–– 60 insurers60 insurers–– $850 billion $850 billion
>$25 Billion>$25 Billion–– 40 insurers40 insurers–– $4,300 billion$4,300 billion
Lack dedicated resources Lack dedicated resources –– finance finance professionals oversee investmentsprofessionals oversee investments
–– Extensively outsource investmentsExtensively outsource investments–– Employ consultant or manager for Employ consultant or manager for
ALM, strategy, accountingALM, strategy, accounting
11--2 dedicated professionals2 dedicated professionals–– Frequently employ third party Frequently employ third party
managersmanagers–– Moderately broader restrictionsModerately broader restrictions–– Core plus mandatesCore plus mandates
Established investment functionsEstablished investment functions–– Frequently manage core bonds Frequently manage core bonds
internallyinternally–– Require third party for alphaRequire third party for alpha--producing producing
specialtiesspecialties
Extensive investment organization with Extensive investment organization with multiple specialtiesmultiple specialties
–– Selectively outsource alternative Selectively outsource alternative investments (mezzanine, hedge funds, investments (mezzanine, hedge funds, distressed)distressed)
Source: Patpatia & Associates, Inc. 2007.
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Your ConferenceYour ConferenceExpertsExperts
ACE Asset ManagementACE Asset ManagementAllied World Assurance Allied World Assurance CompanyCompanyA.M. Best CompanyA.M. Best CompanyFitch RatingsFitch RatingsGenworthGenworth FinancialFinancialGoldman Sachs Asset Goldman Sachs Asset ManagementManagementMoodyMoody’’s Investors Services Investors Service
Morgan Stanley Morgan Stanley Investment ManagementInvestment ManagementPrime AdvisorsPrime AdvisorsSidley Austin, LLPSidley Austin, LLPState Street Global State Street Global AdvisorsAdvisorsStandard & PoorStandard & Poor’’ssTillinghastTillinghast
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Your ConferenceYour ConferenceFormatFormat
WorkshopsWorkshops1.1. Understanding the Potential of Your Fixed Income Portfolios: SetUnderstanding the Potential of Your Fixed Income Portfolios: Setting ting
Risk and Return ExpectationsRisk and Return Expectations2.2. Private Equity Investing for Insurance CompaniesPrivate Equity Investing for Insurance Companies3.3. A Managed Volatility ApproachA Managed Volatility Approach4.4. Maximizing Your Core Fixed Income PortfolioMaximizing Your Core Fixed Income Portfolio5.5. Using Asset Liability Management (ALM) to Drive Investment StratUsing Asset Liability Management (ALM) to Drive Investment Strategy egy
DesignDesignPanelsPanels1.1. The Changing Accounting and Regulation PictureThe Changing Accounting and Regulation Picture2.2. The Lure of AlternativesThe Lure of Alternatives3.3. Reassessing Benchmarking in TodayReassessing Benchmarking in Today’’s Investment Climates Investment Climate4.4. Contagion: What Insurers Need to Know to be Successful in TodayContagion: What Insurers Need to Know to be Successful in Today’’s s
Fixed Income MarketsFixed Income MarketsSpeechSpeech1.1. Enterprise Risk Management for InsurersEnterprise Risk Management for Insurers
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Your ConferenceYour ConferenceAcronymsAcronyms
ABS ABS ABS ABS CDOsCDOsABXABXABX.HEABX.HEAltAlt--AACADRCADRCBOCBOCC0CC0CDRCDRCDXCDXCLOCLOCMBSCMBSCMBXCMBXCPRCPRDIPDIPGCMCGCMCHYCDXHYCDX
JJ--CurveCurveLCDSLCDSLCFLCFLSTALSTANIMsNIMsOASOASOIDOIDREOREORMBSRMBSRPMCRRPMCRTBATBATLATLATRSTRSVaRVaRWALWALWALAWALAWARFWARF
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Capital MarketsCapital MarketsStructured ProductsStructured Products
2007 has been a volatile year in the capital markets. 2007 has been a volatile year in the capital markets.
Losses in subLosses in sub--prime mortgages led to large price prime mortgages led to large price dislocations and illiquidity in most forms of structured dislocations and illiquidity in most forms of structured products.products.
Do credit investors view this as a buying opportunity?Do credit investors view this as a buying opportunity?
Do ABS investors remain largely on the sidelines due to Do ABS investors remain largely on the sidelines due to questions about the quality of ratings as well as questions about the quality of ratings as well as underlying collateral?underlying collateral?
Source: Barclays Capital. 2007.
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Capital MarketsCapital MarketsSubSub--prime Falloutprime Fallout
September 26, 2007September 26, 2007-- ““Credit rating agencies today defended themselves Credit rating agencies today defended themselves against criticism that they contributed to the mortgageagainst criticism that they contributed to the mortgage--market debacle. The market debacle. The U.S. Senate Committee on Banking, Housing and Urban Affairs todaU.S. Senate Committee on Banking, Housing and Urban Affairs today held a y held a hearing to explore the agencieshearing to explore the agencies’’ role in the subrole in the sub--prime mortgage disaster.prime mortgage disaster.””
““These loans were facilitated by Wall Street with the support of These loans were facilitated by Wall Street with the support of credit rating credit rating agencies,agencies,”” said Senate Banking Committee chairman Christopher Dodd (Dsaid Senate Banking Committee chairman Christopher Dodd (D--ConnConn.) .)
““In a testimony today, Christopher Cox, chairman of the SecuritieIn a testimony today, Christopher Cox, chairman of the Securities and s and Exchange Commission, said that the regulatory group was investigExchange Commission, said that the regulatory group was investigating the ating the agencies, especially to see if they were influenced by Wall Streagencies, especially to see if they were influenced by Wall Street firms, et firms, which pay for their own ratings.which pay for their own ratings.””
““The agencies defended their methods.The agencies defended their methods.””
What happens next?What happens next?
Source: September 26, 2007, Investment News.
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Capital MarketsCapital MarketsMassive Global Derivative ScaleMassive Global Derivative Scale
0
50
100
150
200
250
300
350
400
450
500
2002 2003 2004 2005 2006
(US$
Tril
lion)
OTC Futures Options
Sources: Goldman Sachs; June 30, 2006 OTC; December 31, 2006 exchange traded; notional values adjusted for double counting. Bank for International Settlements.
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$0
$200
$400
$600
$800
$1,000
$1,200
$1,400
$1,600
$1,800
$2,000
1990 1992 1994 1996 1998 2000 2002 2004 2006
Bill
ions
Capital MarketsCapital MarketsExplosive Direct Hedge Fund GrowthExplosive Direct Hedge Fund Growth
Source: Hedge Fund Research (HFR) direct hedge funds; estimate for 2007 is July 31, 2007.
1515
Capital MarketsCapital MarketsFixed Income Hedge Fund ReturnsFixed Income Hedge Fund Returns
Source: Hedge Fund Research (HFR) Fixed Income Total monthly returns, August 31, 2007. Sub-strategies include arbitrage, convertible bonds, diversified, high yield, mortgage-backed.
-1
-0.5
0
0.5
1
1.5
Jan-
04
Mar
-04
May
-04
Jul-0
4
Sep
-04
Nov
-04
Jan-
05
Mar
-05
May
-05
Jul-0
5
Sep
-05
Nov
-05
Jan-
06
Mar
-06
May
-06
Jul-0
6
Sep
-06
Nov
-06
Jan-
07
Mar
-07
May
-07
Jul-0
7
Per
cent
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Capital MarketsCapital MarketsDoes YaleDoes Yale’’s Model Matter to Insurers?s Model Matter to Insurers?
The The YaleYale Endowment, which has led the academic world in Endowment, which has led the academic world in investment performance over the last decade, posted a 28 percentinvestment performance over the last decade, posted a 28 percentreturn for the fiscal year ended June 30, 2007 bringing its totareturn for the fiscal year ended June 30, 2007 bringing its total l value to $22.5 billion.value to $22.5 billion.David David SwensenSwensen argued in his book argued in his book ““Pioneering Portfolio Pioneering Portfolio ManagementManagement”” that depending solely on stocks and bonds would not that depending solely on stocks and bonds would not necessarily provide enough protection to a fund. His approach hanecessarily provide enough protection to a fund. His approach has s led Yaleled Yale’’s endowment into hedge funds, private equity funds and s endowment into hedge funds, private equity funds and hard assets like timber and oil and gas.hard assets like timber and oil and gas.Source: September 27, 2007, Alan S. Orling for The New York Times
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Investment Strategy Investment Strategy Create, Implement and MonitorCreate, Implement and Monitor
CreateCreate–– Financial analysisFinancial analysis–– Peer analysisPeer analysis–– Asset class educationAsset class education–– Asset class choicesAsset class choices–– Asset and liability modelingAsset and liability modeling–– Asset allocation analysesAsset allocation analyses–– Dynamic financial analysisDynamic financial analysis–– Enterprise risk managementEnterprise risk management–– Portfolio goals: book yield and total returnPortfolio goals: book yield and total return–– Investment policyInvestment policy
Source: Cardinal Investment Advisors.
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Investment Strategy Investment Strategy Create, Implement and MonitorCreate, Implement and Monitor
ImplementImplement–– Customized benchmark designCustomized benchmark design–– Tax models and optimizationTax models and optimization–– Insourcing versus outsourcing analysisInsourcing versus outsourcing analysis–– Manager search and selectionManager search and selection–– Transition managementTransition management–– Investment accounting Investment accounting –– GAAP, Stat, PGAAP, TaxGAAP, Stat, PGAAP, Tax–– Custodian search and selectionCustodian search and selection–– Securities lendingSecurities lending
Source: Cardinal Investment Advisors.
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Investment Strategy Investment Strategy Create, Implement and MonitorCreate, Implement and Monitor
MonitorMonitor–– Rating agency supportRating agency support–– Risk analysisRisk analysis–– Performance analysis Performance analysis -- measurement and attributionmeasurement and attribution–– Compliance monitoringCompliance monitoring–– Management reportingManagement reporting
Source: Cardinal Investment Advisors.
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Investment Strategy Investment Strategy Asset Class ChoicesAsset Class Choices
Investment grade fixed income Investment grade fixed income including structured productsincluding structured products
Treasury inflationTreasury inflation--protected protected securities (TIPS)securities (TIPS)
High yield bondsHigh yield bonds
High yield bank loansHigh yield bank loans
Convertible securitiesConvertible securities
Preferred equityPreferred equity
Real estateReal estate
Emerging market debtEmerging market debt
Distressed debtDistressed debt
Mezzanine debtMezzanine debt
Buyout fundsBuyout funds
Venture capitalVenture capital
Hedge fundsHedge funds
CommoditiesCommodities
Source: Cardinal Investment Advisors
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Investment StrategyInvestment StrategyHow to Choose Asset Classes?How to Choose Asset Classes?
Which asset classes make sense?Which asset classes make sense?What are the RBC or BCAR implications?What are the RBC or BCAR implications?What does your rating agency analyst What does your rating agency analyst think?think?What methodologies are you using to What methodologies are you using to justify your asset class choices? justify your asset class choices?
Source: Cardinal Investment Advisors
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Gather dataCustomize
ForecastingModel
Create Portfolios Across Risk
Spectrum
Assess Risk/Return Tradeoffs
Optimal Asset
Allocation
Collect company’s historical financial and available forecast dataInterview management
• Strategic direction
• Growth projections
• Underwriting objectives
• Reserving Policy• Tax situation• Legacy
investment strategy
• Corporate culture as it relates to risk
Identify financial performance measuresAnalyze liability and cash flow trendsAssess capital adequacyIdentify capital requirements for infrastructure improvements and strategic initiatives, if anyBuild expected, worst, and best case operating assumptions
Screen assets for• Regulatory
restrictions• RBC
requirements• Liquidity• Taxes
Construct optimal portfolios
• Provide education on asset classes new to the client
• Design alternative portfolio structures with varying degrees of risk
Stress test financials for each portfolioEvaluate downside risk with respect to
• Capital adequacy• Profitability• Cash flow• Liquidity • Leverage
Shock test portfolios for dramatic negative market and operating conditionsAnalyze risk/reward tradeoff across feasible portfolios
Select the optimal asset allocation that meets the client’s return objectives within their unique constraints
Investment StrategyInvestment StrategyAsset Allocation AnalysesAsset Allocation Analyses
Source: Cardinal Investment Advisors
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Industry Outlook
Strategic Initiatives
Business Objectives
Operating Trends
Capital Investments
Regulations
Federal Income Tax
OTTI*
Rating Agency CAR
Economic Value
Corporate Culture
Operating Earnings
BCAR
Leverage
Liquidity/Cash Flow OU
TPU
TS
INPU
TS
InvestmentInvestment StrategyStrategyDynamic Financial AnalysisDynamic Financial Analysis
DYNAMIC FINANCIAL ANALYSIS
“DFA”
MODEL
Source: Cardinal Investment Advisors
Surplus
Peers
*Other-Than-Temporary Impairment, FAS 115, EITF 03-01.
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Frequency Chart
.000
.008
.016
.023
.031
0
15.5
31
46.5
62
12,500.0 18,125.0 23,750.0 29,375.0 35,000.0
2,000 Trials 1,996 Displayed
Forecast: Year 5 GAAP PHS
Investment StrategyInvestment StrategyExpected SurplusExpected Surplus
Source: Cardinal Investment Advisors
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OutsourcingOutsourcingTrendTrend
““Insurance companies have significantly Insurance companies have significantly increased their use of unaffiliated increased their use of unaffiliated investment managers to manage general investment managers to manage general account assets over the past several account assets over the past several years.years.””
Source: Eager, Davis Holmes, LLC 2007
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OutsourcingOutsourcingAsset ChoicesAsset Choices
As firms move up the size spectrum, core As firms move up the size spectrum, core fixed income investments become fixed income investments become complemented by specialty strategies complemented by specialty strategies ––bank loans, high yield, and emerging bank loans, high yield, and emerging markets debt. markets debt. P&C firms, in particular, are penetrating P&C firms, in particular, are penetrating alternative investment sectors alternative investment sectors –– public public and private equities, real estate, hedge and private equities, real estate, hedge funds, and derivatives.funds, and derivatives.Source: Patpatia & Associates, Inc. 2007.
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OutsourcingOutsourcingTrend or Exception?Trend or Exception?
NEW YORK, May 29, 2007 (Reuters) NEW YORK, May 29, 2007 (Reuters) –––– Safeco Corp. (SAF), a property and casualty insurer, Safeco Corp. (SAF), a property and casualty insurer,
said on Tuesday asset management firm XYZ will said on Tuesday asset management firm XYZ will assume management of its roughly $10.5 billion assume management of its roughly $10.5 billion investment portfolio.investment portfolio.
–– Safeco said it expects to move its assets to XYZ in the Safeco said it expects to move its assets to XYZ in the third quarter, according to a filing with the U.S. third quarter, according to a filing with the U.S. Securities and Exchange Commission.Securities and Exchange Commission.
–– Previously the portfolio was managed internally, a Previously the portfolio was managed internally, a spokesman told Reuters.spokesman told Reuters.
–– He said the development was part of the insurer's He said the development was part of the insurer's previously announced previously announced ““process improvement process improvement initiative.initiative.””
Source: Reuters, May 29, 2007. XYZ is an alteration.
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ModeratorModerator’’s Goalss Goals
Learn,Learn,Find an investment idea to pursue further,Find an investment idea to pursue further,Ask many questions,Ask many questions,Build a new relationship, andBuild a new relationship, andFind a colleague Find a colleague ““in the same boat.in the same boat.””
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Questions?Questions?
