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Insurer Investment Forum XIII   Investing for Insurers:    Review and Preview     Alton Cogert, CFA, CPA, CAIA, CGMA      ...
The #1 Investment Challenge in Over 30 Years:           “Low Rates for Longer”                                            ...
U.S. Financial RepressionSource: Federal Reserve, J.P. Morgan Asset Management                                            ...
Where We Are Today     • Book Yields Continue Downward Path     • Insurers Grappling with Risk     • Insurers Grappling wi...
Improving Investment Income - It Takes Planning                                Improved Investment Income - It is possible...
Key Long-Term Asset Class Return Assumptions    Source:JP Morgan 2013 Long-Term Capital Market Return Assumptions   6     ...
Key Long-Term Asset Class Risk Assumptions Source:JP Morgan 2013 Long-Term Capital Market Return Assumptions   7          ...
Risk/Return/Correlation Expectations vs. Aggregate InvestmentGrade Bond                                                   ...
What Does “Low Rates for Longer” Mean?   • How Long?      NOV, 2009 “Federal Reserve Chairman Ben      Bernanke said inter...
What Does “Low Rates for Longer” Mean?            Until Unemployment Rate Hits 6.5%, which will be... It would take an ave...
What Does “Low Rates for Longer” Mean?           Comparison with Japan - 15 Years and counting?                10 year JGB...
How About ‘Black Swans’ - Very Low Probability/Very High Impact?        Inflation - according to the ‘experts           Key...
How About ‘Black Swans’ - Very Low Probability/Very High Impact?                                                          ...
The Fed says, “Take More Risk”...Should You?                      What is Your Risk Appetite?                             ...
The Fed says, “Take More Risk”...Should You?             Over the long run, Process determines Results.          Thus, Pro...
What about Luck versus Skill?       Texthttp://insurercio.com/content/how-much-ones-success-or-failure-skill-or-luck   Tex...
What about Luck versus Skill?                             Paradox of Skill:    Standard deviation of skill decreases as ex...
From the London Business School...     • Decisions Are More Important Than Results           • Results don’t necessarily r...
Could we make understanding risk any more complicated?                                Text                                ...
8 Steps to Answering: “Should You Take More Risk?”     • Step 1 - What do you mean by ‘risk’?         • Probability of Not...
8 Steps to Answering: “Should You Take More Risk?”      •   Step 3      •   How do different asset mixes impact risk metri...
8 Steps to Answering: “Should You Take More Risk?”      •   Step 4 - Implementation Issues          • Strategic or Tactica...
8 Steps to Answering: “Should You Take More Risk?”      •   Step 5 - Consider Game Theory Impact                          ...
8 Steps to Answering: “Should You Take More Risk?”     • Step 6          • Know your Board/Senior Management Team      •  ...
What has SAA seen so far?                            Text                             Text                              Te...
Goldman Sachs Insurance CIO Survey - July, 2012                     Insurers expecting to increase risk: 26%              ...
Asset Classes - a Layer Cake of Choices        Tex The Next Layer       Text                                  Text        ...
Asset Classes - a Layer Cake of Choices                                  Text         •Tex The Next/Next/Next Layer       ...
The Risk Trap      •   Always ask, “Who is on the other side of the trade? And why?”      •   Too easy to see well groomed...
The Risk Trap   • Other Questions:      •   Will this play in Oldwick?      •   Ask for ideas from your peers, independent...
The #1 Investment Challenge in Over 30 Years                                               31                             ...
The #1 Investment Challenge in Over 30 Years   • Low rates for longer gives us the opportunity to      •   Reassess our as...
The #1 Investment Challenge in Over 30 Years                        Thank You                           More updates at:  ...
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Investing for Insurers: Review and Preview

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SAA is consistently meeting and discussing issues with insurers, investment managers and others involved in the insurance investment process. What have been the common themes and challenges we hear? And how are various insurers approaching these key issues? What might we expect in the financial markets and economy over the next year? And, how might that impact insurers’ future plans? This session serves as the starting point for the day’s sessions, which are focused on helping you succeed in an increasingly challenging investment environment.

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Transcript of "Investing for Insurers: Review and Preview"

  1. 1. Insurer Investment Forum XIII Investing for Insurers: Review and Preview Alton Cogert, CFA, CPA, CAIA, CGMA President & CEO March 21st, 2013 1
  2. 2. The #1 Investment Challenge in Over 30 Years: “Low Rates for Longer” 2 2
  3. 3. U.S. Financial RepressionSource: Federal Reserve, J.P. Morgan Asset Management 3 3
  4. 4. Where We Are Today • Book Yields Continue Downward Path • Insurers Grappling with Risk • Insurers Grappling with Product Pricing • Insurers Grappling with ERM “A further unpleasant reality adds to the industry’s dim prospects: Insurance earnings are now benefiting from “legacy” bond portfolio that deliver much higher yields than will be available when funds are reinvested during the next few years - and perhaps for many years beyond that. Today’s bond portfolios are, in effect, wasting assets. Earnings of insurers will be hurt in a significant way as bonds mature and are rolled over.” - Berkshire Hathaway Shareholders’ Letter, March, 2013 4 4
  5. 5. Improving Investment Income - It Takes Planning Improved Investment Income - It is possible... Unchanged Market interest Rates 4.25 Portfolio Book Yield 4.10 3.95 3.80 3.65 3.50 1 2 3 4 5 6 7 8 9 10 11 12 Improved Unchanged 5 5
  6. 6. Key Long-Term Asset Class Return Assumptions Source:JP Morgan 2013 Long-Term Capital Market Return Assumptions 6 6
  7. 7. Key Long-Term Asset Class Risk Assumptions Source:JP Morgan 2013 Long-Term Capital Market Return Assumptions 7 7
  8. 8. Risk/Return/Correlation Expectations vs. Aggregate InvestmentGrade Bond 8 8
  9. 9. What Does “Low Rates for Longer” Mean? • How Long? NOV, 2009 “Federal Reserve Chairman Ben Bernanke said interest rates will remain low for an extended period as the U.S. economy still faces considerable challenges.” FEB, 2010 “Chairman Ben Bernanke told Congress on Wednesday a weak job market and tame inflation warrant low interest rates for an extended period.” JAN, 2012, “The Federal Reserve anticipates that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.” FEB 2013 - “It plans to hold short-term interest rates near zero even longer, at least until the unemployment rate falls below 6.5 percent.” 9 9
  10. 10. What Does “Low Rates for Longer” Mean? Until Unemployment Rate Hits 6.5%, which will be... It would take an average job-growth rate of 250,000 each of the next 13 months to arrive at a 6.5% unemployment rate. But if increases were just 125,000, the average trend rate for the last 30 years, it would take 96 months — or eight full years — before unemployment got to 6.5%. (This isn’t just job additions, mind you, but net job creation; that’s why simply jumping from 125,000 to 250,000 cuts the time down so dramatically.) So bond bulls and dollar bears take heart. It looks like Helicopter Ben will be hovering for some time to come. - http://blogs.wsj.com/marketbeat/2013/01/04/when-the-unemployment-rate-hit-6-5- calculate-it/ Here’s the Atlanta Fed’s calculator to help answer this question: http://www.frbatlanta.org/chcs/calculator/ 10 10
  11. 11. What Does “Low Rates for Longer” Mean? Comparison with Japan - 15 Years and counting? 10 year JGB: Jan, 1990 to March, 2013 11 11
  12. 12. How About ‘Black Swans’ - Very Low Probability/Very High Impact? Inflation - according to the ‘experts Keynesians - - Demand/pull - increased economic activity - Cost push - supply side disruptions - Built-in inflation - wage/price spiral Monetarists - - Quantity Theory of Money - Long run inflation = Money supply growth rate + Rate of change in Velocity of Money - Growth rate in Real Output 12 12
  13. 13. How About ‘Black Swans’ - Very Low Probability/Very High Impact? 13 13
  14. 14. The Fed says, “Take More Risk”...Should You? What is Your Risk Appetite? 14 14
  15. 15. The Fed says, “Take More Risk”...Should You? Over the long run, Process determines Results. Thus, Process becomes more important than Results. Positive Negative Result Result Good Quality Expected Bad Luck Process Bad Quality Good Luck Expected Process 15 15
  16. 16. What about Luck versus Skill? Texthttp://insurercio.com/content/how-much-ones-success-or-failure-skill-or-luck Text 16 16
  17. 17. What about Luck versus Skill? Paradox of Skill: Standard deviation of skill decreases as expertise increases, which means Luck has more to do with results And that means Difficult to rely upon historical performance More important to rely upon process Counter-intuitively, process is more important than results 17 17
  18. 18. From the London Business School... • Decisions Are More Important Than Results • Results don’t necessarily reflect a high-quality process • Ultimate criteria for good decision making is tied to: • What are we trying to achieve with this decision? (Criteria) • What can we feasibly do? (Alternatives) • What do we have to watch out for? (Consequences) • It’s not enough to measure leaders on results; How they are achieved is equally important. • Implement a good process; Manage risks - http://bsr.london.edu/lbs-article/407/index.html 18 18
  19. 19. Could we make understanding risk any more complicated? Text Text Text Text Text Text Text 19 19
  20. 20. 8 Steps to Answering: “Should You Take More Risk?” • Step 1 - What do you mean by ‘risk’? • Probability of Not Meeting a Goal • Not VaR • What Goal? • Return on Surplus, • Net Income Text Text • Spread Over Liability Text Text Text Text • PV Enterprise Value Text • Drawdown • Step 2 - Quantify Risk • Single, multi periods, 1 yr. 5 yr.? 20 20
  21. 21. 8 Steps to Answering: “Should You Take More Risk?” • Step 3 • How do different asset mixes impact risk metric Text Text Text Text Text Text Text 21 21
  22. 22. 8 Steps to Answering: “Should You Take More Risk?” • Step 4 - Implementation Issues • Strategic or Tactical Strategic Tactical Text Text Parameters Set for Entry Text Board OK Text Entry Text Text Text Execution Slowly, Over Time Active Management Parameters Set for Exit Board Decision Exit 22 22
  23. 23. 8 Steps to Answering: “Should You Take More Risk?” • Step 5 - Consider Game Theory Impact Risk Assets Rise Risk Assets Fall Increase Risk Text Bad Good Text Text Text Text Text Text Opportunity Cost/ Opportunity Gain/ Maintain Risk Gain Cost Decrease Risk Good Bad 23 23
  24. 24. 8 Steps to Answering: “Should You Take More Risk?” • Step 6 • Know your Board/Senior Management Team • Step 7 • Make a Decision - Even if it is to make no decision • Step 8 • Monitor the Impact of the Decision Text Text • Stewardship Report Text Text Text Text Text 24 24
  25. 25. What has SAA seen so far? Text Text Text Text Text Text Text 25 25
  26. 26. Goldman Sachs Insurance CIO Survey - July, 2012 Insurers expecting to increase risk: 26% Insurers expecting to decrease risk: 14% % Who Expect Asset Class to Increase % Who Expect to Allocation Asset Class Decrease AllocationHigh Yield 36 TextIG Corporates 35 Text Text TextReal Estate 34 Text Cash/Short Term 39 Text TextEmerging Market Debt 31Private Equity 27 European 24 Financial CreditBank Loans 25Mezzanine Debt 23http://www.goldmansachs.com/s/GMeT_othermailings_attachments/6347837329351787503251.pdf 26 26
  27. 27. Asset Classes - a Layer Cake of Choices Tex The Next Layer Text Text Text • Lower investmentText grade mandates for Text munis (where applicable) Text Text • Below investment grade in various guises t The Basics • Make certain all IG asset classes are included (public/ private) • Diversified equity allocation • High yield/growing dividend slant 27 27
  28. 28. Asset Classes - a Layer Cake of Choices Text •Tex The Next/Next/Next Layer Text Text • More complex Text Textstrategies using Text derivatives explicitly or implicitly t Text • The Next/Next Layer • Non-equity exposures • More illiquid asset classes • What your manager may suggest, based upon their proven expertise 28 28
  29. 29. The Risk Trap • Always ask, “Who is on the other side of the trade? And why?” • Too easy to see well groomed, credentialed person in a suit as authority figure. • It could still be snake oil. • If presenter is too confident, walk out of the room. • Investment management is a humbling activity. Text Text • Ask more questions - the “dumber” the better until... Text Text Text • You fully understand ALL aspects of the asset class Text Text • Remember: • There is NEVER a dumb question, especially in a Committee or Board setting. 29 29
  30. 30. The Risk Trap • Other Questions: • Will this play in Oldwick? • Ask for ideas from your peers, independent third parties, etc. • There is no way you are expected to know it all. Text Text Text Text Text Text Text 30 30
  31. 31. The #1 Investment Challenge in Over 30 Years 31 31
  32. 32. The #1 Investment Challenge in Over 30 Years • Low rates for longer gives us the opportunity to • Reassess our asset allocation • Shed the blinders of ‘we’ve always done it this way’ • Reassess the relationship between investments and reserves • Reassess the relationship between investments and product pricing Text Text • Take a deep breath, step back and review the overall Text Text investment process Text Text Text • Be better prepared for meeting future challenges • Improve profitability over what it might have been • Get a ‘leg up’ over competitors - succeed where others may fail • Develop a process for constantly improving your company 32 32
  33. 33. The #1 Investment Challenge in Over 30 Years Thank You More updates at: Text Text LinkedIn: www.linkedin.com/in/acogert Text Text Text Twitter: www.twitter.com/saa123 Text Text www.insurercio.com www.saai.com 33 33
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