May 2015 SA Insurance Conference Optimal asset allocation under SAM
May 2015
SA Insurance Conference Optimal asset allocation under SAM
Agenda
1. Investment challenges faced by SA insurers
2. Balance sheet management considerations
3. SAM as an economic capital framework
4. Deep diving into credit
5. Illustrative SAM efficient frontier
6. Concluding remarks
Investment challenges faced by SA insurers � Managing balance sheet volatility as a result of investment risk
� Economic and regulatory capital efficiency
� Interest rate and inflation protection
� Yield enhancement
� Managing liquidity
� Stringent reporting requirements under SAM
� Governance and resources to manage investment risks with a holistic balance sheet management mind set
Challenges we are aware of
Overarching Challenge
Investment strategy considerations
Expe
cted
re
turn
Economic risk
Expe
cted
re
turn
Economic risk
Liability matching
70%
Return seeking
30% Liability
matching 0%
Return seeking
100% Asset
allocation
Risk budgeting
Traditional approach BSM approach
SAM places emphasis on efficient capital management of investment portfolios
Additional challenges faced by SA insurers • SAM Standard formula approach: “One size fits all”?
• Scale of business and resources required to implement efficient balance sheet management?
The ‘elephant in the room’…
How important is this in the SA context? SAM QIS3 findings – attribution of Market Risk SCR
Life insurers Non-life insurers
FSB QIS3 results Source X
28%
100% 67% 4%
11% 14% 10% 2% 35%
14%
100%
61% 1% 10%
26% 20% 33%
A multi-disciplinary investment team and a core focus in the management of credit-backed portable alpha strategies
Asset class comparison
0%
10%
20%
30%
40%
50%
60%
70%
Mar
ket R
isk
SCR
Market Risk SCR per Asset Class (excluding diversification benefit) 0.7% 1.6% 4.0% 1.6% 4.5% 4.5% 5.0% 6.0% 6.3% Return above cash
100% SA Equities
30% SA Equities, 70% Money Market
100% Money Market
0%
1%
2%
3%
4%
5%
6%
0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%
Expe
cted
Ret
urn
abov
e ca
sh
SCR
Traditional asset allocation
100% SA Equities
30% SA Equities, 70% Money Market
100% Money Market
10% SA Equities, 32% IG Credit, 28% HY Credit, 30%
Money Market
10% SA Equities, 49% IG Credit, 11% HY Credit, 30%
Money Market
0%
1%
2%
3%
4%
5%
6%
0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%
Expe
cted
Ret
urn
abov
e ca
sh
SCR
Optimised asset allocation
Addition of credit has improved insurers investment return per unit of capital
Mezzanine debt
Preferred equity
Common equity
Senior unsecured debt (including bonds)
Senior secured debt (including loans)
Highest recovery rate and security
Lowest recovery rate and security
Corporate capital structure SAM QIS 3
Capital charge
~15-43%
~15-43%
~43-50%
5-25%
5-25%
SAM perspective on investing across the capital structure
Consider seniority, security and diversity of credit relative to equity exposure
4% 5% 6% 5% 12% 5% 4% 4% 11% 11% 4% 6% 7% 7%
32%
7% 6% 3%
42%
25%
0% 9% 11% 0%
14%
12% 1%
0%
32%
3%
0
5
10
15
20
25
30
35
40
45
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
SOE (Govtguarantee)
(Mod Duration6)
SOE Bonds(non govt
guarantee)(Mod Duration
4)
Muni Bonds(Mod Duration
4)
Big 4 Banks(Mod Duration
3)
Banks (ex Big4) (Mod
Duration 2)
FinancialServices (Mod
Duration 2)
IG Corp Bonds(Mod Duration
2)
IG Corp Loans(Mod Duration
3)
HY Corp Bonds(Mod Duration
1)
HY Corp Loans(Mod Duration
4)
Num
ber o
f Iss
uers
in S
ecto
r
Cred
it Ri
sk S
CR (S
prea
d +
Defa
ult +
Con
cent
ratio
n)
Spread Risk Default Risk Concentration Risk Number of Issuers
Deep diving into credit Source of credit SCR per credit sector
Return above cash 77 118 194 137 295 149 159 162 400 450
* IG and HY Corporate loans proxied by Ashburton SACCIF
Deep diving into credit Impact of diversification on credit risk SCR
0%
10%
20%
30%
40%
50%
60%
70%
80%
1 2 3 4 5 6 7 8 9 10 11 12
Cred
it Ri
sk S
CR
Number of Investments
Effect of Diversification on Components of Credit Risk SCR of A-Rated Investments (5-year Maturity, Senior Unsecured)
Total
Spread Risk SCR
Default Risk SCR
Concentration Risk SCR
A multi-disciplinary investment team and a core focus in the management of credit-backed portable alpha strategies
Deep diving into credit
0%
10%
20%
30%
40%
50%
60%
70%
1 2 3 4 5 6 7 8 9 10 11 12
Cred
it Ri
sk S
CR (C
once
ntra
tion)
Number of investments
Effect of Diversification on Concentration Risk SCR (5-year Maturity, Senior Unsecured)
AAA/AA
A/BBB
BB/B
CCC/UR
0%
5%
10%
15%
20%
25%
30%
35%
40%
1 2 3 5 10 20
Cred
it Ri
sk S
CR (S
prea
d)
Maturity of Investment
Effect of Maturity of Investment on Spread Risk (Senior Unsecured, 10 Name Portfolio)
AAA
AA
A
BBB
BB
B
CCC
UR
Deep diving into credit Credit risk SCR vs. maturity
Deep diving into credit
0
50
100
150
200
250
300
350
400
450
500
0.00% 5.00% 10.00% 15.00% 20.00% 25.00%
Spre
ad a
bove
cas
h
Credit Risk SCR
SA Credit Co-Investment Fund
IG Secured
IG Unsecured
IG CCIF
Portfolio impact of diversification, ratings, security and maturity
Our belief on asset allocation for insurers
IG Credit [Govi + 0.5 -1.5% p.a.]
SOE [Govt + 0.25 - 1% p.a.]
Risk
Expe
cted
exc
ess
retu
rn o
ver g
over
nmen
t bon
ds
Government bonds 7-8% p.a.
How insurers allocate today Equities, property, commodities [Govi + 4 – 7% p.a.]
Sub-IG Credit [Govi + 3 – 5% p.a.]
Index tracking
Alternatives
Risk
How insurers will allocate
Government bonds 7-8% p.a.
Expe
cted
exc
ess
retu
rn o
ver g
over
nmen
t bon
ds Equities, property, commodities
[Govi + 4 – 7% p.a.] Sub-IG Credit
[Govi + 3 – 5% p.a.]
IG Credit [Govi + 0.5 -1.5% p.a.]
SOE [Govi + 0.25 – 1% p.a.]
Index tracking
Alternatives
SA Equity
Global Equity
Other Equity
IG Credit (unlisted)
HY Credit (unlisted)
Banks (ex Big 4)
Financial Services
IG Corporate
HY Corporate
Non Gov Guaranteed SOE
Municipality
Big 4 Banks
Property
Money Market
-1%
0%
1%
2%
3%
4%
5%
6%
7%
0% 10% 20% 30% 40% 50% 60% 70%
Expe
cted
retu
rn a
bove
cas
h
Market Risk SCR
Illustrative SAM efficient frontier
A multi-disciplinary investment team and a core focus in the management of credit-backed portable alpha strategies
Concluding remarks
1. SCR as per SAM can be a useful proxy for an economic capital measure
2. Balance sheet management mindset for investment management important in a SAM context
3. Credit is an efficient asset class to use within an insurers asset allocation
4. Diversification across seniority, security and number of exposures are crucial
5. Financial risk mitigation techniques may be useful for more capital efficient exposure to growth assets