Title Slide JUN 8 – 10, 2015 Introduction to Captive Investments.

Title Slide

JUN 8 – 10, 2015

www.bermudacaptive.bm

Introduction to Captive Investments


Speakers:• Brad Komenda, Vice President and Portfolio Manager, Pioneer Investments

• Andrew Baron, CFA, Head of Group Fixed IncomeButterfield Asset Management

• Colleen McHugh, Corporate Investment Adviser, Vice President, Barclays Wealth & Investment Management

• Robert Steinhoff, CFA, Investment Manager, Clarien Investments Limited

Moderator:• Carl Terzer, Principal, CapVisor Associates, LLC

Agenda

– Investment Plan Design

– Strategic Asset Allocation

– Tactical Plan implementation

– Monitoring, Reviewing and updating Captive Investment Programs


• Investment Plan Design– Investment Planning Elements

• Self assessment– Business objectives – Investment objectives– Risk tolerance– Regulatory requirements– Accounting considerations

• Investment Policy Statement (IPS)


Investment Objectives The Continuum

Income Maximization Total Return

Liquidity Surplus

Reserves

Insurance Portfolio Segmentation:

Liquidity, Reserves and Surplus


Insurers Others

Defining Investment Program Risk• Traditional investment measure:

– Standard deviation

• Practical investment measures– Losing money, i.e. safety of principal– Not producing a targeted level of income– Not having sufficient liquidity to pay claims

• Other insurance operational measures– Failing to preserve or attain an AM Best rating– Not growing surplus at desired rate– Underperforming competitors


Risk Tolerance

Must recognize the existence of market risks in the investment portfolio Should also make clear what the priorities are in terms of:

• Volatility (can range between “don’t care” and “Low”• Liquidity• Asset Quality• Diversification

Within this section, some mention can be given to the following other items:

• Any specified and regular liquidity needs• The Time Horizon of the investment portfolio (nearly always “long)• The existence of taxes, whether things like withholding tax should be avoided, the

Captive files as 953d, no Canadian Source Income, etc• Other unique circumstances (green, ethical, etc)


The Basics

Every Investment Policy Statement should have these building blocks:

1. Purpose Statement/Introduction/Overview

2. Portfolio Goals and Objectives

3. Definition of Duties

4. Investment Strategy and Asset Allocation

5. Liquidity and Collateral Considerations

6. Monitoring and Review Procedures

7. Investment Limitations


At a minimum, each of the relevant parties that has some responsibility for the IPS should be identified• The Board of the Captive

• Has ultimate Fiduciary responsibility for the Captive company• If there are employees of the Captive Manager on the Board of the company,

they should know and recognize that they have a fiduciary responsibility in this regard.

• Should state whether monitoring the compliance to the IPS is the responsibility of an Investment Committee or the Board

• Investment Committee• Common in Captive governance, but not required• Usually responsible for recommending investment strategies, service

providers, brokers, custodians, etc to the full Board

• Investment Managers• Investment Consultants• Custodian• Actuarial provider – may have an effect on Investment Policy


The Importance of Investment Philosophy

Items that can be covered include:

• Whether costs are important

• Whether inflation is a concern

• Whether any contrarian views are desired

• The purpose of inclusion of Alternative asset classes

• Whether Active Management is desired or if there is a belief that an active manager can add value

• Whether any tactical shifts in asset allocation are going to be employed and who is responsible for those decisions

• Whether equities should have any inherent size bias (small, medium, large-cap

• Whether equities should any kind of style tilt (Value, dividends, etc)


Step 1 - Define Allowable Asset Classes

• “Equities” and “Bonds” is not an asset allocation

• Specifically set the type of assets that are allowable, unless you want a “go anywhere” global manager

• Set a strategic allocation that makes sense in the context of the objectives of the Captive – attempt to incorporate a forward Capital Markets assumption

• Be Realistic

• Set allowable ranges for the strategic or tactical allocation – this avoids the possibility of getting over-emotional and potentially acting without an Investment Committee vote


Strategic Asset Allocation


Terminology

Strategic Asset Allocation• Intermediate to long term horizon typically 3-5 yrs. Measured in “business cycles” • Utilizes underwriting, claims, expected return projections • Incorporates customized risk and return measures

• Governed by broad tax, statutory, and company- specific guidelines• Defines range of allocations

Tactical Asset Allocation• Short to intermediate-term horizon

– Typically 3-18 months measured in weeks, months & quarter

•Utilizes actual underwriting results

•Incorporates current capital market pricing and relative valuations

•Governed by “temporary” modifications to portfolio based on market conditions

•Defines specific allocation


Strategic Asset Allocation

Determinants of long term investment results


Sources: Ibbotson and Kaplan entitled "Does Asset Allocation Policy Explain 40%, 90% or 100% of Performance?" (2000).


Risk

Re

turn

100% US Govt.

Int. Gov. Credit

Core Fixed Income

90% Core FI; 10% S&P 500

75% Core FI & 25% S&P 500

“Unoptimized” Client Portfolio

• Efficient Frontier line represents the best possible risk/reward portfolio combinations available in the marketplace

• Captives investment portfolios should lie on the efficient frontier to improve performance within the same risk reward characteristics, i.e. increasing return at the same risk level (up arrow) or reducing portfolio risk for the same return (left arrow)

Captive Portfolio Optimization using Efficient Frontier Analysis

Risk and Reward

http://us.fotolia.com/id/589502

10 year Asset Class Correlation Matrix


Strategic Asset Classes (lower correlation)

• US bonds

• High Yield bonds

• Convertible bonds

• US equities

• International equities

• Emerging market bonds/equities

• Commodities, REITs, MPLS

• Hedge Funds

• Private equity, mezzanine debt


Tactical Plan Implementation


Tactical Asset Classes

Fixed Income (Bonds)

• Treasuries

• Corporate Bonds

• Asset Backed Securities

• Mortgage backed securities

• Municipals, etc.

• High Yield

Equities (Stocks)

• Large Cap

• Mid Cap

• Small Cap

• Growth vs Value

• Country/industry


Security Level Risks- Bonds

• Credit– Downgrade– Default

• Interest rate (Duration)

• Liquidity

• Inflation

• Prepayment

• Reinvestment

• Convexity

• Currency


Bond Market Mechanics Interest Rates and Prices


Interest Rates

Bond Prices

Interest Rates Bond

Prices


Duration

Defined: a measurement of the portfolio’s sensitivity to interest rate changes that approximates the % change in portfolio market value for a given % rate change

Portfolio Duration = 3.5 years

Duration

Interest Rate Changes Portfolio Market Value Changes

1%

1% 3.5%

3.5%


Investment Manager Style Risks

Equities- price volatility

Tactical

•capitalization

• liquidity

• sector

Strategic

• geographic

• political

• geographic

Bonds–income volatility• Duration• Yield curve • Sector• Security


Bond Manager’s Style Risks

Probability of Success

Potential Reward

Strategy ToolboxDuration Yield Curve Sector Rotation SecurityManagement Selection


– Philosophy• “Total Return” or “Yield

Maximization”• Active, passive or blended

management

– Process• Top down or bottom up• Alpha attribution: duration, yield

curve, sector, security selection• Style analysis • Tax efficiency

– Performance• MPT Statistical assessment

(Risk-adjusted return analysis)• After-tax performance• Adherence to guidelines• Universe comparison

– Personnel• Insurance asset management

experience • Insurance regulatory, tax and

accounting expertise • Insurance Accounting and

reporting capabilities

– Client-specific criteria • Execution of policy objective &

adherence to guidelines and regulations

• Fees/Value for service• Portfolio tax liability

management• Client service and other

administrative responsibilities• Accounting & Reporting

efficacy• Overall relationship efficiency

Manager Selection Criterion


QUARTILE RANKING BAR

PSN LARGE CAP CORE

PERIODS ENDING DECEMBER 31, 2014

0

5

10

15

20

25

30R

AT

E O

F R

ET

UR

N

1 Year 3 Years 5 Years 10 Years

HIGH (0.05) 17.62 23.80 18.28 10.32

FIRST QUARTILE 14.84 21.53 16.27 8.99

MEDIAN 13.40 20.56 15.51 8.43

THIRD QUARTILE 11.66 19.07 14.55 7.89

LOW (0.95) 7.73 15.66 11.95 6.49

MEAN 13.22 20.26 15.37 8.44

VALID COUNT 303 290 279 226

Manager A

Manager B

Manager C

Standard & Poor's 500

1 Year 3 Years 5 Years 10 Years

VALUE RANK VALUE RANK VALUE RANK VALUE RANK

13.69 43 20.69 45 14.18 81 9.57 7

16.34 7 20.96 36 16.41 20 8.99 24

9.97 92 19.10 74 13.01 95 8.99 25

13.69 43 20.41 53 15.45 53 7.67 86

Rolling Period Nominal Returns


MULTI-STATISTIC QUARTILE RANKING BARPSN LARGE CAP CORE

DECEMBER 31, 2011 TO DECEMBER 31, 2014

14

15

16

17

18

19

20

21

22

23

24

25

-6

-5

-4

-3

-2

-1

0

1

2

3

4

5

6 7.0

8.0

9.0

10.0

11.0

-0.2

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

-1.5

-0.5

0.5

1.5

HIGH (0.95)

FIRST QUART

MEDIAN

THIRD QUART

LOW (0.05)

MEAN

VALID COUNT

ROR

23.80

21.53

20.56

19.07

15.66

20.26

290

Alpha

4.29

0.94

0.08

-1.18

-4.54

-0.16

290

Std Dev Pop

7.37

8.85

9.38

10.00

11.34

9.37

290

Batting Avg

0.75

0.58

0.50

0.42

0.25

0.51

290

Info Ratio Pop

1.81

0.56

0.07

-0.56

-1.46

0.06

290

Manager A

Manager B

Manager C

Standard & Poor's 500

VALUE RANK

20.69 45

20.96 36

19.10 74

20.41 53

VALUE RANK

1.65 13

0.23 45

-2.68 90

0.00 53

VALUE RANK

8.97 32

9.25 46

10.77 94

8.94 30

VALUE RANK

0.67 10

0.50 41

0.50 41

0.00 99

VALUE RANK

0.08 49

0.30 38

-0.28 64

0.00 53

Nominal Vs. Risk-Adjusted Returns

Monitoring, Reviewing and Updating Captive Investment Programs



Annual Program Review

• Incorporate changes in: – Operating conditions- underwriting, claims,

premiums, reinsurance, fronting, etc.– Risk tolerance or investment objectives– Captive growth expectations, etc.

• Review and modify planning documentation– IPS/guideline or asset allocation changes– Rebalancing rules– Benchmarks, etc.

• Evaluation of manager performance

• Evaluation of overall program efficacy


Evolving Strategic Asset Allocation

30

Equities10%

Cash5%

Investment Grade Bonds85%

Bonds50%

Equities25%

High Yield10%

Cash5%

Alt. Investments10%

Mature Captive

Advanced Captive

New/Small Captive

Cash25%

Investment Grade Bonds75%

Title Slide JUN 8 – 10, 2015 Introduction to Captive Investments.

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Transcript of Title Slide JUN 8 – 10, 2015 Introduction to Captive Investments.