Delaware Captive Insurance Association 2016 Fall Forum

Transcription

1 Delaware Captive Insurance Association 2016 Fall Forum Investment Considerations During Periods of Economic Uncertainty David Kilborn, CFA Chief Investment Officer Performa Limited (US), LLC (843) Patrick Theriault, CPA, CPCU, AIAF Managing Director Strategic Risk Solutions (802)

2 Agenda 1) Developing a Successful Investment Program 2) Demographics and Benchmarking 3) Case Studies 4) Market Update & Outlook 5) Q&A 2

3 Developing a Successful Investment Program 3

4 How Captive Manager & Investment Manager Work Together Captive Manager Captive Manager dual role: Captive Financial Controller + Regulatory Oversight Typically has direct contact with Captive Board and Officers: ability to make recommendations Positioned to share with client what captive peers are doing Primary contact for other service providers including investment manager Cash/liquidity tracking Aware of potential impact on operation or regulation of certain investment types works best when having regular communications with investment manager Investment Manager Partnership approach with captive owners, captive managers and service providers Offer customized solutions tailored to unique needs of each captive Investment policy statement development and ongoing review Discretionary management of investment portfolios Portfolio design, development and execution Comprehensive client reporting 4

5 Key to Success Plan Ahead Prepare investment plan at the time of captive approval Develop a thorough and appropriate investment strategy that is tailored to each captive Recognize that your captive has different investment objectives than mainline insurers, individuals and even your parent company s pools of assets Be aware of multiple layers of fees, lower liquidity (small position sizes) and unnecessary over diversification Put your money to work: holding cash over and above daily operational or known liquidity needs has two distinct costs: 1) no income generation 2) value erosion from inflation 5

6 Nominal Dollars (US$) What Happens When You Don t Have a Plan? loss of potential income Holding $1,000 in cash for 30 years means you start and end with $1,000 (dark blue bar): Breaking down $1,000 invested at 3% over 30 years $2,500 Principal Coupon Interest-on-Interest $2,105 $2, no income generation i.e. no coupon payments (green bar) - also means no compound interest (light blue) $2,000 $1,500 $1,000 $1,030 $1,161 $1,347 $1,563 $1,814 However, investing $1,000 at 3% over 30 years could earn $900 in coupon payments + $543 in Interest-on-Interest for a total of $2,443 (vs $1,000 if your money sat in cash) $500 $ Years 1 Example assumes $1,000 is invested at a fixed rate of 3% over 30 years. Source: Performa Limited (US) 6

7 Dollars (US$) Beware of the Inflation Trap Cost of Cash Holding cash might protect nominal value (black line), but sitting in cash means losing real value (blue line) $1,000 $975 $950 Value of $1,000 Investment in Cash Adjusted for Inflation (using CPI 1 ) Over time, inflation erodes purchasing power $925 $900 Example Holding $1,000 in cash since 2005 would result in a value of roughly $800 in 2015, adjusted for inflation $875 $850 $825 $800 $802 Dec-04 Nov-06 Oct-08 Sep-10 Aug-12 Jul-14 Jun-16 Years Source: Bloomberg, Performa Limited (US) 1 US CPI (Consumer Price Index) Urban Consumers Less Food and Energy (Seasonally Adjusted) 7

8 Building an Investment Program Recommendations should incorporate both Client Variables Capital (i.e., current, target, surplus) Risk tolerance & liquidity needs Stage of the captive life cycle Ownership structure Claims history Domicile Portfolio Variables Portfolio diversification Opinion of asset classes Review of strategy cost effectiveness Performance analysis (past and future) Portfolio Construction Investment Policy & Guidelines Forecasting: Market trends and interest rates Asset Allocation Modeling Client Structure Built for Current Stage of the Life Cycle Risk Tolerance Liabilities Objectives 8

9 Asset Allocation through a Captive s Life Cycle 9

10 Demographics and Benchmarking 10

11 Profile of SRS Captives 11

12 Profile of SRS Captives Number of Captives by Size Average Assets by Captive Size 1% 3% 14% 6% 10% 14% 42% 61% 19% 7% 20% 3% Less than $5M Between $5M to $15M Between $15M to $25M Between $25M to $50M Between $50M to $75M Greater than $75M 12

13 Asset Allocation By Captive Size 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Average Asset Allocation by Captive Size LESS THAN $5M $5M TO $15M $15M TO $25M $25M TO $50M $50M TO $75M GREATER THAN $75M Fixed Income Equity Alternative Assets Money Markets Cash Average of Investment Return % 7% 6% 5% 4% 3% 2% 1% 0% 13

14 Cash Breakdown By Captive Size 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Average Cash Breakdown by Captive Size Class LESS THAN $5M $5M TO $15M $15M TO $25M $25M TO $50M $50M TO $75M GREATER THAN $75M Unrestricted Cash Restricted Held in Trust Average of Investment Return % 7% 6% 5% 4% 3% 2% 1% 0% 14

15 Asset Allocation By Ownership Type 15

16 Case Studies 16

17 Case Study #1 Background Onshore single parent captive formed in 2002 providing E&O liability coverage Very conservative owner and management focused on preservation of capital to achieve fully insured status Annual Premium roughly $1million providing excess coverage only Great claims experience, current investable assets = $13.3 million Only started investing liquid funds in late 2013, Bond Mutual Fund, currently about 23% of total investable assets Handle all investment decisions internally / No outside manager The Good Achieved goal of fully funded status Avoided crash of 2008 Minimal investment expenses The Potential Misses Investment Committee duties are secondary responsibilities = slow response Minimal to negative cash rate of return 17

18 Millions ($) Percent Return (%) Case Study #1 $14 $12 $10 $8 $6 $4 $2 $0 Investable Assets vs. Return % 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Investable Assets Investment Return $400,000 $350,000 $300,000 $250,000 $200,000 $150,000 $100,000 $50,000 $0 Investment Income Opportunity cost compared to 2% annual return = $685,000 Opportunity cost compared to 2.5% annual return = $1,225,000 18

19 Case Study #2 Background Onshore Reciprocal formed in 2004 providing Medical Malpractice coverage in 6 states Annual Premium roughly $13 Million / Current investable assets = $50 Million Investment mix as of 6/30/16 Cash: 9% / Bonds: 82% / Equities: 3% / MPLs: 2% / Private Investments: 3% One primary third party manager Extremely active Investment Committee, weekly meetings The Good Detailed investment policy with conservative industry target returns Regular investment policy reviews and Board reporting allowing the company to be responsive to market fluctuations Expansion of investment policy has allowed for stabilization of overall returns The Potential Misses Mix results with portfolio pocket money and market timing activities Too much input from Investment Committee members at times? Manager does not have oversight of all assets Client was not familiar with side effects of alternative investments 19

20 Market Update & Outlook 20

21 Market Update & Outlook After seven years of easing, the U.S. Federal Reserve finally increased short-term rates from 0% in December 2015 How do the following affect Captive Insurance portfolios going forward? The path of Fed policy and overall interest rates? The state of the U.S. economy: growth, employment, inflation? Current financial market conditions? How should Captive Insurers be best positioned? 21

22 Yield 2015 The Year The Fed Finally Moved 3.0% 2.5% 2.0% U.S. Treasury Curve Comparison 12/31/2015 6/30/2016 8/31/2016 Beware the front-end, safety can be a trap While rates drifted higher across the curve since June % 1.0% 0.5% 0.0% 1M1Y2Y3Y 5Y 7Y 10Y 30Y Maturity Source: Bloomberg, Performa Limited (US) front-end has been hit hardest Is this time for real? The Fed is sending signals 22

23 Feb-09 Jun-09 Oct-09 Feb-10 Jun-10 Oct-10 Feb-11 Jun-11 Oct-11 Feb-12 Jun-12 Oct-12 Feb-13 Jun-13 Oct-13 Feb-14 Jun-14 Oct-14 Feb-15 Jun-15 Oct-15 Feb-16 Jun-16 sa, YoY% Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 sa, thousands sa, thousands Improving Economy Nonfarm Payrolls and Initial Jobless Claims Change in NonFarm U.S. economy continues to lead the global recovery, supported by an improving labor market Source: BLS, DOL, Performa Limited (US) Less people getting fired & new jobs created are steady at around 190k/month 5% 4% 3% 2% 1% 0% -1% -2% -3% U.S. Real Average Hourly Earnings Recession Previously, many pointed to lack of growing wages but look out! After years of little growth, improvements are kicking in Source: BLS, Performa Limited (US) 23

24 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Oil Price Inflation rate Apr-04 Nov-04 Jun-05 Jan-06 Aug-06 Mar-07 Oct-07 May-08 Dec-08 Jul-09 Feb-10 Sep-10 Apr-11 Nov-11 Jun-12 Jan-13 Aug-13 Mar-14 Oct-14 May-15 Dec-15 Jul-16 Index Improving Economy The U.S. Dollar Index Recession Source: Bloomberg, Performa Limited (US) U.S. Personal Consumption Expenditure and Oil Oil (LHS) Headline (RHS) Core (RHS) Inflation Target (RHS) 3% Source: BEA, Bloomberg, Performa Limited (US) 2% 1% 0% -1% -2% After staging a dramatic rally, the U.S. dollar has stalled and is looking to the Fed for its next cue (it s a delicate balance) A strong dollar is great for shoppers, but hurts American multinationals while weighing on exports Oil prices (black line) have seen a bottom (for now) and that feeds into boosting headline inflation numbers While inflation is still below the Fed s 2% target, it is trending higher (blue line for headline and green line for core) 24

25 Dec-15 Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Cats and Dogs Sleeping Together. Risk Assets have recovered from the early year swoon, yet Treasury yields (green line) remain well below where they started the year S&P Year Treasury Yield High Yield Bond Index Commodities Index Since when do stock prices and bond prices move in tandem? Isn t there an inverse relationship? 25

26 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 Apr-13 Jul-13 Oct-13 Jan-14 Apr-14 Jul-14 Oct-14 Feb-15 May-15 Aug-15 Nov-15 Feb-16 May-16 Aug-16 P/E Ratio Dividend Yield Value or Growth Stocks for Captives? S&P 500 Value index is CHEAPER - lower P/E ratio - than the S&P 500 Growth Index and has a HIGHER dividend yield % % % 2.20% 1.80% 1.40% % S&P 500 Growth P/E S&P 500 Value P/E S&P 500 Growth Dividend Yield S&P 500 Value Dividend Yield Source: Bloomberg, BofA Merrill Lynch, Performa Limited (US) 26

27 Primary Dealer Positions ($Bln) Investment Grade Corporate Market Value ($Bln) Vanishing Bond Market Liquidity Many factors determine market liquidity, but these changes are clear: Banks have to hold more capital Banks had to eliminate Proprietary Trading Corporate bond issuance has increased dramatically over the past few years Positioning Fixed Income portfolios must be done prior to any stampede $50 $45 $5,000 $40 $35 $4,500 $30 $25 $4,000 $20 $15 $3,500 $10 $5 $3,000 Apr-13 Aug-13 Dec-13 Apr-14 Aug-14 Dec-14 Apr-15 Aug-15 Dec-15 Apr-16 Aug-16 Primary Dealer Positions - Net Outright Total Corporates ($Bln) Investment Grade Corporate Market Value ($Bln) Source: Bloomberg, BofA Merrill Lynch, Performa Limited (US) 27

28 Key Macro Themes Global Monetary Policy November Election China and Commodity Prices Money Market Reform Brexit Fallout 28

29 Final Thoughts Summary Rising short-term interest rates pose a significant risk to bond portfolios US economy is improving & continues to lead other countries After selling off in early 2016, risk assets rebounded in March and April, sold off post-brexit and rallied again Large-cap value stocks are cheaper than growth - providing more cash flow for every dollar invested and greater cushion if markets stall or correct Implications for Captives Keep interest rate risk at the lower end of the range Be wary of too much risk in less liquid sectors Favor value over growth stocks Active portfolio management and diversification is more important than ever 29

30 Q&A 30