Insurance Company Investment Trends A Client Survey Marco Bravo, CFA Principal, Senior Portfolio Manager AAM - Insurance Investment Management
Summary of Survey Respondents Company Type Portfolio Size Health 2% Multi- Line 2% Other 2% Life 21% Less than $100M $100M - $500M 48 Total Respondents $500M - $1B P&C 73% $1B - $5B 0% 10% 20% 30% 40% 50% 60% 2
Who is responsible for management of the investment portfolio? External Asset Manager 60% Managed Internally 13% Combination Internal & External 27% 3
Companies considering outsourcing investment management? Yes 6% No 29% N/A - Already Outsourced 65% 4
What s Important When Considering Outsourcing Investment Management? Expertise / Ideas 68% Limited Time / Resources 20% Risk Management Tools 7% Cost Efficiency 5% 5
Investment management services should go beyond just portfolio management Asset Allocation / Risk Asset Analysis Dynamic Financial Analysis Investment Policy Construction / Review Investment Income Projections Tax Modeling ALM / Duration Targeting Cash Flow Testing Performance Benchmarking & Attribution Liquidity Analysis Peer Analysis Rating Agency Support RBC / BCAR Sensitivity Analysis Investment Accounting Accounting Support Portfolio Acquisition Due Diligence 6
Which investment objective is most important? Maximize Total Return 10% 23% P&C Life Maximize Income 6% 20% Preservation of Capital 71% 70% Provide Liquidity 0% 0% 7
Ranking of Investment Objectives 0% 20% 40% 60% 80% 100% Most Important Least Important Maximize Total Return Provide Liquidity Maximize Income Preservation of Capital 8
Which investment risk is most important? Credit 68% 80% Duration 20% 24% Other 0% 9% P&C Life 9
Ranking of Portfolio Risks 0% 50% 100% Most Important Credit Risk Duration Yield Curve Call Risk Liquidity Mark to Market Foreign Exchange Least Important 10
Industry credit trends exposure to below investment grade bonds. 7% P&C Industry 60% Life Industry 6% 50% 5% 40% 4% 3% 30% 2% 20% 1% 10% 0% 2010 2011 2012 2013 2014 0% 2010 2011 2012 2013 2014 % of Total Bonds % of Surplus % of Total Bonds % of Surplus Source: SNL 11
Credit risk considerations. Cumulative Default Rate (%) 60 50 40 30 20 10 0 Cumulative Default Rates (1983-2014) 5yr 10yr 15yr AA A BBB BB B Default rates do not increase linearly as rating is decreased. Set portfolio concentration limits that take into account default and recovery rates. Consider surplus exposure if Assets to Surplus leverage is high. Source: Moody s Annual Default Study (Mar 2015) 12
Industry duration trends exposure to 10+ year bond maturity. 20% P&C Industry 40% Life Industry 18% 16% 14% 35% 30% 12% 25% 10% 20% 8% 6% 4% 15% 10% 2% 5% 0% 2010 2011 2012 2013 2014 0% 2010 2011 2012 2013 2014 10yr - 20yr > 20yr 10yr -20yr >20yr Source: SNL 13
Duration risk considerations. Surplus volatility Liquidity needs ALM considerations Asset Leverage Income needs Formula: D S = (D A -D L ) x (A/S) + D L D = Duration L = Liabilities A = Assets S = Surplus To immunize surplus from interest rate risk, set D S = 0 Then Asset Duration = D L x (L/A) To set specific level of surplus interest risk, D A = (D S -D L ) x (S/A) + D L 14
Which macro-economic risk are you most concerned with? Monetary Policy 37% Inflation 30% Slowing Global Growth 20% Deflation 11% Oil Prices 2% 15
Which investment risk are you most concerned with? Low Yields 58% Rising Rates 23% Equity Volatility 13% Increase in Credit Defaults 4% Credit Spread Widening 2% 16
Worrisome trend in corporate market as credit metrics are weakening. 1.40 Use of Cash from Operations for A/better 1.60 Use of Cash from Operations for BBBs 1.20 1.40 1.00 0.80 0.60 0.40 0.20 1.20 1.00 0.80 0.60 0.40 0.20-12/1/2004 7/1/2005 2/1/2006 9/1/2006 4/1/2007 11/1/2007 6/1/2008 1/1/2009 8/1/2009 3/1/2010 10/1/2010 5/1/2011 12/1/2011 7/1/2012 2/1/2013 9/1/2013 4/1/2014 11/1/2014 Capital Expenditures M&A Dividends Net Share repurchases - 12/1/2004 7/1/2005 2/1/2006 9/1/2006 4/1/2007 11/1/2007 6/1/2008 1/1/2009 8/1/2009 3/1/2010 10/1/2010 5/1/2011 12/1/2011 7/1/2012 2/1/2013 9/1/2013 4/1/2014 11/1/2014 Capital Expenditures M&A Dividends Net Share repurchases Source: AAM, Capital IQ (Universe includes 451Industrial companies; Financial data as of 3/31/2015 17
Worrisome trend in corporate market as credit metrics are weakening. Source: AAM, Capital IQ (Universe includes 451Industrial companies; Financial data as of 3/31/2015 18
Corporate sector expectations. PROS: Consumer is in a better position to spend Job market is improving Global demand for yield with limited alternatives CONS: AAM s view of US HG Source: JPM Where We Are In The Credit Cycle 10/14/2014 Liquidity is challenging in fixed income Fed action should slow (already nonexistent) credit growth Event risk remains high with debt funded deals increasing Late stage of the credit cycle; Companies acting more aggressively In this stage of the cycle, focus on liquidity and quality 19
How do current investment opportunities compare to a year ago? The Same 64% Better 13% Worse 23% 20
Which risks are you currently willing to increase to achieve a higher yield/return? None 42% Credit 27% Duration 13% Liquidity 9% Market 9% 21
Risk premiums appear fair. OAS (bps) 1200 1000 800 600 400 200 0 BBB Industrial - A Industrial High Yield (ex Energy) - BBB Industrial Source: Barclays 22
Which non core fixed income asset class have you been adding (or considering adding)? 40% 35% 30% 25% 20% 15% 10% 5% 0% Equity Commercial Loans High Yield Convertibles MLPs EM Debt EM Equity Other 23
Equity valuations appear fully valued. Ratio 3.0 2.8 2.6 2.4 2.2 2.0 1.8 5/20/2011 5/20/2012 5/20/2013 5/20/2014 20 19 18 17 16 15 14 13 12 11 10 Ratio S&P500 Price to Book (LHS) S&P500 Price to Earnings Estimates (RHS) S&P500 Price to Earnings (RHS) Source: Bloomberg 24
U.S. New Issue Supply ($Bln) Consider Convertibles as an alternative to equities. Convertible issuance has picked up 120 100 80 60 40 20 0 61 106 55 88 49 39 71 95 59 38 37 Annualized New Issue 23 21 44 44 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 YTD Source: Zazove Associates, LLC, BAML Global Convertibles Research Why consider convertibles? Equity market exposure Downside protection Low correlation to traditional fixed income Low interest rate sensitivity Historically good performance in rising rate environments Favorable regulatory and accounting treatment 25
Industry trends regarding alternative assets. 60% Alternative Assets as % of Surplus 50% 40% 30% 20% 10% Understand the risks Model the tail risks Liquidity could be challenging in a higher volatility environment 0% 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Common Stocks Other Investments High Yield Bonds Preferred Stocks Real Estate Mortgage Loans Source: SNL 26
Questions? 27