Alton R. Cogert, CFA, CPA, CAIA, CGMA

President and Chief Executive Officer

June 25, 2012

NAMIC Management

Conference:

Investment Perspectives

Part I

Investment Policy and Strategy

Investment Process Value

Chain

Investment Policy &

Guidelines

Strategic Asset

Allocation

Peer Group Analysis

Investment Manager

Evaluation & Selection

Portfolio Monitoring

Performance Measurement

& Analysis

Strong investment results

require a strong investment

process. This goes beyond

choosing the right investment

manager.

2

Review of Investment Policy and Guidelines

Key components of „Best Practices‟ Investment Policy:

Preamble – Who? What? Roles and Responsibilities

Investment Return and Management Objectives

Asset Allocation and Risk Management Guidelines

Investment Performance and Reporting

Investment Policy and Guidelines Evaluation

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Question #1

How often does your company review and approve the investment policy?

A. Less Than Annually

B. Annually

C. Every Two Years

D. As Needed

E. Other

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Strategic Asset Allocation

How to approach Strategic Asset Allocation:

Start with the company‟s goals and objectives

Understand the company‟s lines of business

Understand the Board‟s and senior management‟s risk appetite

Don‟t be fooled by fancy models, and never use historical stats without

skepticism; common sense is the final arbiter

Over 90% of investment returns are determined by asset allocation

Core fixed income versus „risky bucket‟

Components of the „risky bucket‟

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Question #2

How did your company primarily determine its strategic asset allocation?

A. Efficient Frontier Model

B. “Matching” to the Duration of Liabilities

C. Stress Testing

D. Comparison with Peers

E. Some of the above

F. All of the above

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Efficient Frontier Approach: Common but Flawed

210% of Surplus (Net Assets) allocated to risk assets

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Case Study ( Early 2008)

Asset Class% of

Portfolio

Expected

Return

Expected

Volatility

Investment Grade Core Fixed Income 69% 4.50% 3.75% 1.00

Risk Assets (US Equity, International Equity, High Yield) 32% 7.50% 16.50% 0.15 1.00

Ratio of Risk Asset Metric to Core FI 166.7% 440.0%

Net Assets as % of Total Portfolio 15%

Risk Assets as % of Net Assets 210% 7.50% 16.50%

Core Fixed Income as % of Net Assets 0% 4.50% 3.75%

Total Portfolio 5.45% 6.13%

Net Asset Portfolio 15.75% 34.65%

Correlation

Impact of Change in Risk Assets on Surplus

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Max Loss = 13%

Max Loss = 33%

Max Loss = 52%

Max Loss = 62%

2.5x 4.8x

4.0x

Downside exposure is measured by:

1. The magnitude of the downside movement;

2. The frequency of downside movement; and

3. The duration of downside movement.

Question #3

What is your company using for its fixed income investment benchmark?

A. A major generic index (e.g. Barclays‟ Aggregate Index)

B. Customized from parts of the generic index

C. Required (or budgeted) minimum book yield

D. Required (or budgeted) investment income

E. Other

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Review of Investment Benchmarks

SAA Philosophy

Core fixed income: Over time, 96%+ of total return comes from yield. Thus,

the manager is biased in choosing a benchmark with a heavier allocation of

low yielding US Treasuries.

Your benchmark should reflect your risk tolerance, but still be tilted toward

higher yielding “spread” products that produce better risk-adjusted returns

over time.

Benchmarks must be investable, measurable and provide a „high hurdle.‟

Most managers will stay close to benchmark because they do not want to be

fired.

Benchmark must be tied to strategic asset allocation.

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Review of Investment Benchmarks

Investment Manager Evaluation Process

Evaluating Managers

Investment grade fixed income: Unless they are taking risks well outside the

benchmark, it is very difficult for a manager to consistently add value, after

fees and taxes.

Equities: The more “efficient” the market, the more difficult it is for active

management to consistently add value, after fees and taxes.

Thus, it is always important to consider constraints under which the manager

has operated

Managers change (style, people, etc.) and sometimes they even tell you in

advance…

For insurer investment grade fixed income, managers are usually terminated

for non-performance, qualitative reasons.

Fees for managing insurance core fixed income are substantially lower than

other institutional assets.

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Question #4

When was the last time you formally evaluated your investment

manager(s)?

A. Within the Past Year

B. Within the Past Three Years

C. Within the Past Five Years

D. Longer than Five Years

E. No Formal Evaluation Conducted

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7 Steps to a Successful Investment Manager Search

How to Approach a Manager Search

Have a very specific time line and plan

Know the current state of the market

Understand trends in manager fees

Use a specialized database for best results

7 Steps to a Successful Investment Manager Search

1. Determine the company‟s initial preferences. Set criteria for search.

2. Screen for initial list of managers (company may include/exclude)

3. Develop and transmit a confidential company specific questionnaire

4. Recommend a final set of managers. Transmit refined questionnaire, as

necessary.

5. Schedule and attend finals presentation, assisting in final selection.

6. Schedule and attend manager due diligence visits, as necessary.

7. Negotiate acceptable fees. Establish service standards, including specific

manager expectations.

Question #5

When was the last time you conducted a fixed income investment manager

search?

A. Within the Past Year

B. Within the Past Three Years

C. Within the Past Five Years

D. Within the Past Ten Years

E. Longer than Ten Years

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Performance Measurement and Compliance Reporting

What is important about measuring performance and

compliance…

Determine what is more important and why: Total Return (Economic Value)

versus Yield (Investment Income)

Performance must be net of fees and, where applicable, after tax

Performance must be risk adjusted

Don‟t stop with judging just one manager, look at the entire portfolio

Understand the „whys‟ behind performance

Compliance is more than a comparison to limits

Determine if you got what you paid for: Was manager‟s actual investment

style expected?

Manager must be actively updating your company on potential problems and

issues. They must act like they are just „down the hall‟.

Question #6

1. What is the most important investment issue facing your

company?

A. Low rates for longer

B. Credit risk

C. Manager communication

D. Adequacy of risk culture for investments

E. Efficiently managing the portfolio with limited resources

F. Other

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