Session 13 - Portfolio Optimization: Collaboration Between ...

13 - Portfolio Optimization: Collaboration Between Portfolio Manager and Actuary

SOA Antitrust Disclaimer SOA Presentation Disclaimer

https://www.soa.org/legal/antitrust-disclaimer/

https://www.soa.org/legal/presentation-disclaimer/

Proprietary & Confidential | ©2019 New England Asset Management, Inc. |

Presentation Title Would Go HerePresentation Title Would Go Here

The material contained in this presentation has been prepared solely for informational purposes by New England Asset Management Limited (“NEAM Limited”) and/or New England Asset Management, Inc. (“NEAM, Inc.”) and is not to be distributed outsideof the organization to which it is presented. The material is based on sources believed to be reliable and/or from proprietary data developed by NEAM, but we do not represent as to its accuracy or its completeness. This is not an offer to buy or sell anysecurity or financial instrument. Certain assumptions, including tax assumptions, may have been made which have resulted in any returns detailed herein. Past performance results are not necessarily indicative of future performance. Changes to theassumptions, including valuations or cash flows of any instrument, may have a material impact on any results. Please consult with your tax experts before relying on this material. Additional information is available upon request. This document and itscontents are proprietary to NEAM. They were prepared for the exclusive use of your company. Neither this document nor its contents are to be given or discussed with anyone other than employees, directors, trustees or auditors of your company without ourprior written consent. Any reference in this presentation to “NEAM” is defined as NEAM Limited and NEAM, Inc. NEAM Limited is a subsidiary of NEAM, Inc. NEAM Limited is regulated by the Central Bank of Ireland. NEAM Limited is authorized by theCentral Bank of Ireland and subject to limited regulation by the Financial Conduct Authority. Details about the extent of our regulation by the Financial Conduct Authority are available from us on request. NEAM Limited is not registered with the SEC. Becausethis is intended to be an overview please note that some services described in this presentation may not be available to all clients in certain jurisdictions.

Portfolio Optimization: Collaboration Between Portfolio Manager and Actuary

August 2019


• Background and Context

• Traditional Bottom-up Portfolio Construction

• Holistic Top-Down Enterprise Based Asset Allocation

• Summary

Topics

2

Background and Context


Reaching An Enterprise Profile Geared Towards Optimal Risk Adjusted Returns

4

Internal Enterprise Decisions

Risk Mitigation• Reinsurance • Capital market hedging• Natural internal hedges

Capital Management • Risk-based capital• Capital structure• Capital allocation

External Driving Factors

Rating agency criteriaMultiple currency implications

Regulatory regimesAccounting regimes

Financial markets conditions

Macroeconomic outlook

Company niche market and expertise

Market volatility

Competitive landscape

Merger & acquisition

opportunities

Capital offering environment

Market dislocations

Investment Strategy• Risk / reward trade-off • Asset / product

correlations • Income vs. total return

Product Strategy• Drivers of profitability • Product / asset

correlations• Claims / benefits

payout horizon


EnterpriseRisk Budget

Performance Benchmarks*

Enterprise Objectives

Return/Risk Metrics

Portfolio

Investment Philosophy: An Integrated Approach

“Enterprise Decisions” “Portfolio Execution”

* Customization to Investment Policy Statement constraints and portfolio cash flows.

Capital

Leverage, Debt& Goodwill

Reinsurance Reserving & Derivatives

Product Mix,

Returns & Volatility

Asset Mix, Returns & Volatility

Policy

Controls

Strategy

Execution

5


Life Insurance Co. Traditional Investment Philosophy

6

Decision Factors Influencing Investment Management

• Pricing, Design & Innovation

• Asset Liability Management

• Yield Target

• Policyholder Behavior

• Regulatory Constraints

• Risk Management & Budgeting

• IMR, AVR & Capital Charge Sensitivity

“Enterprise Decisions”



Product Mix,



Capital


Life Insurance Co.: An Integrated Approach

7

Capital

“Enterprise Decisions”



Product Mix,




NEAM’s EBAA™ Process Integrates ALM

8

Holistic “Top-Down” Approach:• Interdependencies among assets/products• “Unassigned” assets • Risk impact to overall enterprise capital

Segment “Bottom-Up” Approach:• Minimum rate guarantee • Cash flow sensitivity • Duration/convexity• Default adjusted yield

Traditional Bottom-up Portfolio Construction


Introduction – Asset Liability Management for Life Insurers

• Life insurance products are long-term in nature and the timing and magnitude of liability cash flows influence how assets should be invested to meet these liability obligations

• ALM techniques vary by levels of sophistication and common practices include cash flow matching and duration matching:

− Cash flow matching fully eliminates the asset / liability mismatch risk

− Duration matching minimizes but not totally removes the mismatch risk

• Duration matching techniques can further classify as overall duration and key rate duration

Cash Flow

Matching

Key RateDurationMatching

OverallDurationMatching

$

10


Duration Explained

Duration is a measure for how sensitive bond prices are to interest rate movements. The concepts of Effective Duration, Dollar Duration and Key Rate Duration are explained below.

• Effective Duration− Definition: The percentage change in price caused by a 100 bps change in rates

(yield curve shift is parallel)

• Dollar Duration− Definition: The dollar change in price caused by a 100 bps change in rates

• Key Rate Duration (effective or dollar)− This metric measures the price sensitivity (percentage or dollar change in price) at a

specific point on the yield curve. Instead of a parallel shift, the yield curve shift is largest at the key rate year.

11


Source: NEAM Analytics

Segment Portfolio Review and Optimization Analysis

Duration (+/-)

Asset Classes(+/-)

Rating & Regulatory

Capital Charges

Liquidity / Optionality etc.

Overall Portfolio Risk Charge

Impact

Expected Loss Adjusted Yield

Segment Specifications

• Segment Structure and Platform

• Liability Profile and Cash Flow SensitivityReview

• Alternative Asset Class Considerations and Implications

• Currency and CountryExposures

• Expected Gross and Net Yield Assumptions

• Review Preliminary Investment Policy Statement and Portfolio Guidelines

Iterative Portfolio Construction Process

Recommendation & Risk Analysis Reporting

• Investment Policy Statement & Guideline Recommendations

• Asset Class Configurations Based on Duration and Quality Constraints

• Security buy/sell listing

• Comprehensive Portfolio and Risk Reporting Package Delivered

Portfolio Optimisation

Analysis

Phase 1 Phase 3Phase 2

12


Liability Cash Flow Profile

• Life and annuity block with cash flows (CFs) projected over 20 years

• Net present value (NPV) of liability cash flows @ treasury risk-free rate ~ $368MM

• Duration, key rate durations and cash flows:

Source: NEAM Analytics

Phase 1

13

Modified Duration / Key Rate Durations

Sum of KRDs 1 Yr 2 Yr 3 Yr 4 Yr 5 Yr 7 Yr 10 Yr 15 Yr 20 Yr 30 Yr

Liability CFs 7.72 0.07 0.10 0.19 0.91 0.91 1.78 2.36 1.43 0.88 0.00

$-

$20.0

$40.0

$60.0

$80.0

$100.0

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Year

Liability Cash Flows


Portfolio Construction

Objectives:Recommend portfolio configurations that will:

• Satisfy liability liquidity needs

• Meet financial statement and reporting goals (e.g. minimise earnings volatility)

• Enhance income, return and earnings potential of the asset portfolio

Illustrations:Compare and contrasts three potential portfolios that meet the above objectives:

1. Cash flow matching

2. Key rate duration matching

3. Overall duration matching

14

Phase 2


Portfolio Construction – Cash Flow Matching (1/2)

Cash Flow Matching (CFM): • Liability cash flows matched on an annual basis

with assets satisfying cash flow requirements (duration and key rate duration matched as well)

• CFM approach minimizes asset sales under potential rising rate environment (preventing realized losses)

• Matching annual cash flows requires regular portfolio turnover, increasing trading costs and decreasing investment universe.

• To facilitate no future cash flow mismatch, only fixed rate securities used

• Portfolio market value ~$323MM vs. NPV of liability CFs @ treasury rate ~$368MM

• Gross book yield of 3.93% vs. net book yield of 3.61%

Source: NEAM

Phase 2

15

CF MatchedPortfolio Overview ($MM)Market Value 323Book Yield 3.93%Annualized Book Income 12.7Duration 7.0

SectorSovereign 17%Quasi Government 3%Corporate 48%ABS 4%CMBS 11%Municipal 10%Preferred 7%


Portfolio Construction – Cash Flow Matching (2/2)

Cash Flow Matching (CFM): • Liability cash flows matched on an annual basis

with assets satisfying cash flow requirements (duration and key rate duration matched as well)

• CFM approach minimizes asset sales under potential rising rate environment (preventing realized losses)

• Matching annual cash flows requires regular portfolio turnover, increasing trading costs and decreasing investment universe.

• To facilitate no future cash flow mismatch, only fixed rate securities used

• Portfolio market value ~$323MM vs. NPV of liability CFs @ treasury rate ~$368MM

• Gross book yield of 3.93% vs. net book yield of 3.61%

Source: NEAM

Phase 2

16

Quality (%)AAA 3%AA 36%A 35%BBB 22%BB 4%Average Quality A

Fixed Income Annualized Default and Reco Default Rate 0.4%Recovery Rate 25.5%Default Net of Recovery Rate 0.3%Expected Loss 1.0Net Book Yield 3.61%

Fixed Income Annualized Default and Recovery Rates

CF MatchedPortfolio Overview ($MM)M k t V l 323


Portfolio Construction – Duration Matching (1/2)

Key Rate Duration vs. Overall Duration: • In general, duration matching offers higher book

yield than cash flow matching

• KRD and OAD show similar sector distributions

• OAD matched portfolio shows a slightly lower average credit quality (A- vs. A)

• The more constraining KRD approach shows a lower gross yield (4.61% vs. 4.80%); however, the net yield turns out slightly higher (4.15% vs. 4.11%)

• Key rate duration mismatched through out the curve

17

Phase 2

Source: NEAM

KRD Matched

OAD Matched

KRD vs OAD

311 308

4.61% 4.80% -0.19% 14.8 15.3

7.0 6.9

0% 0% 0% 0% 0% 0%

40% 43% -3%25% 25% 0%15% 15% 0%15% 12% 3%

5% 5% 0%

9% 5% 4%21% 10% 11%40% 55% -15%25% 25% 0%

5% 5% 0% A A-

Portfolio Overview ($MM)Market ValueBook YieldAnnualized Book IncomeDuration

SectorSovereignQuasi GovernmentCorporateABSCMBSMunicipalPreferred

QualityAAAAAABBBBBAverage Quality


Portfolio Construction – Duration Matching (2/2)

Key Rate Duration vs. Overall Duration: • In general, duration matching offers higher book

yield than cash flow matching

• KRD and OAD show similar sector distributions

• OAD matched portfolio shows a slightly lower average credit quality (A- vs. A)

• The more constraining KRD approach shows a lower gross yield (4.61% vs. 4.80%); however, the net yield turns out slightly higher (4.15% vs. 4.11%)

• Key rate duration mismatched through out the curve

18

Phase 2

Source: NEAM

Fixed Income Annualized De Default RateRecovery RateDefault Net of Recovery RateExpected Loss Net Book Yield

Key Rate Durations1 Yr2 Yr3 Yr5 Yr7 Yr10 Yr15 Yr20 Yr30 Yr

and Recovery Rates 0.6% 0.8%

25.1% 23.3% 0.4% 0.6%

1.4 2.0 4.15% 4.11% 0.04%

0.04 0.06 -0.02 0.11 0.19 -0.08 0.27 0.40 -0.13 1.05 0.95 0.10 1.69 1.25 0.45

2.29 1.47 0.82 1.18 1.64 -0.46 0.48 1.08 -0.61 0.04 0.08 -0.05

Fixed Income Annualized Default and Recovery Rates

KRD Matched

OAD Matched

KRD vs OAD

Portfolio Overview ($MM)


Asset / Liability Interest Rate Sensitivity Analysis: Overall Duration Matching Portfolio (1/2)

Phase 3

19

Source: NEAM

Modified DurationModified Duration 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 15 Yr 20 Yr 30 Yr

Positive CFs 7.13 0.06 0.19 0.40 0.95 1.25 1.47 1.64 1.08 0.08

Negative CFs 7.12 0.08 0.11 0.20 0.94 1.77 2.16 1.20 0.67 0.00

Present Value of Cash Flows (MM)Asset Cash Flows Insurance Cash Flows Positive Cash Flows Negative Cash Flows

Principal & Interest Claims & Expenses (-) Principal, Interest & Premiums Claims & Expenses

$307.8 $307.6 $307.8 $307.6


Asset / Liability Interest Rate Sensitivity Analysis: Overall Duration Matching Portfolio (2/2)

Phase 3

20

$-

$5,000,000

$10,000,000

$15,000,000

$20,000,000

$25,000,000

ModifiedDollar

Duration

1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 15 Yr 20 Yr 30 Yr

Dur

atio

n

Treasury Curve Year

Dollar Duration

Positive CFs (Premiums + Principal & Interest)Source: NEAM

Dollar Duration (MM per 100 bps)Modified Dollar

Duration 1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 15 Yr 20 Yr 30 Yr

Positive CFs $21.94 $0.19 $0.58 $1.22 $2.92 $3.84 $4.53 $5.06 $3.34 $0.26

Negative CFs $21.90 $0.24 $0.34 $0.62 $2.88 $5.44 $6.63 $3.69 $2.06 -

Difference in Duration $0.04 $(0.05) $0.24 $0.60 $0.04 $(1.61) $(2.10) $1.37 $1.28 $0.26


Portfolio Construction Summary Phase 3

21

CF MatchedKRD

MatchedOAD

MatchedPortfolio Overview ($MM)Market Value 323 311 308Book Yield 3.93% 4.61% 4.80%Annualized Book Income 12.7 14.3 14.8Duration 7.0 7.0 7.0

SectorSovereign 17% - - Quasi Government 3% - - Corporate 48% 40% 43%ABS 4% 25% 25%CMBS 11% 15% 15%Municipal 10% 15% 12%Preferred 7% 5% 5%

Source: NEAM

• Higher book yield under duration matching vs. cash flow matching

• More sovereigns and fewer corporate bonds under cash flow matching

• Relatively higher average credit quality for cash flow matching

• Net book yield higher for duration matched portfolios

Quality (%)AAA 3% 9% 5%AA 36% 21% 10%A 35% 40% 55%BBB 22% 25% 25%BB 4% 5% 5%Average Quality A A A-

Fixed Income Annualized Default and Recovery RatesDefault Rate 0.4% 0.6% 0.8%Recovery Rate 25.5% 25.1% 23.3%Default Net of Recovery Rate 0.3% 0.4% 0.6%Expected Loss 1.0 1.4 2.0Net Book Yield 3.61% 4.15% 4.11%

Holistic Top-Down Enterprise Based Asset Allocation


Enterprise Based Asset Allocation™ (EBAA™) ProcessWhat is it?

How Does it Work?

What’s the Potential Benefit?Enhanced Risk-Adjusted Return Profile

Investment portfolio optimization within an enterprise framework• Considers liability profile and cash flow sensitivity• Enables holistic economic, rating agency and regulatory impact assessment

InputClient Operating Information• Product segment cash flows forecast • Additional financial statement

information

NEAM Provided Information• Prospective investment returns

and volatility • Additional return and risk metrics

+

OutputRecommendations for:• Asset Allocations• Investment Guidelines• Benchmarks

Macro & Micro Return & Risk

EvaluationIterative Process

Efficient Frontier

Macro & Micro Return & Risk

Regulator & Rating Agency Capital Impact

Stress Testing

23


Recent Publications

24

Case Study – New BCAR Impact on Asset Allocation


Compare and Contrast: New BCAR 95 vs. Old BCAR

VaR 95 Old BCAR

Rating 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 Yearaaa 0.00% 0.00% 0.00% 0.00% 0.01% 0.02% 0.03% 0.04% 0.05% 0.05%aa+ 0.00% 0.05% 0.09% 0.14% 0.18% 0.21% 0.24% 0.26% 0.28% 0.30%aa 0.00% 0.10% 0.18% 0.27% 0.34% 0.41% 0.45% 0.48% 0.52% 0.54%aa- 0.08% 0.24% 0.37% 0.52% 0.62% 0.71% 0.78% 0.82% 0.86% 0.91%a+ 0.25% 0.53% 0.78% 1.01% 1.19% 1.33% 1.43% 1.48% 1.55% 1.62%a 0.33% 0.67% 0.99% 1.25% 1.47% 1.63% 1.74% 1.81% 1.89% 1.96%a- 0.42% 0.86% 1.24% 1.56% 1.82% 2.02% 2.13% 2.21% 2.30% 2.38%bbb+ 0.75% 1.52% 2.16% 2.70% 3.13% 3.46% 3.69% 3.83% 3.99% 4.13%bbb 0.88% 1.75% 2.47% 3.09% 3.56% 3.93% 4.18% 4.33% 4.48% 4.65%bbb- 1.16% 2.29% 3.20% 3.95% 4.53% 4.97% 5.25% 5.41% 5.58% 5.78%bb+ 1.89% 3.65% 5.15% 6.43% 7.48% 8.35% 9.03% 9.49% 9.93% 10.34%bb 2.21% 4.24% 5.94% 7.36% 8.54% 9.49% 10.22% 10.71% 11.18% 11.61%bb- 4.35% 8.14% 11.12% 13.47% 15.24% 16.55% 17.46% 18.00% 18.46% 18.82%b+ to b- 6.52% 11.91% 16.32% 19.90% 22.67% 24.85% 26.48% 27.66% 28.45% 28.92% 12.0%ccc+ to ccc- 24.38% 37.13% 43.41% 46.09% 46.77% 46.77% 46.77% 46.77% 46.77% 46.77% 25.0%cc to c 28.45% 43.32% 50.64% 53.77% 54.56% 54.56% 54.56% 54.56% 54.56% 54.56%d 32.51% 49.51% 57.87% 61.45% 62.36% 62.36% 62.36% 62.36% 62.36% 62.36%Equity 30.0%

6.0%

30.0%

25.00%

0.8%

2.5%

Most new risk charges are higher than the old risk charges (108 out of 170)

Source: Understanding BCAR for U.S. and Canadian Life/Health Insurers - October 13, 2017

26

VaR 95 Old BCAR


6.0%

30.0%

25.00%

0.8%

2.5%


Compare and Contrast: New BCAR 99.6 vs. Old BCAR

Most new risk charges are higher than the old risk charges (131 out of 170)

Source: Understanding BCAR for U.S. and Canadian Life/Health Insurers - October 13, 2017

27

New BCAR - VaR 99.6 Old BCAR


0.8%

2.5%

44.00%

6.0%

30.0%


Portfolio OptimizationFramework and Assumptions • Enterprise Based Asset Allocation* with U.S. life industry 2017 year end reported statutory

financials, investment holdings, and generic product and liability assumptions

Steps: 1. Objective: maximize book yield (income return) while maintaining initial BCAR C1 charges

2. Optimize asset portfolio under old and new BCAR C1 charges (95 and 99.6 confidence level) separately

3. Assess the impact of new BCAR 95 and 99.6 C1 charges on optimizations

4. Assess the impact of duration constraint on optimizations

5. Identify key directional differences between optimized allocations based on old and new BCAR C1 charges

*Refer to NEAM’s “Adopting a Holistic Enterprise Approach to Life Insurer Portfolio Optimization,” May 21, 2019

Sources of Enterprise Return and Risk

28


Book Yield Maximization: Old vs. New (1/2)

Book income maximization with BCAR C1 maintained at initial levels:

• New BCAR C1 more restrictive than old BCAR C1

– 99.6 BCAR more restrictive than 95 BCAR

• Maximized book yield: 4.86 ( old) vs. 4.82 ( BCAR 95) vs. 4.79 ( BCAR 99.6)

Efficient frontier under old BCAR

Efficient frontier under new BCAR 95Efficient frontier under

new BCAR 99.6

Current Portfolio

Old BCAR New BCAR 95 New BCAR 99.6Results Current Maximize BY Maximize BY Maximize BY

Enterprise StatisticsTotal Return on Equity 9.8 14.0 13.6 13.3Earnings Risk (Std Dev) 20.6 25.5 24.5 23.095.00 VAR % Capital 32.5 39.0 37.3 34.7Total Return on Assets 4.6 5.1 5.0 5.0Investment Leverage 9.6 9.6 9.6 9.6Product Leverage 8.5 8.5 8.5 8.5Product Margin (4.1) (4.1) (4.1) (4.1)Add. Return/Risk MetricsBCAR C1($) Old 141 141BCAR C1($) New 95 189 189BCAR C1($) New 99.6 276 276Book Yield 4.40 4.86 4.82 4.79Market Yield (OAY) 3.52 4.39 4.20 4.10Duration (OAD) 7.1 9.8 9.4 8.8

Source: NEAMFigures are for illustrative purposes only.

29


Book Yield Maximization: BCAR 95 vs. BCAR 99.6 (2/2)

• Green dot (BCAR 95) portfolio has a longer duration than Orange dot portfolio; similar average credit rating (& default loss) but different letter rating distribution

• Orange dot (BCAR 99.6) portfolio has overweight in structured securities and underweight in IG corporate bonds relative to Green dot portfolio



new BCAR 99.6

Current Portfolio


Enterprise StatisticsTotal Return on Equity 9.8 14.0 13.6 13.3Earnings Risk (Std Dev) 20.6 25.5 24.5 23.095.00 VAR % Capital 32.5 39.0 37.3 34.7Add. Return/Risk MetricsBCAR C1($) Old 141 141BCAR C1($) New 95 189 189BCAR C1($) New 99.6 276 276Book Yield 4.40 4.86 4.82 4.79Market Yield (OAY) 3.52 4.39 4.20 4.10Duration (OAD) 7.1 9.8 9.4 8.8Default Loss ($) 5.1 7.5 6.2 6.2Quality DistributionAverage Rating A A- A- A-AAA 15.9 3.3 4.4 8.2AA 15.5 8.5 8.6 11.6A 19.6 30.3 29.0 26.1BBB (%) 37.9 47.6 48.8 44.2<BBB (%) 4.7 4.0 3.0 3.6Non-FI (%) 6.3 6.3 6.3 6.3Total 100.0 100.0 100.0 100.0Sector DistributionShort Term 2.8 2.7 2.7 2.7US Govt_Agncy 7.1 1.2 2.0 2.6Public InvGrd Credit 39.2 57.9 58.0 50.5Muni - Tax Exempt 0.9 0.0 0.0 0.0Private Placement 11.4 11.4 11.4 11.4High Yield 3.8 3.0 2.0 2.7Structured Sec. 15.7 4.6 4.6 10.9Comml Mortgage 12.5 12.5 12.5 12.5Bank Loans 0.0 0.0 0.0 0.0Equity 1.3 1.3 1.3 1.3Alternative 5.3 5.3 5.3 5.3Total 100.0 100.0 100.0 100.0


30


Book Yield Maximization: Targeting a Relative Book Yield of 4.79%

• New BCAR (95 & 99.6) optimized portfolios exhibit longer OAD and higher credit quality than old BCAR optimized portfolio

• New BCAR (95 & 99.6) favors more structured securities and less IG corporate and HY than old BCAR

• Among new BCAR optimized portfolios, BCAR 99.6 portfolio has higher credit quality than BCAR 95 portfolio



new BCAR 99.6

Current Portfolio

Old BCAR New BCAR 95 New BCAR 99.6Current Maximize BY Maximize BY Maximize BY

Enterprise StatisticsTotal Return on Equity 9.8 13.3 13.3 13.3Earnings Risk (Std Dev) 20.6 18.1 19.4 23.095.00 VAR % Capital 32.5 25.2 27.7 34.7Add. Return/Risk MetricsBCAR C1($) Old 141 141BCAR C1($) New 95 189 189BCAR C1($) New 99.6 276 276Book Yield 4.40 4.79 4.79 4.79Market Yield (OAY) 3.52 4.18 4.10 4.10Duration (OAD) 7.1 8.2 8.3 8.8Default Loss ($) 5.1 7.1 6.6 6.2Quality DistributionAverage Rating A A- A- A-AAA 15.9 4.3 8.0 8.2AA 15.5 9.2 9.1 11.6A 19.6 33.7 27.5 26.1BBB (%) 37.9 42.4 46.1 44.2<BBB (%) 4.7 4.1 2.9 3.6Non-FI (%) 6.3 6.3 6.3 6.3Total 100.0 100.0 100.0 100.0Sector DistributionShort Term 2.8 2.7 2.7 2.7US Govt_Agncy 7.1 2.7 2.7 2.6Public InvGrd Credit 39.2 56.3 53.9 50.5Muni - Tax Exempt 0.9 0.0 0.0 0.0Private Placement 11.4 11.4 11.4 11.4High Yield 3.8 3.1 1.9 2.7Structured Sec. 15.7 4.6 8.2 10.9Comml Mortgage 12.5 12.5 12.5 12.5Bank Loans 0.0 0.0 0.0 0.0Equity 1.3 1.3 1.3 1.3Alternative 5.3 5.3 5.3 5.3Total 100.0 100.0 100.0 100.0


31


Book Yield Maximization with Constant Duration

• Old (Blue) and new (Green and Orange) efficient frontiers overlap; similar maximized book yields: 4.74% vs. 4.76% vs. 4.74%

• Optimized portfolios under new BCARs show lower expected losses (7.5 vs 8.5); new BCARs favor AAA and BBB over A than old BCAR

• New BCARs favor structured securities over IG corporate and HY than old BCAR

Efficient frontier under new BCAR 99.6

Efficient frontier under new BCAR 95


Current Portfolio


Enterprise StatisticsTotal Return on Equity 9.8 12.9 13.0 12.8Earnings Risk (Std Dev) 20.6 21.8 21.3 20.695.00 VAR % Capital 32.5 32.5 31.5 30.3Add. Return/Risk MetricsBCAR C1($) Old 141 141BCAR C1($) New 95 189 189BCAR C1($) New 99.6 276 276Book Yield 4.40 4.74 4.76 4.74Market Yield (OAY) 3.52 4.16 4.02 4.00Duration (OAD) 7.1 7.1 7.1 7.1Default Loss ($) 5.1 8.5 7.5 7.5Quality DistributionAverage Rating A A- A- AAAA 15.9 4.7 15.2 15.2AA 15.5 11.4 11.7 12.4A 19.6 33.3 14.0 17.5BBB (%) 37.9 39.0 49.2 44.7<BBB (%) 4.7 5.3 3.6 4.0Non-FI (%) 6.3 6.3 6.3 6.3Total 100.0 100.0 100.0 100.0Sector DistributionShort Term 2.8 2.7 2.7 2.7US Govt_Agncy 7.1 1.4 2.1 2.7Public InvGrd Credit 39.2 52.3 44.0 43.0Muni - Tax Exempt 0.9 0.0 0.1 0.1Private Placement 11.4 11.4 11.4 11.4High Yield 3.8 4.3 2.7 3.0Structured Sec. 15.7 8.7 17.9 17.9Comml Mortgage 12.5 12.5 12.5 12.5Bank Loans 0.0 0.0 0.0 0.0Equity 1.3 1.3 1.3 1.3Alternative 5.3 5.3 5.3 5.3Total 100.0 100.0 100.0 100.0


32


Key Takeaways – New BCAR Impact on Asset Optimization

• New BCARs, which vary C1 capital charges by letter credit rating and maturity, produce more restrictive efficient frontiers than the old BCARs.

• New BCARs produce optimized portfolios with shorter duration and lower default loss than old BCARs; 99.6 factors result in optimized portfolios with lower default losses than 95 factors.

• Portfolio optimizations under new BCAR will favor structured securities as these tend to have high credit qualities and short durations.

• Portfolio optimization needs to evaluate the “risk-adjusted returns” of various asset classes along with their respective BCAR charges. Use of marked-to-market metrics (Value at Risk or VaR) may result in different optimization outcomes.

33

Summary


Key Takeaways

1. Asset portfolio construction and optimization require both bottom-up and top-down approaches

2. Bottom-up ALM portfolio construction involves collaborations between actuaries and portfolio managers; various ALM techniques exhibit different risk-return tradeoffs

3. Top-down portfolio optimization considers the interdependencies among assets and products and the risk impact to overall enterprise capital (or surplus)

Life insurer investment portfolio needs to satisfy liability obligations and address enterprise goals and objectives

35


Q&A

Mark M. Yu, CFA, FSA, FRM, MAAA

Mark is an Enterprise Risk and Capital Management Professional at NEAM, Inc. focusing on the capital management and corporate development activities for U.S. insurance companies. He joined the Firm in 2012 having been a Senior Risk Manager within the Governance and Strategy team at AIG Enterprise Risk Management. Prior to working at AIG ERM, he was a Senior Vice President and Treasury Director within the Group’s Capital Management division of Swiss Re. Mark holds a Bachelor of Arts from National Tsing Hua University in Taiwan, an M.S. from the University of Iowa, is a Fellow of the Society of Actuaries, a CFA Charterholder, a Financial Risk Manager, and is a Member of the American Academy of Actuaries. He has been employed in the insurance industry since 1999. [email protected]

Christopher N. Lech, CFA Chris is Head of Client Strategy at NEAM, Inc., responsible for delivering investment and capital management services to our clients and is a member of the Firm’s Policy Committee. He joined the Firm in 1996 as a Client Strategist and became head of the Client Strategy Group in 2014. Prior to joining the Firm, Chris was a Managing Director in the Financial Analytics and Structured Transactions Group at Bear, Stearns & Company. Previously he was a Structured Securities Consultant for KPMG Peat Marwick. Chris is a CFA Charterholder, member of the Hartford Society of Financial Analysts and a graduate of Syracuse University with dual Bachelor of Science degrees in Finance and Marketing. He has been employed in the investment industry since 1989.

[email protected]

36

Thank You

Session 13 - Portfolio Optimization: Collaboration Between ...

Documents

Transcript of Session 13 - Portfolio Optimization: Collaboration Between ...