The document discusses how low interest rates are expected to persist for an extended period, posing challenges for insurers. It outlines strategies insurers can take to improve investment income in a low rate environment, such as enhancing their investment processes and considering alternative asset classes. It emphasizes the importance of understanding risk appetite and having a disciplined investment process focused on goals and risk management over outcomes.

1. Insurer Investment Forum XIII
Investing for Insurers:
Review and Preview
Alton Cogert, CFA, CPA, CAIA, CGMA
President & CEO
March 21st, 2013
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2. The #1 Investment Challenge in Over 30 Years:
“Low Rates for Longer”
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3. U.S. Financial Repression
Source: Federal Reserve, J.P. Morgan Asset Management
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4. Where We Are Today
• Book Yields Continue Downward Path
• Insurers Grappling with Risk
• Insurers Grappling with Product Pricing
• Insurers Grappling with ERM
“A further unpleasant reality adds
to the industry’s dim prospects:
Insurance earnings are now
benefiting from “legacy” bond
portfolio that deliver much higher
yields than will be available when
funds are reinvested during the
next few years - and perhaps for
many years beyond that.
Today’s bond portfolios are, in
effect, wasting assets. Earnings of
insurers will be hurt in a
significant way as bonds mature
and are rolled over.”
- Berkshire Hathaway
Shareholders’ Letter, March, 2013 4
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5. Improving Investment Income - It Takes Planning
Improved Investment Income - It is possible...
Unchanged Market interest Rates
4.25
Portfolio Book Yield
4.10
3.95
3.80
3.65
3.50
1 2 3 4 5 6 7 8 9 10 11 12
Improved Unchanged
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6. Key Long-Term Asset Class Return Assumptions
Source:JP Morgan 2013 Long-Term Capital Market Return Assumptions 6
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7. Key Long-Term Asset Class Risk Assumptions
Source:JP Morgan 2013 Long-Term Capital Market Return Assumptions 7
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8. Risk/Return/Correlation Expectations vs. Aggregate Investment
Grade Bond
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9. What Does “Low Rates for Longer” Mean?
• How Long?
NOV, 2009 “Federal Reserve Chairman Ben
Bernanke said interest rates will remain low for
an extended period as the U.S. economy still
faces considerable challenges.”
FEB, 2010 “Chairman Ben Bernanke told
Congress on Wednesday a weak job market
and tame inflation warrant low interest rates
for an extended period.”
JAN, 2012, “The Federal Reserve anticipates
that economic conditions–including low rates
of resource utilization and a subdued outlook
for inflation over the medium run–are likely to
warrant exceptionally low levels for the federal
funds rate at least through late 2014.”
FEB 2013 - “It plans to hold short-term
interest rates near zero even longer, at least
until the unemployment rate falls below 6.5
percent.”
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10. What Does “Low Rates for Longer” Mean?
Until Unemployment Rate Hits 6.5%, which will be...
It would take an average job-growth rate of 250,000 each of the next 13 months to arrive at a
6.5% unemployment rate.
But if increases were just 125,000, the average trend rate for the last 30 years, it would take
96 months — or eight full years — before unemployment got to 6.5%.
(This isn’t just job additions, mind you, but net job creation; that’s why simply jumping from
125,000 to 250,000 cuts the time down so dramatically.)
So bond bulls and dollar bears take heart. It looks like Helicopter Ben will be hovering
for some time to come.
- http://blogs.wsj.com/marketbeat/2013/01/04/when-the-unemployment-rate-hit-6-5-
calculate-it/
Here’s the Atlanta Fed’s calculator to help answer this question:
http://www.frbatlanta.org/chcs/calculator/
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11. What Does “Low Rates for Longer” Mean?
Comparison with Japan - 15 Years and counting?
10 year JGB: Jan, 1990 to March, 2013
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12. How About ‘Black Swans’ - Very Low Probability/Very High Impact?
Inflation - according to the ‘experts
Keynesians -
- Demand/pull - increased economic activity
- Cost push - supply side disruptions
- Built-in inflation - wage/price spiral
Monetarists -
- Quantity Theory of Money
- Long run inflation =
Money supply growth rate
+ Rate of change in Velocity of Money
- Growth rate in Real Output
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13. How About ‘Black Swans’ - Very Low Probability/Very High Impact?
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14. The Fed says, “Take More Risk”...Should You?
What is Your Risk Appetite?
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15. The Fed says, “Take More Risk”...Should You?
Over the long run, Process determines Results.
Thus, Process becomes more important than Results.
Positive Negative
Result Result
Good Quality
Expected Bad Luck
Process
Bad Quality
Good Luck Expected
Process
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16. What about Luck versus Skill?
Text
http://insurercio.com/content/how-much-ones-success-or-failure-skill-or-luck
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17. What about Luck versus Skill?
Paradox of Skill:
Standard deviation of skill decreases as expertise increases, which
means
Luck has more to do with results
And that means
Difficult to rely upon historical performance
More important to rely upon process
Counter-intuitively, process is more important than results
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18. From the London Business School...
• Decisions Are More Important Than Results
• Results don’t necessarily reflect a high-quality process
• Ultimate criteria for good decision making is tied to:
• What are we trying to achieve with this decision?
(Criteria)
• What can we feasibly do? (Alternatives)
• What do we have to watch out for? (Consequences)
• It’s not enough to measure leaders on results; How they
are achieved is equally important.
• Implement a good process; Manage risks
- http://bsr.london.edu/lbs-article/407/index.html
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19. Could we make understanding risk any more complicated?
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20. 8 Steps to Answering: “Should You Take More Risk?”
• Step 1 - What do you mean by ‘risk’?
• Probability of Not Meeting a Goal
• Not VaR
• What Goal?
• Return on Surplus,
• Net Income Text
Text
• Spread Over Liability Text
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• PV Enterprise Value Text
• Drawdown
• Step 2 - Quantify Risk
• Single, multi periods, 1 yr. 5 yr.?
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21. 8 Steps to Answering: “Should You Take More Risk?”
• Step 3
• How do different asset mixes impact risk metric
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22. 8 Steps to Answering: “Should You Take More Risk?”
• Step 4 - Implementation Issues
• Strategic or Tactical
Strategic Tactical
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Text Parameters Set for
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Board OK
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Execution Slowly, Over Time Active Management
Parameters Set for
Exit Board Decision
Exit
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23. 8 Steps to Answering: “Should You Take More Risk?”
• Step 5 - Consider Game Theory Impact
Risk Assets Rise Risk Assets Fall
Increase Risk Text
Bad Good
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Opportunity Cost/ Opportunity Gain/
Maintain Risk
Gain Cost
Decrease Risk Good Bad
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24. 8 Steps to Answering: “Should You Take More Risk?”
• Step 6
• Know your Board/Senior Management Team
• Step 7
• Make a Decision - Even if it is to make no decision
• Step 8
• Monitor the Impact of the Decision
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• Stewardship Report Text Text
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25. What has SAA seen so far?
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26. Goldman Sachs Insurance CIO Survey - July, 2012
Insurers expecting to increase risk: 26%
Insurers expecting to decrease risk: 14%
% Who Expect
Asset Class to Increase % Who Expect to
Allocation Asset Class Decrease
Allocation
High Yield 36
Text
IG Corporates 35 Text
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Real Estate 34 Text
Cash/Short Term 39
Text
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Emerging Market Debt 31
Private Equity 27 European
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Financial Credit
Bank Loans 25
Mezzanine Debt 23
http://www.goldmansachs.com/s/GMeT_othermailings_attachments/6347837329351787503251.pdf
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27. Asset Classes - a Layer Cake of Choices
Tex The Next Layer Text
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• Lower investmentText
grade mandates for
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munis (where applicable)
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• Below investment grade in various
guises t
The Basics
• Make certain all IG asset classes are included (public/
private)
• Diversified equity allocation
• High yield/growing dividend slant 27
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28. Asset Classes - a Layer Cake of Choices
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•Tex The Next/Next/Next Layer
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• More complex Text
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derivatives explicitly or implicitly t
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• The Next/Next Layer
• Non-equity exposures
• More illiquid asset classes
• What your manager may suggest, based upon their
proven expertise
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29. The Risk Trap
• Always ask, “Who is on the other side of the trade? And why?”
• Too easy to see well groomed, credentialed person in a suit as
authority figure.
• It could still be snake oil.
• If presenter is too confident, walk out of the room.
• Investment management is a humbling activity.
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• Ask more questions - the “dumber” the better until...
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• You fully understand ALL aspects of the asset class
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• Remember:
• There is NEVER a dumb question, especially in a Committee
or Board setting.
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30. The Risk Trap
• Other Questions:
• Will this play in Oldwick?
• Ask for ideas from your peers, independent third parties, etc.
• There is no way you are expected to know it all.
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31. The #1 Investment Challenge in Over 30 Years
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32. The #1 Investment Challenge in Over 30 Years
• Low rates for longer gives us the opportunity to
• Reassess our asset allocation
• Shed the blinders of ‘we’ve always done it this way’
• Reassess the relationship between investments and reserves
• Reassess the relationship between investments and product
pricing
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• Take a deep breath, step back and review the overall
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investment process Text
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• Be better prepared for meeting future challenges
• Improve profitability over what it might have been
• Get a ‘leg up’ over competitors - succeed where others may fail
• Develop a process for constantly improving your company
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33. The #1 Investment Challenge in Over 30 Years
Thank You
More updates at:
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LinkedIn: www.linkedin.com/in/acogert
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Twitter: www.twitter.com/saa123
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www.insurercio.com
www.saai.com
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