Impact of Liability Profile on Investment Strategy NZ Society of Actuaries Conference 2010 Presented by Rob Paton 24 November 2010 Based on a paper by Anton Kapel, Graeme Miller and Rob Paton prepared for the Institute of Actuaries of Australia Financial Services Forum, 13 and 14 May 2010. © 2010 Towers Watson. All rights reserved. Melville Jessup Weaver is the Alliance Partner of Towers Watson in New Zealand.

Contents Background to paper Why do we invest? Common practice An alternative approach Role of Appointed Actuary

Background to paper What prompted this paper Investment practices vary GFC Universal concepts that apply to all underlying insurance businesses Avoid addressing some of the more complex areas associated with particular liabilities

Why do Insurers invest? Insurers invest assets to meet liabilities In most cases, there is an asset portfolio that would (closely) “match” the liabilities Complications arise: What measure of liabilities? Matching is not always possible We are not suggesting an insurer should always hold the minimum risk investment portfolio But it is important to understand the implications of not doing so

Good investment practice The allocation to investments from the insurer’s overall risk appetite should be central How is “risk” assessed? Benchmark asset mixes set to align investment risk taken with the investment risk appetite Regular monitoring and periodic review

Current Investment Practice in New Zealand Little publicly available data (none?) Proposed Minimum Solvency Capital strict on Asset Risk Capital Factors (eg minimum risk investments, risky investments, no diversification benefit, unlisted trusts, investments in $Australian) How will Appointed Actuaries approach the investment related parts of their FCR’s Will current investment practice need to change under new regulatory requirements (if so, what are implications)

Issues that may arise Risk exposures can move out of line with risk appetite Asset class managers have different view of risk Focus on performance relative to benchmark “Tactical” decisions made from an asset-centric viewpoint

A “textbook” approach Governance structures are critical ALCO or similar body Actuarial input (particularly regarding capital) is needed Treasury function Separates investment (mismatch) decisions from underlying liability portfolio management Monitoring function Current investment risk appetite versus current investment risk taken

Liability management team Investment management team Treasury function Delivers “matching” cash flows to the liability management team Articulates minimum risk portfolio and risk appetite to investment management team Treasury function (responsible for management of mismatch risk between assets and liabilities) Liability management team Investment management team Advises Treasury of minimum risk portfolio Delivers returns from underlying investments to Treasury function Insurance business earns matching portfolio return Investment business “owns” mismatch capital and actual returns (and pays matching portfolio return)

Role of Appointed Actuary Communicate capital implications Communicate the investment-related implications of the insurer’s liability profile Develop appropriate trigger points Communicate any cash flow patterns and liquidity constraints which have implications for investments Calculate and communicate the investment component of the insurer’s total risk budget Monitor the suitability of the insurer’s overall investments in the context of the insurer’s investment risk appetite

Discussion Do insurers do it now? What’s stopping it being done now? What New Zealand characteristics get in the way? Do Appointed Actuaries have sufficient powers?