Title Slide JUN 8 – 10, Introduction to Captive Investments

Introduction to Captive Investments Speakers: Brad Komenda, Vice President and Portfolio Manager, Pioneer Investments Andrew Baron, CFA, Head of Group Fixed Income Butterfield Asset Management Colleen McHugh, Corporate Investment Adviser, Vice President, Barclays Wealth & Investment Management Robert Steinhoff, CFA, Investment Manager, Clarien Investments Limited Moderator: Carl Terzer, Principal, CapVisor Associates, LLC

Agenda –Investment Plan Design –Strategic Asset Allocation –Tactical Plan implementation –Monitoring, Reviewing and updating Captive Investment Programs Introduction to Captive Investments

Investment Plan Design –Investment Planning Elements Self assessment –Business objectives –Investment objectives –Risk tolerance –Regulatory requirements –Accounting considerations Investment Policy Statement (IPS) Introduction to Captive Investments

Investment Objectives The Continuum Income Maximization Total Return Liquidity Surplus Reserves Insurance Portfolio Segmentation: Liquidity, Reserves and Surplus Introduction to Captive Investments Insurers Others

Defining Investment Program Risk Traditional investment measure: –Standard deviation Practical investment measures –Losing money, i.e. safety of principal –Not producing a targeted level of income –Not having sufficient liquidity to pay claims Other insurance operational measures –Failing to preserve or attain an AM Best rating –Not growing surplus at desired rate –Underperforming competitors Introduction to Captive Investments

Risk Tolerance Must recognize the existence of market risks in the investment portfolio Should also make clear what the priorities are in terms of: Volatility (can range between “don’t care” and “Low” Liquidity Asset Quality Diversification Within this section, some mention can be given to the following other items: Any specified and regular liquidity needs The Time Horizon of the investment portfolio (nearly always “long) The existence of taxes, whether things like withholding tax should be avoided, the Captive files as 953d, no Canadian Source Income, etc Other unique circumstances (green, ethical, etc) Introduction to Captive Investments

The Basics Every Investment Policy Statement should have these building blocks: 1.Purpose Statement/Introduction/Overview 2.Portfolio Goals and Objectives 3.Definition of Duties 4.Investment Strategy and Asset Allocation 5.Liquidity and Collateral Considerations 6.Monitoring and Review Procedures 7.Investment Limitations Introduction to Captive Investments

At a minimum, each of the relevant parties that has some responsibility for the IPS should be identified The Board of the Captive Has ultimate Fiduciary responsibility for the Captive company If there are employees of the Captive Manager on the Board of the company, they should know and recognize that they have a fiduciary responsibility in this regard. Should state whether monitoring the compliance to the IPS is the responsibility of an Investment Committee or the Board Investment Committee Common in Captive governance, but not required Usually responsible for recommending investment strategies, service providers, brokers, custodians, etc to the full Board Investment Managers Investment Consultants Custodian Actuarial provider – may have an effect on Investment Policy Introduction to Captive Investments

The Importance of Investment Philosophy Items that can be covered include: Whether costs are important Whether inflation is a concern Whether any contrarian views are desired The purpose of inclusion of Alternative asset classes Whether Active Management is desired or if there is a belief that an active manager can add value Whether any tactical shifts in asset allocation are going to be employed and who is responsible for those decisions Whether equities should have any inherent size bias (small, medium, large- cap Whether equities should any kind of style tilt (Value, dividends, etc) Introduction to Captive Investments

Step 1 - Define Allowable Asset Classes “Equities” and “Bonds” is not an asset allocation Specifically set the type of assets that are allowable, unless you want a “go anywhere” global manager Set a strategic allocation that makes sense in the context of the objectives of the Captive – attempt to incorporate a forward Capital Markets assumption Be Realistic Set allowable ranges for the strategic or tactical allocation – this avoids the possibility of getting over-emotional and potentially acting without an Investment Committee vote Introduction to Captive Investments

Strategic Asset Allocation Introduction to Captive Investments

Terminology Strategic Asset Allocation Intermediate to long term horizon typically 3-5 yrs. Measured in “business cycles” Utilizes underwriting, claims, expected return projections Incorporates customized risk and return measures Governed by broad tax, statutory, and company- specific guidelines Defines range of allocations Tactical Asset Allocation Short to intermediate-term horizon –Typically 3-18 months measured in weeks, months & quarter Utilizes actual underwriting results Incorporates current capital market pricing and relative valuations Governed by “temporary” modifications to portfolio based on market conditions Defines specific allocation Introduction to Captive Investments

Strategic Asset Allocation Determinants of long term investment results Introduction to Captive Investments Sources: Ibbotson and Kaplan entitled "Does Asset Allocation Policy Explain 40%, 90% or 100% of Performance?" (2000).

Introduction to Captive Investments 100% US Govt. Int. Gov. Credit Core Fixed Income 90% Core FI; 10% S&P % Core FI & 25% S&P 500 “Unoptimized” Client Portfolio Efficient Frontier line represents the best possible risk/reward portfolio combinations available in the marketplace Captives investment portfolios should lie on the efficient frontier to improve performance within the same risk reward characteristics, i.e. increasing return at the same risk level (up arrow) or reducing portfolio risk for the same return (left arrow) Captive Portfolio Optimizati on using Efficient Frontier Analysis Risk and Reward

10 year Asset Class Correlation Matrix Introduction to Captive Investments

Strategic Asset Classes (lower correlation) US bonds High Yield bonds Convertible bonds US equities International equities Emerging market bonds/equities Commodities, REITs, MPLS Hedge Funds Private equity, mezzanine debt Introduction to Captive Investments

Tactical Plan Implementation Introduction to Captive Investments

Tactical Asset Classes Fixed Income (Bonds) Treasuries Corporate Bonds Asset Backed Securities Mortgage backed securities Municipals, etc. High Yield Equities (Stocks) Large Cap Mid Cap Small Cap Growth vs Value Country/industry Introduction to Captive Investments

Security Level Risks- Bonds Credit –Downgrade –Default Interest rate (Duration) Liquidity Inflation Prepayment Reinvestment Convexity Currency Introduction to Captive Investments

Bond Market Mechanics Interest Rates and Prices Introduction to Captive Investments Interest Rates Bond Prices Interest Rates Bond Prices

Introduction to Captive Investments Duration 22 Defined: a measurement of the portfolio’s sensitivity to interest rate changes that approximates the % change in portfolio market value for a given % rate change Portfolio Duration = 3.5 years Duration Interest Rate ChangesPortfolio Market Value Changes 1% 3.5%

Introduction to Captive Investments Investment Manager Style Risks Equities- price volatility Tactical capitalization liquidity sector Strategic geographic political geographic Bonds–income volatility Duration Yield curve Sector Security

Introduction to Captive Investments Bond Manager’s Style Risks Probability of Success Potential Reward Strategy Toolbox Duration Yield Curve Sector Rotation Security Management Selection

Introduction to Captive Investments –Philosophy “Total Return” or “Yield Maximization” Active, passive or blended management –Process Top down or bottom up Alpha attribution: duration, yield curve, sector, security selection Style analysis Tax efficiency –Performance MPT Statistical assessment (Risk-adjusted return analysis) After-tax performance Adherence to guidelines Universe comparison –Personnel Insurance asset management experience Insurance regulatory, tax and accounting expertise Insurance Accounting and reporting capabilities –Client-specific criteria Execution of policy objective & adherence to guidelines and regulations Fees/Value for service Portfolio tax liability management Client service and other administrative responsibilities Accounting & Reporting efficacy Overall relationship efficiency Manager Selection Criterion

Introduction to Captive Investments Rolling Period Nominal Returns

Introduction to Captive Investments Nominal Vs. Risk- Adjusted Returns

Monitoring, Reviewing and Updating Captive Investment Programs Introduction to Captive Investments

Annual Program Review Incorporate changes in: –Operating conditions- underwriting, claims, premiums, reinsurance, fronting, etc. –Risk tolerance or investment objectives –Captive growth expectations, etc. Review and modify planning documentation –IPS/guideline or asset allocation changes –Rebalancing rules –Benchmarks, etc. Evaluation of manager performance Evaluation of overall program efficacy

Introduction to Captive Investments Evolving Strategic Asset Allocation 30 Mature Captive Advanced Captive New/Small Captive