Investing for the future
Paul Nealon, chief investment officer, Ariel Re
Is your company thinking opportunistically about investments, considering the shifting capital requirements framework?
We continually evaluate our investment allocation in the context of satisfying a number of capital requirements, including regulatory, rating agency, shareholder, etc. In our case, we continue to have ample capital and seek to invest to optimise our risk-adjusted return on that capital. The shifting capital requirements framework isn’t a major factor in our thinking about investments, as its impact is on the margin and is consistent with the investment allocation decisions we would already have made based on our prior capital situation. That being said, we do have additional capital to invest, although the investment environment has become more challenging given the return experience in 2009.
How are you dealing with the current yield environment?
We are essentially at a risk-neutral position relative to our investment policy limits and will look for opportunistic investment situations on the margin. We remain cautious about a broad-based increase in risk, especially given how far the markets have come over the past year. That being said, we continue to see pockets of opportunity in the markets, but they are few and far between. We still like some areas of the securitised fixed income market, as well as some emerging markets opportunities we are exploring. We have a modest allocation to hedge funds that have performed well and that we expect to maintain. We expect yields to remain low for the remainder of 2010, but with upward pressure on rates given the economic environment.
Are you paying closer attention to the impact that the investment process has on GAAP ROE and statutory solvency considering the current environment?
"Our investment portfolio has been constructed to ensure that it is appropriately matched with our reinsurance liabilities."
Again, we are in the fortunate position of being well capitalised, so considerations of the investment process relate less to solvency and more to GAAP ROE. In addition, we account for our investment portfolio on a trading basis, so changes in unrealised gains/losses flow through our operating income, creating some level of volatility in earnings. However, we pursue a conservative investment strategy, with much of the portfolio invested in short-duration, high-quality debt securities. The result has been a favourable contribution to the earnings of the company, and we do not expect that to change in spite of the challenging investment environment.
Mark Byrne, chairman, Flagstone Re
Is your company thinking opportunistically about investments, considering the shifting capital requirements framework?
We are being fairly conservative, requiring 85 percent of assets to be in highly liquid, investment-grade fixed income. The remaining 15 percent is invested somewhat opportunistically, but still with a bias towards liquid instruments versus, for example, alternatives.
How are you dealing with the current yield environment?
First, we are reducing our return forecasts for the portfolio and the business. This leads to some preferences regarding lines of business, as many longer-tail lines don’t make sense when the value of float is as low as it is now. We have a fairly short duration, very high credit quality— so the yield will not be much for the next few quarters at least.
Are you paying closer attention to the impact that the investment process has on GAAP ROE and statutory solvency considering the current environment?
On the GAAP ROE, yes. Rather than increase operating leverage to preserve returns, we have instead decided to keep operating leverage the same and lower our expectations for a couple of years. Statutory solvency and rating agency solvency are heavily driven by value-atrisk (VaR) constraints, and in a company like ours, with 50 percent of business in diversified property/catastrophe exposures and a highly conservative investment portfolio, at least 90 percent of the VaR is a function of underwriting, rather than investment risk. So the investment risks are not a huge part of the solvency calculation.
Andrew Cook, chief financial officer, Harbor Point Re Is your company thinking opportunistically about investments, considering the shifting capital requirements framework?
The changing regulatory environment is an important factor to consider when a company is developing its investment policies; however, there have always been rating agency capital charges associated with a diversified investment portfolio. Further, our investment portfolio has been constructed to ensure that it is appropriately matched with our reinsurance liabilities. It must also demonstrate sufficient liquidity and credit quality in order to satisfy our obligations to our business partners. Therefore, we maintain a fixed income investment portfolio that is very high quality, short duration and well diversified in terms of individual names and sectors.
How are you dealing with the current yield environment?
"Understanding what has changed and how the market operates today is a key consideration in appropriately framing asset allocation."
In the current environment, a company must cautiously weigh the incremental pickup in yield by extending duration or credit quality with the overall uncertainties facing the global economy. We clearlyunderstand the need to enhance yield, but capital preservation is much more important to us, particularly in these volatile times. When we see opportunities, we act on them. As an example, early last year, we invested heavily in the US government-backed Temporary Liquidity Guarantee Program, where we could add three-year corporate yields with a government guarantee. We see some value in putting modest amounts of cash to work in the one to two-year section of the curve, where we can pick up some yield by extending duration into the steepest part of the curve. The short duration nature of the trade will also limit the potential for realising any capital losses.
Jason Pratt, senior vice president and chief investment officer, Montpelier Group
Is your company thinking opportunistically about investments considering the shifting capital requirements framework?
Montpelier has developed an asset allocation format that we believe complements our business model, noting that we have had an eye on Solvency II for quite some time. We consider ourselves ahead of the new regulatory initiatives and, as a result, there are no meaningful challenges we foresee with the structure of our asset allocation. Recent periods, beginning with 2003 through mid-2007, coupled with the volatility of 2008 and 2009, offered a number of lessons about how risk is transferred in the capital markets.
I think understanding what has changed with how the market operates today is a key consideration in appropriately framing asset allocation. How are you dealing with the current yield environment?
The yield environment is a challenge, but it’s not something that is unique to Montpelier or the reinsurance industry. The larger issue would appear to be whether or not current market yields fairly represent implied risk. US mortgage and shorter maturity corporate bonds were looking fairly rich at year-end. Now that we have officially crossed into 2010, we do think more volatility is likely, and therefore there is a good chance that additional yield may be available as the year progresses. Inflation will certainly continue to be discussed, but it will likely take some time to show itself. One of the big challenges of the current environment is that the issues impacting yields and performance now, more often than not, go beyond fundamental analysis.
Are you paying closer attention to the impact that the investment process has on GAAP ROE and statutory solvency considering the current environment?
I don’t think we are unique among our peers, because we focus predominantly on growing book value per share. Given that we account for our portfolio on a trading basis, which means that both realised and unrealised gains and losses hit our income statement, our investment portfolio and performance are very much an open book. It demonstrates our comfort with our asset allocation and focuses on how our investment approach seeks to complement our underwriting efforts.
Joe Roberts, chief financial officer, Max Capital Group
Is your company thinking opportunistically about investments considering the shifting capital requirements framework?
We don’t anticipate that regulatory changes will result in us making any fundamental changes to our investment approach, as Max retains more than enough capital to satisfy the new requirements. Our investments are conservatively managed on a total return basis, duration matching assets with known liabilities. We carefully structure our fixed maturities portfolio with a view to ensuring liquidity and preserving capital, and we reduce risk by proactively repositioning our allocations. We believe this approach, and our ongoing focus on fundamental credit and risk analysis, assures the high quality of our investments.
How are you dealing with the current yield environment?
Our existing fixed maturities portfolio is benefiting from picking up a reasonable yield. For the investment of new cash, however, it is more difficult in the current low interest rate environment. For a portion of our new investments, we are looking to go further out on the investment spectrum to access higher yields. Market dislocations seem to have provided the opportunity to invest in undervalued assets at very attractive rates. Overall, we remain defensive, with a higher than normal cash balance, to some extent sacrificing current income and ROE to protect book value in the face of almost inevitable increases in interest rates.
Are you paying closer attention to the impact that the investment process has on GAAP ROE and statutory solvency considering the current environment?
We continually seek to employ investment strategies that reduce investment volatility, which must be recognised through the income statement and hence impact GAAP ROE. In addition, a portion of our fixed maturities portfolio is categorised as ‘held to maturity’, a designation that prevents fluctuations in the market value of those assets from impacting the income statement, ROE and book value, hence serving to reduce volatility.