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IFoA Asia Conference Presentation - Investment Risk Management Under New Regulatory Framework

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IFoA Asia Conference Presentation - Investment Risk Management Under New Regulatory Framework

  1. 1. Investment Risk Management Under New Regulatory Framework Steven Yang Yu Muqiu Liu Redington Ltd 08 May 2015
  2. 2. Dramatic growth of insurance market 08 May 2015 2 139 160 211 305 388 432 493 564 704 978 1,114 1,453 1,434 1,549 1,722 2,023 0 500 1,000 1,500 2,000 2,500 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 PremiumswritteninbillionRMB Direct premium written in China Source: CIRC
  3. 3. 4th largest globally 08 May 2015 3 1,259 532 330 278 255 247 169 145 125 101 0 200 400 600 800 1,000 1,200 1,400 PremiumswritteninbillionU.S.dollars Direct premium written by countries 2013 Ping An Insurance is one of the 9 Globally Systematically Important Insurers (G-SIIs) in the world! Source: Statista
  4. 4. Opportunities but also challenges 08 May 2015 4 • Weak risk management capability • Low capital efficiency • Long-term investment not performing well • Customer complaints, mis-selling • High expenses
  5. 5. Agenda for this workshop 08 May 2015 5 • Regulations: C-ROSS • Key investment risks • Example strategies to manage risk • Equities • Credit • Interest rate • Conclusion: 4 key takeaways
  6. 6. C-ROSS 08 May 2015 6 Pillar I Quantitative Capital Requirements Pillar II Qualitative Supervisory Requirements Pillar III Market Discipline Mechanism Company Solvency Management One Supervision Emerging Markets Risk-Oriented with Value Consideration Institutional Characteristics Supervisory Pillars Supervisory Foundation
  7. 7. C-ROSS 08 May 2015 7 Quantifiable Risk Market Risk Interest Rate Risk Credit Risk Insurance Risk Investment Strategy
  8. 8. Multi-Dimensional Challenge 08 May 2015 8 Return on Capital Regulatory Capital Economic Capital Governance Surplus Volatility Liquidity
  9. 9. Investment Risk Management Framework 08 May 2015 9 Objective Measurement Quantification Action Return Expected return > Shareholder required return on capital Expected return on capital 13.5% -Required return on capital 12.0% Margin (Expected return less required return) 1.5% Risk / Capital Current capital > required capital Economic basis Current capital budget £1,150m - Required capital (VaR 99.5%) £1,020m Regulatory basis Current capital budget £1,300 Bring current capital in line with required capitalRequired capital (VaR 99.5%) £1,350 Liquidity The company should hold enough eligible assets to cover additional liquidity requirements in an adverse scenario Available liquid asset £400m - 5 year cashflows if lapse rate increases by 20% £250m Asset allocation target benchmark The current asset allocation is to be kept within +/- 5% of the target benchmark allocation Government bonds 20% 36.2% Allocate out of overweight assets into relatively underweight assets to bring in line with target benchmark allocations Corporate bonds 10% 10.5% Equity 35% 27.0% Property 5% 6.3% Other assets 30% 26.0% On track Within 10% of target Off track
  10. 10. Equity Risk Management 08 May 2015
  11. 11. Rationale 08 May 2015 11 Why investing in equities • Offers a decent level of positive risk premiums over the long term • Relatively liquid market • Match certain type of liabilities for institutional investors 0 500 1000 1500 2000 2500 3000 3500 4000 4500 5000 1980 1985 1990 1995 2000 2005 2010 UK Equity Total Return UK Gilts Total Return Inflation Source: Bloomberg, Redington
  12. 12. Downside Risk • Infrequent large drawdowns (>30%) • Frequently enough to be a problem in a portfolio context 08 May 2015 12 -100% -90% -80% -70% -60% -50% -40% -30% -20% -10% 0% 1927 1940 1954 1968 1981 1995 2009 S&P500Drawdownfrom priorpeak(%) Source: Bloomberg, Redington
  13. 13. Volatilities • Chinese equity market could also suffer significant volatilities (if not larger than developed market) on a daily basis 08 May 2015 13 -15.00% -10.00% -5.00% 0.00% 5.00% 10.00% 15.00% ShanghaiCompositeIndexDailyReturn(%) Source: Bloomberg, Redington 115 days of higher than 5% loss
  14. 14. Negative impact 08 May 2015 14 100% 120% 140% 160% 180% 200% 220% 240% 2014 2016 2018 2020 2022 2024 2026 2028 2030 2032 2034 5 year periods Target Equity Return >> 8.0% 9.0% 10.0% Capital Drawdown >> -10% 10.3% 11.3% 12.3% -15% 11.5% 12.5% 13.6% -20% 12.8% 13.9% 14.9% -25% 14.3% 15.3% 16.4% 20 year periods Target Equity Return >> 8.0% 9.0% 10.0% Capital Drawdown >> -10% 8.6% 9.6% 10.6% -15% 8.9% 9.9% 10.9% -20% 9.2% 10.2% 11.2% -25% 9.5% 10.6% 11.6%
  15. 15. Solutions 08 May 2015 15 Diversification Downside protection Risk Control “Risk Management should be put in place in the good times to have most effect in the bad times”
  16. 16. 5.00% 5.50% 6.00% 6.50% 7.00% 7.50% 8.00% 1.5% 3.5% 5.5% 7.5% 9.5% 11.5% 13.5% 15.5% 17.5% 19.5% EXpectedReturn Risk (measured by standard deviation of annual returns) Efficient Frontier 1. Diversification 08 May 2015 16 Concentrated equity portfolio 50% DM Equity 10% EM Equity 30% Alternatives 40% DM Equity 0% EM Equity 60% Alternatives 50% DM Equity 30% EM Equity 20% Alternatives 20% DM Equity 80% EM Equity 0% Alternatives Source: Redington
  17. 17. 2. Risk Control 08 May 2015 17 Source: Bloomberg, Redington Volatility controlled equities provides greater exposure to equity markets at times of low volatility and reduces equity exposure at times when markets have higher volatility and in general: -Equity volatility rises when equities fall -Equity volatility falls when equities rise Equity volatility 100% exposure 67% equity exposure (as equity vol is 15%) 15%*0.67 = 10% 125% equity exposure (as equity vol is 8%) 8%*1.25 = 10% Time 0% 20% 40% 60% 80% 100% 120% 140% 160% 1999 2001 2003 2005 2007 2009 2011 2013 % Allocation in Equity 15% 10% 8%
  18. 18. 2. Risk Control 08 May 2015 18 0% 10% 20% 30% 40% 50% 60% 70% AnnualizedVolatility(%) MSCI World Index Daily Net TR Local MSCI World Volatility Controlled Index -40% -30% -20% -10% 0% 10% 20% 30% 40% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 AnnualPercentageReturn MSCI World MSCI World Volatility Controlled IndexSource: Bloomberg, Redington
  19. 19. 3. Downside Protection 08 May 2015 19 Payoff Equity value Equity Equity + 90% Put Source: Redington
  20. 20. Performance 08 May 2015 20 0 50 100 150 200 1999 2002 2005 2008 2010 2013 MSCI World Index MSCI World Vol Control (10% Vol) Index MSCI World Vol Control (10% Vol) with Put (90% strike) Source: Bloomberg, Redington
  21. 21. Credit Optimization 08 May 2015
  22. 22. Why credit optimization 08 May 2015 22 Credit Optimization Liability Matching Valuation discount rate Capital Charges Economic Return
  23. 23. Chinese fixed income market 08 May 2015 23 • Primarily driven by government related bonds; • Growing demand and supply of corporate and SME bonds. • Diversity of ratings and maturities. 9708 9591 6168 3390 2924 1764 1162 757 422 0 2000 4000 6000 8000 10000 12000 Policy Bank Bonds Ministry of Finance Bonds Others Medium-Term Notes Enterprise Bonds Commercial Paper Local Gov't Bonds Corporate Bonds Central Bank Notes RMBbillion The size of various sectors of the market Source: Wind
  24. 24. Dynamics within credit market 08 May 2015 24 -100.0 0.0 100.0 200.0 300.0 400.0 500.0 600.0 700.0 800.0 CreditSpread Aaa Aa A Baa -100.0 0.0 100.0 200.0 300.0 400.0 500.0 600.0 700.0 800.0 CreditSpread Maturity[1,3) Maturity[3,5) Maturity[5,7) Maturity[7,10) Maturity[10,15) Maturity[15,) Source: Barclays POINT, Redington
  25. 25. How to do credit optimization 08 May 2015 25 Return on Economic Capital Credit risk premium Required capital Numerator Denominator Credit Risk Premium Capital Required Maximise expected returns. Maximise implied illiquidity premium in bonds. Reduce regulatory capital requirement. Reduce economic risk i.e. Surplus at Risk
  26. 26. How to do credit optimization 08 May 2015 26 Source: Barclays POINT, Redington 1 - 3 Years 3 - 5 Years 5 - 7 Years 7 - 10 Years 10 - 15 Years > 15 Years AAA 0.3% 0.2% 2.1% 1.9% 0.4% 0.3% AA 3.2% 2.5% 3.6% 2.7% 5.4% 0.7% A 5.4% 3.6% 7.4% 5.3% 2.4% 0.8% BBB 5.9% 5.6% 5.5% 3.5% 2.8% 1.9% Capital Efficiency (Return on Economic Capital)
  27. 27. How to do credit optimization 08 May 2015 27 Objective Before Optimization After Optimization Return Expected return > Shareholder required return on capital Credit spread 1.5% Credit spread 2.2% Minimum illiquidity premium required 1.0% Minimum illiquidity premium required 1.0% Credit spread after default allowance 1.1% Credit spread after default allowance 1.7% Risk / Capital Current capital > required capital Economic basis £1,050 million Economic basis £1,070 million Regulatory basis £1,350 million Regulatory basis £1,280 million Liquidity Hold enough eligible assets to cover liquidity requirements in an adverse scenario 1 year net cashflow £80 million 1 year net cashflow £80 million 1 year net cashflow under stress £20 million 1 year net cashflow under stress £20 million Asset allocation target benchmark The current asset allocation is to be kept within +/- 5% of the target benchmark allocation AAA 5% AAA 1% AA 30% AA 10% A 40% A 55% BBB 25% BBB 34% Non-Investment Grade 0% Non-Investment Grade 0%
  28. 28. Other fixed income investments 08 May 2015 28 • Long dated cashflows • Diversifier • Exposure to residential property Equity Release Mortgages • Return pick up • Well collateralized Infrastructure debt • Inflation protection • Return pick up • Exposure to commercial property Secured leases
  29. 29. Managing Interest Rate Risk 08 May 2015
  30. 30. Why Manage Interest Rate Risk? 08 May 2015 30 Interest rates fall Liabilities PV increases Surplus falls 10 years £100 £61 £82 Today 2% 5% £100 (1 + Rate)time = Present Value
  31. 31. Why Manage Interest Rate Risk? 08 May 2015 31 Interest Rate Risk Management Duration Mismatch Capital Requirement Surplus Volatility Unrewarded Risk
  32. 32. Why Manage Interest Rate Risk? 08 May 2015 32 0 1 2 3 4 5 6 7 1/1/2007 1/1/2008 1/1/2009 1/1/2010 1/1/2011 1/1/2012 1/1/2013 1/1/2014 1/1/2015 Falling interest rate in major developed countries - 10Y swap rate JPY Swap USD Swap GBP Swap CNY Govt Source: Bloomberg, Redington
  33. 33. How Could You Manage it? 08 May 2015 33 PV01 (£’m) Maturity5040302010 Liabilities Swaps Government bonds Corporate bonds 12 4 4 4 15 4.5 5 5.5 4.5 19 3 11.5 8 15 2 11 1 5.5 1 0.5 7
  34. 34. Economic vs. Regulatory 08 May 2015 34 Economic Regulatory Risk (VaR 99.5%) £70m £45m Risk Budget £75m £50m 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 0 5 10 15 20 25 30 35 40 45 50 55 60 Risk free Interest Rate EUR Swap UFR
  35. 35. Conclusion: 4 key takeaways • Strong need of risk/capital management practices • Investment strategy in the context of ALM • People, system and process • Constant learning and dynamically adapt to changes 08 May 2015 35
  36. 36. 08 May 2015 36 Expressions of individual views by members of the Institute and Faculty of Actuaries and its staff are encouraged. The views expressed in this presentation are those of the presenter. Questions Comments

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