Delaware Captive Insurance Association 2016 Fall Forum Investment Considerations During Periods of Economic Uncertainty David Kilborn, CFA Patrick Theriault, CPA, CPCU, AIAF Chief Investment Officer Managing Director Performa Limited (US), LLC Strategic Risk Solutions (843) 297-4130 (802) 861-2630 dkilborn@performausa.com patrick.theriault@strategicrisks.com
Agenda 1) Developing a Successful Investment Program 2) Demographics and Benchmarking 3) Case Studies 4) Market Update & Outlook 5) Q&A 2
Developing a Successful Investment Program 3
How Captive Manager & Investment Manager Work Together Captive Manager • Captive Manager dual role: Captive Financial Controller + Regulatory Oversight • Typically has direct contact with Captive Board and Officers: ability to make recommendations • Positioned to share with client what captive peers are doing • Primary contact for other service providers including investment manager • Cash/liquidity tracking • Aware of potential impact on operation or regulation of certain investment types – works best when having regular communications with investment manager Investment Manager • Partnership approach with captive owners, captive managers and service providers • Offer customized solutions tailored to unique needs of each captive • Investment policy statement development and ongoing review • Discretionary management of investment portfolios • Portfolio design, development and execution • Comprehensive client reporting 4
Key to Success – Plan Ahead • Prepare investment plan at the time of captive approval • Develop a thorough and appropriate investment strategy that is tailored to each captive • Recognize that your captive has different investment objectives than mainline insurers, individuals and even your parent company’s pools of assets • Be aware of multiple layers of fees, lower liquidity (small position sizes) and unnecessary over diversification • Put your money to work: holding cash over and above daily operational or known liquidity needs has two distinct costs: 1) no income generation 2) value erosion from inflation 5
What Happens When You Don’t Have a Plan? … loss of potential income Breaking down $1,000 invested at 3% over 30 years • Holding $1,000 in cash for 1 Principal Coupon Interest-on-Interest 30 years means you start $2,443 $2,500 and end with $1,000 (dark blue bar): $2,105 $2,000 - no income generation $1,814 i.e. no coupon payments (green bar) $1,563 Nominal Dollars (US$) $1,500 $1,347 - also means no $1,161 compound interest $1,030 (light blue) $1,000 • However, investing $1,000 at 3% over 30 years could $500 earn $900 in coupon payments + $543 in Interest-on-Interest for a $0 total of $2,443 (vs $1,000 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 if your money sat in cash) Years 1 Example assumes $1,000 is invested at a fixed rate of 3% over 30 years. Source: Performa Limited (US) 6
Beware of the Inflation Trap… Cost of Cash Value of $1,000 Investment in Cash Adjusted for Inflation (using CPI 1 ) • Holding cash might $1,000 protect nominal value (black line), but sitting in $975 cash means losing real value (blue line) $950 • Over time, inflation Dollars (US$) $925 erodes purchasing power $900 $875 • Example – Holding $1,000 in cash since $850 2005 would result in a value of roughly $800 in $825 2015, adjusted for $802 inflation $800 Dec-04 Nov-06 Oct-08 Sep-10 Aug-12 Jul-14 Jun-16 Years Source: Bloomberg, Performa Limited (US) 1 US CPI (Consumer Price Index) Urban Consumers Less Food and Energy (Seasonally Adjusted) 7
Building an Investment Program Recommendations should incorporate both… Client Variables • Capital (i.e., current, target, surplus) • Risk tolerance & liquidity needs Client Structure • Stage of the captive life cycle • Ownership structure Portfolio Liabilities Construction • Claims history Built for • Domicile Current Stage Investment of the Life Portfolio Variables Policy & Objectives Guidelines Cycle • Portfolio diversification • Opinion of asset classes Asset • Review of strategy cost effectiveness Risk Allocation Tolerance Modeling • Performance analysis (past and future) • Forecasting: Market trends and interest rates 8
Asset Allocation through a Captive’s Life Cycle 9
Demographics and Benchmarking 10
Profile of SRS Captives 11
Profile of SRS Captives Number of Captives by Size Average Assets by Captive Size 1% 6% 3% 14% 10% 42% 14% 19% 61% 7% 20% 3% Less than $5M Between $5M to $15M Between $15M to $25M Between $25M to $50M Between $50M to $75M Greater than $75M 12
“Asset Allocation” By Captive Size Average Asset Allocation by Captive Size 100% 7% 90% 6% 80% 5% 70% 60% 4% 50% 3% 40% 30% 2% 20% 1% 10% 0% 0% LESS THAN $5M $5M TO $15M $15M TO $25M $25M TO $50M $50M TO $75M GREATER THAN $75M Fixed Income Equity Alternative Assets Money Markets Cash Average of Investment Return % 13
“Cash Breakdown” By Captive Size Average Cash Breakdown by Captive Size Class 100% 7% 90% 6% 80% 5% 70% 60% 4% 50% 3% 40% 30% 2% 20% 1% 10% 0% 0% LESS THAN $5M $5M TO $15M $15M TO $25M $25M TO $50M $50M TO $75M GREATER THAN $75M Unrestricted Cash Restricted Held in Trust Average of Investment Return % 14
“Asset Allocation” By Ownership Type 15
Case Studies 16
Case Study #1 Background • Onshore single parent captive formed in 2002 providing E&O liability coverage • Very conservative owner and management focused on preservation of capital to achieve fully insured status • Annual Premium roughly $1million providing excess coverage only • Great claims experience, current investable assets = $13.3 million • Only started investing liquid funds in late 2013, Bond Mutual Fund, currently about 23% of total investable assets • Handle all investment decisions internally / No outside manager The Good • Achieved goal of fully funded status • Avoided crash of 2008 • Minimal investment expenses The Potential Misses • Investment Committee duties are secondary responsibilities = slow response • Minimal to negative cash rate of return 17
Case Study #1 Investable Assets vs. Return $14 6.00% $12 5.00% Percent Return (%) $10 Millions ($) 4.00% $8 3.00% $6 2.00% $4 1.00% $2 $0 0.00% 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 Investable Assets Investment Return Investment Income $400,000 $350,000 $300,000 • Opportunity cost compared to $250,000 2% annual return = $685,000 $200,000 $150,000 • Opportunity cost compared to $100,000 2.5% annual return = $1,225,000 $50,000 $0 2015 2014 2013 2012 2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 18
Case Study #2 Background • Onshore Reciprocal formed in 2004 providing Medical Malpractice coverage in 6 states • Annual Premium roughly $13 Million / Current investable assets = $50 Million • Investment mix as of 6/30/16 • Cash: 9% / Bonds: 82% / Equities: 3% / MPLs: 2% / Private Investments: 3% • One primary third party manager • Extremely active Investment Committee, weekly meetings The Good • Detailed investment policy with conservative industry target returns • Regular investment policy reviews and Board reporting allowing the company to be responsive to market fluctuations • Expansion of investment policy has allowed for stabilization of overall returns The Potential Misses • Mix results with portfolio pocket money and market timing activities • Too much input from Investment Committee members at times? • Manager does not have oversight of all assets • Client was not familiar with side effects of alternative investments 19
Market Update & Outlook 20
Market Update & Outlook After seven years of easing, the U.S. Federal Reserve finally increased short- term rates from 0% in December 2015… • How do the following affect Captive Insurance portfolios going forward? – The path of Fed policy and overall interest rates? – The state of the U.S. economy: growth, employment, inflation? – Current financial market conditions? • How should Captive Insurers be best positioned? 21
2015 – The Year The Fed Finally Moved U.S. Treasury Curve Comparison • Beware the front-end, 12/31/2015 6/30/2016 8/31/2016 safety can be a trap 3.0% • While rates drifted 2.5% higher across the 2.0% curve since June... Yield 1.5% • …front -end has been 1.0% hit hardest 0.5% • Is this time for real? 0.0% The Fed is sending 1M 1Y2Y3Y 5Y 7Y 10Y 30Y Maturity signals… Source: Bloomberg, Performa Limited (US) 22
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