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The fundamental purpose of insurance is to transfer the risk (uncertainty) of large financial losses. Investing insurance assets requires strategies that account for these uncertainties and their impacts on the investment horizon, liquidity, and cash-flows. In addition, insurance assets have multiple stakeholders with varying priorities which influence when, how, and where these assets may be invested.

Insurance Assets

Varying stakeholder priorities:

  • Policyholders
  • Regulators
  • Rating agencies

Taxes on income and realized gains.

Corporate cultures, risk tolerance, and organizational structure.

Impact on Investment Strategy

The “universe” of investible assets can be limited by domicile.

Capital allocation across capital markets and underwriting operations.

Taxes should be explicitly addressed by asset class.

Cardinal’s Approach

Economic Capital Model:

  • Constrained frontiers
  • Risk-based capital
  • ORSA support

Explicit consideration of taxes:

  • After-tax efficient frontiers
  • Active gain/loss management
  • After-tax performance reporting

Insurance Assets

Liability durations ranging from 3 months to 5+ years.

Varied cash-flows depending on timing of premium payments, reinsurance recoverables, and operational needs.

Impact on Investment Strategy

Incremental yield (carry) is earned for investing farther out the time horizon but downside risk from interim price volatility increases.  The cost and benefits of both must be balanced.

Cardinal’s Approach

Cash-flow modeling

Pro-forma financial projections

Stochastic and deterministic stress testing

Insurance Assets

Underwriting (and profit) cyclicality

Catastrophe exposures create unpredictable and sometimes significant liquidity needs

Impact on Investment Strategy

Imperative to know the cash needs of the enterprise for:

  • Ongoing underwriting operations
  • Catastrophe PMLs
  • Anticipated reinsurance recoveries (and timing)
  • Strategic capital projects
  • Required cushions or margins of error for the above categories

Cardinal’s Approach

Liquidity analysis and optimization of:

  • Investment cash flows
  • Underwriting cash flows
  • Lines of credit
  • FHLB membership
  • Public securities at gains or losses

Insurance Assets

Inflation can impact claims but varies depending on how premiums and pricing lag within each line of business.

Heavy fixed income portfolios react poorly to inflation.

Impact on Investment Strategy

Asset classes with low correlations to inflation are desirable.

Asset classes with low correlations to interest rates are desirable.

Cardinal’s Approach

Diversification analysis helps to determine which asset classes counteract exposure to inflation and interest rates.

Insurance Assets

Conflicting investment objectives:

  • Principal protection
  • Stable income
  • Surplus growth

Impact on Investment Strategy

Economic surplus should be optimized once all constraints are satisfied.

Cardinal’s Approach

Multi-variate optimization across:

  • Total return
  • Yield and investment income
  • Surplus growth
  • Downside risk
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