Session 18, Tools for Evaluating Insurance Portfolio Investment Performance. Moderator: Peter C. Miller, FSA. Presenter: David L.

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Session 18, Tools for Evaluating Insurance Portfolio Investment

Performance

Moderator:

Peter C. Miller, FSA

Presenter:

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Your Global Investment Authority

Society of Actuaries 2015 Investment Symposium

Tools for Evaluating Insurance Portfolio

Investment Performance

26 March 2015

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pg 1

Your Global Investment Authority Your Global Investment Authority

Disclosures

This material is to be used for one-on-one separate account presentations to institutional investors only and not for any other purpose.

Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 949-720-6000

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pg 2

Biographical information

David L. Braun, CFA, FSA, FRM

Mr. Braun is an executive vice president in the New York office and head of the U.S. financial

institutions portfolio management team. He oversees management of fixed income investment

portfolios for both affiliated and non-affiliated bank and insurance clients. Prior to joining PIMCO in

2009, he was a derivatives portfolio manager and chief risk officer at Hartford Investment

Management Co., a division of The Hartford. Mr. Braun has over 21 years of investment, actuarial and

risk management experience. He holds an undergraduate degree in mathematics from the University

of Connecticut. He is also a Fellow of the Society of Actuaries and a certified Financial Risk Manager.

Peter Miller, CFA, FSA

Mr. Miller is a senior vice president in the New York office and an account manager focusing on

insurance clients. Prior to joining PIMCO in 2010, he was with The Hartford for nine years, working in a

variety of actuarial and investment roles including asset-liability management, portfolio management,

and variable annuity hedging. He has 13 years of investment experience and holds an undergraduate

degree in actuarial science from the University of Nebraska. He is also a Fellow of the Society of

Actuaries (FSA).

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pg 3

Your Global Investment Authority

Your Global Investment Authority Ins_asset_mgmt

How do investors measure success?

Typical approaches include:



Total return

–

Absolute returns

–

Returns relative to a target or benchmark



Accounting return

–

Book Income vs. Target

–

Book Yield vs. Target

–

New money rate vs. product pricing rate



Volatility is still a widely-used risk measure



Other data points such as quality, default experience , and tracking error are often used as supplemental risk measures

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pg 4

Management of insurance constraints

Insurance companies face multiple constraints



Regulatory investment constraints of state laws



Accounting constraints



Management of tax exempt income



Income budgets



Capital gain/loss management



Risk based capital considerations



Credit thresholds

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pg 5

Develop an appropriate benchmark to improve risk and business discipline

Objective: A well defined benchmark and guidelines are the primary tool in monitoring risk,

performance and ALM



Risk management:

The benchmark reflects the company’s overall risk appetite and sets a neutral risk setting for the

investment portfolio



Performance measurement:

An objective return level against which your portfolio manager can be measured



ALM:

A representative benchmark portfolio of securities with similar cashflow and risk characteristics of the liabilities

(e.g., duration, yield requirement, convexity, etc.)

The finer points:



Strike a reasonable balance between yield and total return



Avoid inappropriate sectors relative to the liability (e.g., MBS)



One size does not fit all (e.g., risk tolerances vary)



Should be straight forward, easy to implement, easy to adjust



Bottom Line: don’t let perfect be the enemy of good – custom benchmarks can be helpful in a number of ways

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pg 6

Objectives / characteristics



Generate stable accounting income that exceeds income

assumed in product pricing



Low turnover is typical (some call it “buy-and-hold”)



Performance measure = income vs. target

Rationale



“Investors in our company judge us on our current financial

statement performance so that is our focus.”



“I get one shot to price my liabilities and this is the

investment return I require to make my profit. I’m not

going to let speculative trading on the investment side ruin

my profitability.”

Objectives / characteristics



Generate excess risk-adjusted total return



Portfolio is rebalanced to always reflect your current

forward looking view of risk/return



View $1 of price return the same as $1 of income,

opening the investment universe



Performance measure = excess total return vs. a

market-based benchmark

Rationale



“The capital markets are fluid and conditions can change

materially over time, as such you must actively manage

your portfolio and look for return from multiple sources

in order to achieve success over the long run.”



“The accounting depiction of risk (capital) and reward

(book income) are manufactured measures which do not

represent true risk and reward.”

PIMCO_Insurance_mandates

Right answer is often somewhere in the middle and highly dependent on the client’s situation & book of business.

Sample for illustrative purposes only.

Refer to Appendix for additional investment strategy information.

What is the “right” way to manage an insurance portfolio?

Spectrum of approaches…

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pg 7

100% BOOK YIELD

100% TOTAL RETURN

Book yield managed accounts require book yield reporting

Bringing transparency to how we look to meet each portfolio’s objective



Book yield is an ideal measure of income performance because:

–

Book yield is a very close approximation to investment income;

–

It is a straightforward metric visible to PM’s and the client see every day;

–

It is not sensitive to changes in the size of the portfolio



Book yield oriented clients will have difficulty in assessing the manager’s

performance

–

The book yield attribution model adds a third dimension to the conversation

–

It improves the clients ability to assess our performance

–

Adds to our credibility as a manager of insurance assets



A falling or sustained low rate environment adds additional challenge to

managing income since the bias is lower

–

The roll-off of principal and reinvestment create a constant headwind

–

Active repositioning is discouraged by the inability to increase book yield

OBJECTIVE SCALE

The objective scale provides a simple framework to gauge each portfolio

Excess return

Gain/loss/risk

Book yield

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pg 8

Book yield attribution model

It’s an accounting exercise



The model seeks to explain the change in book yield for a given period

–

The model has three components:

• 1. Beginning and ending book value and book yield from the accounting source (the facts)

• 2. The attribution of the change in the period due to reinvestment, buys, sells, change in cash, etc

• 3. A similar attribution on a passive basis which removes the active trades and assumes index type reinvestment



The passive portion is not seeking to be a true book yield benchmark, but is intended to normalize the change against external

factors beyond our control, e.g., new money flows or maturities/pay-downs



The model components are explained below:



The net purpose of the model is to add transparency to the process and show the role of active management

Sample for illustrative purposes only.

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pg 9

Analysis of book yield changes

Sample Insurance Investment Grade Credit portfolio*

* The portfolio was chosen to illustrate all factors considered when calculating the attribution associated with book yield accounting. The Passive Estimate model utilizes the same portfolio but eliminates any actively managed positioning and instead reinvests capital into the underlying index. The example is intended to illustrate the variances associated with both active and passive management of an overall mandate. No representation is being made that any existing or proposed account will have similar results. The example shown is before any management fees. Past performance is not a guarantee or reliable indicator of future results. The representative account information presented is provided as supplemental information to the PIMCO Insurance Core Income Constrained Composite performance presentation included in the Appendix.

Hypothetical example for illustrative purposes only

Refer to Appendix for additional investment strategy and risk information.



Book yield increased by 4.5 bps to 2.95%; this was driven mainly by the net addition of spread product over the period



There were several large inflows into the portfolio during the period; this negatively impacted yield in the passive estimate by 6.3 bps



Higher investment rates over the period helped to diminish the degradation seen in the prior periods from reinvestment



The net result is the portfolio outperformed the passive estimate by over 12 bps

6693_Insurance_06-06-14

Passive estimate

Description _{contribution (bps)}Actual Bogie_YTW _{reinvestment (bps)}Passive _(bps)Net

Begin period Buy Sell

Change in cash

Paydown principal -0.48 2.96% 0.14 -0.34 Maturity payment 0.59 2.29% -0.88 -0.29

Call -0.13 2.22% -0.34 -0.47

Asset deposit -0.17 -0.17

Amortization/accretion 0.18 0.18

BY adjustments - CPR -0.02 -0.02

Residual

Cash deposit (Capital Change) 2.27% -6.33 -6.33 Cash withdrawal (Capital Change)

Interest payment 2.46% -0.67 -0.67

Total -8.10

Attribution of actual

Description Quantity Book _yield Contribution _(bps)

Begin period 1,825,782,970 2.90%

Buy 279,768,879 3.54% 9.7

Sell -18,400,478 4.06% -1.2 Change in cash 21,590,472 0.06% -3.4 Paydown principal -46,962,665 3.09% -0.5 Maturity payment -26,300,000 2.50% 0.6 Call -8,960,035 3.18% -0.1 Asset deposit 33,917,714 2.81% -0.2 Amortization/accretion -1,628,128 0.86% 0.2

BY adjustments - CPR 0.0

Residual -8,518,911 -0.7

Cash deposit (Capital Change) 181,812,986 Cash withdrawal (Capital Change) -13,800,000 Interest payment 27,410,903

Total 4.5



Book yield attribution provides transparency to the results from an

accounting perspective



The passive estimate provides an estimate which is normalized for external

factors such as new money and maturity payments

Acct(s) Account name Book value Book yield

9999 Sub portfolio 1 1,560,372,037 2.96%

9999 Sub portfolio 2 251,840,597 2.69%

9999 Sub portfolio 3 238,077,184 3.17%

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pg 10

Portfolio reporting: Market outlook, risk analysis, and performance

Mosaic approach to communicating to stakeholders



Market outlook

–

Forward looking outlook of global economy, technical flows in capital markets, and relative value differentials

–

Reconcile with how portfolios are positioned



Risk analysis

–

Detailed risk attribution — where is duration risk coming from? Where is credit risk coming from?

–

Changes — what were they, and why? Reconcile to market outlook.



Performance measurement/attribution

–

Did we generate total return alpha?

–

Did we generate book yield (income) alpha?

–

Attribution of both



Everything should hold together — necessary tradeoffs are illuminated for key stakeholders — highlights potential overreach

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pg 11



Insurance portfolios have a number of unique considerations with respect to performance and risk measurement



Traditional tools, even if imperfect, can still be helpful in illuminating risks and opportunities



Non-traditional tools also exist that address the unique needs of insurance asset managers



Insurance portfolio management is inherently complex – it cannot be boiled down into a single metric or approach – a

“mosaic” approach is recommended

http://www.pimco.com/EN/Insights/Pages/Can-You-Have-Your-Cake-and-Eat-It-Too.aspx

http://www.pimco.com/EN/Insights/Pages/Benchmark-Construction-for-Insurance-Company-Portfolios.aspx

Contact information

Peter Miller

David Braun

Phone: (212) 739-3062

Phone: (212) 739-3104

E-mail: peter.miller@pimco.com

E-mail: david.braun@pimco.com

Ins_asset_mgmt

Summary

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pg 12

Appendix

Past performance is not a guarantee or a reliable indicator of future results. FORECAST

Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.

HYPOTHETICAL EXAMPLE

Hypothetical and simulated examples have many inherent limitations and are generally prepared with the benefit of hindsight. There are frequently sharp differences between simulated results and the actual results. There are numerous factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results. No guarantee is being made that the stated results will be achieved.

INVESTMENT STRATEGY

There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for a long-term especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown.

OUTLOOK

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions, and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.

RISK

Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally

supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. Derivativesmay involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Investors should consult their investment professional prior to making an investment decision..

This material contains the current opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark or registered trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. THE NEW NEUTRAL and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Pacific Investment Management Company LLC in the United States and throughout the world. Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660, 800.387.4626. ©2015, PIMCO.

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