Asset Liability Management and Investment Seminar May Session1: Asset Allocation for Insurance Company Liability Driven Investment.

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Asset Liability Management and Investment Seminar

May 2012

Session1: Asset Allocation for Insurance Company –

Liability Driven Investment

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Asset Liability Management

Liability Driven Investment

Asset Liability Management

Liability Driven Investment

Genghui Wu FSA, CFA, FRM, MAAA Senior Investment Vice President Prudential Financial

Typical Financial Institution Balance Sheet

2

Liabilities

Assets

Cash

Bonds

Mortgages

Stocks

Other

Deposits

Reserves

Life Insurance

Annuities

Long Term Care

Structured Settlements

Assets supporting product liabilities Product Liabilities

Surplus /

Assets  Solvency Insurance  Value to Shareholders

=

Surplus /

Equity

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Surplus

 Surplus is the net of assets less liabilities, or the net worth of the company. It is viewed as a measure of the financial strength of the company

 Insurance companies are required by state laws to hold a certain amount of funds in reserve to ensure they always have enough money on hand to pay claims and other obligations. Any amount over and

above the required reserve level is Surplus

3 above the required reserve level is Surplus.

Surplus Creation

Interest/dividends earned on investments Asset Management Fees Sales Fees Higher premiums than claims paid Surrender charges from cashed‐in policies

$

urplus

 Sign of Profitability / Financial Strength  Mechanism for paying dividends  Used to lower premiums to attract new business and retain existing business  Business growth via acquisitions

Surplus Significance

ALM – Liability Driven Investment

4 

Portfolio construction is liability‐driven. Asset Liability Management is strongly

aligned with the business units it supports.

 Emphasizes a deep understanding of product liability structures

 Emphasizes a deep understanding of product liability structures  Tight duration management with limited intentional exposure to interest rate risk 

Well‐diversified across asset classes, industry sectors, geographic regions, and

issuers



There are meaningful risk mitigating factors in credit portfolio:

 Underweight in troubled sectors

 High Yield exposure weighted towards higher quality and asset‐rich sectors; emphasis on

Proprietary Information ‐ Not for Further Distribution  High Yield exposure weighted towards higher quality and asset rich sectors; emphasis on allocations to private placements with strong covenant packages and ability to restructure  Exposure to commercial mortgages: Diversification with strong overall debt service coverage and modest loan‐to‐value ratios  Within structured securities, focus on the most highly rated tranches

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Proprietary Account Investment Process

IDENTIFY BUSINESS NEEDS

BU #1 BU #2 BU #3 BU #4 BU #5 ………

Profit Centers 5 ALLOCATE ASSETS & OVERSEE ENTIRE PROCESS Asset/Liability Management (ALM) MANAGE THE

ASSETS Bonds Mortgages Equity Alternatives Real Estate …. Asset Management Units

How ALM Constructs Investment Policy

Communicate Product Characteristics & Design Provide Market Intelligence Spreads PROFIT CENTER INVESTMENT UNITS 6 Expected Cash Flows Client Options Pricing Strategy Competitive Considerations Importance of Income vs. Capital Gains Recommended Duration Deal Flow Research Leverage Competitive Investment Strengths Credit Research Regional Presence Direct Origination Flexibility Asset Mix Income Impact Economic Return Surplus Volatility Capital Requirements Liquidity ASSET / LIABILITY MANAGEMENT Flexibility Interest Rate Risk Management Product Pricing Support Investment Policy A Policy Statement determines types of assets to include in portfolio and the level of risk.

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1 Strategy Investment Objectives and Risk Appetite

Components of ALM and Investment Management Framework

“Best Practices” Model ‐ Asset / Liability Management

7 2 Execution Liability

Measurement SAA TAA

Asset Manager

Selection Rebalancing Performance Monitoring and Reporting

Capital and Risk Management Strategy ALM Policy Review of Asset Allocation 3 IT Tools, Performance Controlling, Settlement/Accounting Governance/Organization and Talent Management Performance Monitoring and Reporting Risk Management Organization 4 Systems Support

ALM Control & Reporting Framework

•Daily Trade Review & Authorization •Segregation Between Trading & Operations •Asset Liability Management •Strategic and Tactical Asset 8 Board of

Directors CIO ALM

Asset Management Units Public Trading Units Private Origination Units Investment Policy Delegation of Authority Approval of Policies and Limits Investment Policy Statements Performance Reporting vs. Benchmark Operations •Formal Credit Allocation •Performance Measurement Risk Management Group Approval Process •Ongoing Credit Monitoring Ensures Risks are Within Guidelines & Limits Performs Risk Analysis & Measurement Establishes Risk Guidelines and Limits Management Reports

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Investment Objectives and Constraints

Goals

 Capital Preservation  Minimize risk of real loss

Constraints

 Investment Policy  Fiduciary Responsibility 9  Capital Appreciation  Growth of the portfolio in real terms to meet future needs (liabilities)  Current Income  Focus on generating income rather than capital gains  Fiduciary Responsibility  Regulatory  Economic  Liquidity Needs  Geopolitical  Total Return  Increase portfolio value by capital gains and by reinvesting current income  Maintain moderate risk exposure  Generate surplus  Time Horizon  Tax Concerns

Disclosure

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These materials represent the views, opinions and recommendations of the author(s) regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced herein. Distribution of this information to any person other than the person to whom it was originally delivered y p p g y is unauthorized, and any reproduction of these materials, in whole or in part, or the divulgence of any of the contents hereof, without prior consent of Prudential is prohibited. Certain information contained herein has been obtained from sources that the author believes to be reliable as of the date presented; however, we do cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. Prudential has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or any investment management services and should not be used as the basis for any investment decision Past performance is not a services and should not be used as the basis for any investment decision. Past performance is not a guarantee or a reliable indicator of future results. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this report. The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients or prospects. No determination has been made regarding the suitability of any securities, financial instruments or strategies for particular clients or prospects. For any securities or financial instruments mentioned herein, the recipient(s) of this report must make its own independent decisions