Investing Wisely

Q: What are the key issues insurers face in terms of portfolio/investment management, and how are carriers addressing those issues?

A: Matti Peltonen, New York State Insurance Department: Traditionally, insurers invest predominantly in bonds, so I think the biggest problem right now is the low yields they are experiencing due to low interest rates and thin corporate spreads. This is forcing insurers to take more risk. For example, they might extend asset duration to expand to riskier asset classes (such as hedge funds and limited partnerships), or buy bonds with risky structures such as embedded derivatives. Insurers are largely buy-and-hold investors, so volatility, for them, is not a big risk. I'm not sure risk itself is any more complex today; rather, our awareness of that complexity has increased, and opportunities for better methods to deal with it have developed. Additionally, regulation is a fact of life in the industry - insurers and regulators have to create cost-effective tools and processes to accommodate the requirements for consumer protection. In the end, better transparency serves all parties concerned.

A: Alton Cogert, Strategic Asset Alliance: Today's investing environment is one of increasing complexity. Basic challenges include obtaining adequate yields and/or returns for the risks being taken. Depending upon a company's unique circumstances, our studies have found a need to reconsider current interest rate and credit risk stances in the portfolio, as well as the current allocation to more volatile investments like equities or alternative assets.

A: Harry Rose, Eagle Investment Systems: As the insurance market becomes increasingly regulated, insurance firms are demanding systems that support all of their statutory, GAAP [Generally Accepted Accounting Principles] and tax accounting requirements. They also want drill-down capabilities so they can reveal various components of transactions, such as trade close dates, pricing information, etc., and they want flexibility and operational efficiency. Firms are investing in systems that allow new investment instruments to be added quickly and easily as well as systems that eliminate timely and costly manual processes.

A: Douglas Long, Principia Partners: A major challenge facing insurers is the increasing stringent regulatory environment as it relates to financial risk, transparency and corporate governance. Compliance puts great pressure on investment managers to more tightly integrate trading, risk, operations and accounting processing for all financial assets and liabilities as well as associated derivatives. This approach is evident as insurers are beginning to adopt capital market models for valuation and risk management. A centralized, unified portfolio management platform mitigates operational risks and costs by reducing the potential for human error and data inconsistencies. On the product side, a major trend is the rapid adoption of credit derivatives by the insurance industry. As a result, many firms are gearing up their systems to capture, risk manage and account for the variety of vanilla and complex credit derivatives.

Q: How can portfolio management systems and related technologies help insurers better manage, track and report on investments and financial performance?

A: Peltonen, New York State Insurance Department: Better technology (such as portfolio analysis and asset/liability management systems) should help insurers to understand their risks and anticipate how their assets and liabilities perform under different market scenarios. The key for insurers is to pick their spots, choosing steps in technology that truly improve risk management and asset management processes. It wouldn't be wise for them to simply adopt every new system that comes along.

A: Long, Principia Partners: Data integrity is a major source of many operational challenges. A portfolio management system that can manage both sides of the balance sheet along with vanilla and complex derivatives throughout entire product life cycles will offer significant time and cost-saving advantages. For example, when assets, liabilities and derivatives are modeled on multiple systems before feeding into a single risk engine or accounting system, this can result in "model noise" and data inconsistencies. Another consideration when managing multiple systems or spreadsheets is the ability to have deal transparency and precise audit control, key requirements of the Sarbanes-Oxley Act.

Q: What are the strategic and technological implications for insurers of the new risk-based capital (RBC) standards being developed by the National Association of Insurance Commissioners (NAIC)?

A: Peltonen, New York State Insurance Department: The RBC standard is a factor when insurers take risk via their investment, hedging and policy-writing decisions. It's important that the standard keeps pace with developments in capital markets - and risk management technology - so the RBC does not result in misguided decisions. As the instruments become more complex, the simple classifications between bonds, equities, real estate, etc., are no longer sufficient, so it is important that the RBC standard keeps up. As a result, insurers should be able to make decisions that derive from their business needs and risk-taking appetite. As for technology, the RBC standard is just one factor in an already complex equation - with which the technology must keep up.

A: Cogert, Strategic Asset Alliance: The NAIC, like the banking regulators, has talked about, in some instances, allowing insurers to use their own analytical systems to suggest proper required capital. Should this fully materialize, for many insurers, it would place a large burden on companies to significantly improve their risk management capabilities. This may be a good thing, as it would cause insurers to focus on better risk management. However, an unintended consequence may occur as something like "teaching to the test" occurs - the insurer may simply produce a result it believes can be justified to regulators, while de-emphasizing the importance of producing the most accurate result.

A: Long, Principia Partners: The adoption of capital market risk management and portfolio composition techniques enables insurance firms to control inefficient capital utilization. In the capital markets model, financial companies can apply for relief from burdensome regulatory capital requirements by demonstrating effective market, credit and operational risk management. The risk-based capital approach to calculating capital adequacy provides economic benefits to firms that take the time to categorize and analyze risks.

Q: How can a straight-through processing (STP) approach to investment operations benefit insurers?

A: Peltonen, New York State Insurance Department: A better integrated trading and processing environment is naturally beneficial, but automating and integrating the process has been improving for a long time. Further improvements will create marginal impact. Insurance companies are different from financial intermediaries - their turnover is far lower, which would tend to reduce the impact of STP for them.

A: Rose, Eagle Investment Systems: Straight-through processing has emerged as a priority in the investment management operations of insurance firms. They are striving for more operational efficiencies to eliminate manual processes in order to shorten the closing period of their investment accounting information. In doing this, they reduce the risk of manual error and save resources, time and money when implementing new streamlined systems. The two items getting in the way of achieving STP are budgets and resources. Firms need to invest in newer technologies and properly test these technologies to ensure their effectiveness.

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THE EXPERTS: Portfolio Mgmt.

Matti Peltonen

Chief Risk Management Specialist, Capital Markets Bureau

New York State Insurance Department

(New York)

Alton Cogert

President

Strategic Asset Alliance

(Bellingham, Wash.)

Harry Rose

Eagle STAR for Insurance Product Executive

Eagle Investment Systems

(West Hartford, Conn.)

Douglas Long

EVP - Business Strategy

Principia Partners

(Jersey City, N.J.)

Peggy Bresnick Kendler has been a writer for 30 years. She has worked as an editor, publicist and school district technology coordinator. During the past decade, Bresnick Kendler has worked for UBM TechWeb on special financialservices technology-centered ... View Full Bio