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Allianz Life Insurance Company of North America

Probability versus CertaintyWhat happens to your clients if you are wrong?

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For broker/dealer use only – not for use with the public.2

Add certainty to your client’s portfolio

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Risk and probability̶ Market theories ̶ Types of risk

The next 30‐years̶ A new paradigm ‐What has changed̶ Insurers advantage ‐ Pooling of risk

Certainty with a “protected core”̶ Wilshire proof points̶ How VA’s fit / create benefits for client ‐ Certainty

Why Allianz̶ Strength, conservative approach̶ Our product solutions


Risk and probability

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Many theories of investing / risk

Modern Portfolio Theory ‐ A theory on how risk‐averse investors can construct portfolios to optimize or maximize expected return based on a given level of market risk, emphasizing that risk is an inherent part of higher reward. According to the theory, it's possible to construct an "efficient frontier" of optimal portfolios offering the maximum possible expected return for a given level of risk. This theory was pioneered by Harry Markowitz in his paper "Portfolio Selection," published in 1952 by the Journal of Finance.

Capital Asset Pricing Model ‐ A model that describes the relationship between risk and expected return and that is used in the pricing of risky securities. The general idea behind CAPM is that investors need to be compensated in two ways: time value of money and risk. The CAPM says that the expected return of a security or a portfolio equals the rate on a risk‐free security plus a risk premium. If this expected return does not meet or beat the required return, then the investment should not be undertaken. The security market line plots the results of the CAPM for all different risks (betas).

Efficient Market Hypothesis ‐ An investment theory that states it is impossible to "beat the market" because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. Although it is a cornerstone of modern financial theory, the EMH is highly controversial and often disputed. Believers argue it is pointless to search for undervalued stocks or to try to predict trends in the market through either fundamental or technical analysis. Meanwhile, while academics point to a large body of evidence in support of EMH, an equal amount of dissension also exists. For example, investors, such as Warren Buffett have consistently beaten the market over long periods of time, which by definition is impossible according to the EMH.


Risk is expressed in many ways

What are Tail Events? Improbable events that cause significant portfolio effects

Statistically: Multi‐standard deviation eventsColloquially: Hundred year floods

1982 Mexican default1987 Black Monday, Dow drops 22.6%1989‐91 United States S&L crisis 1989‐91 Latin American debt crises1992‐3 European Monetary System crisis

1994‐5 Mexican peso crisis1997‐8 Asian financial crisis1998 Russian default and LTCM2001‐2 Argentine default, dot‐com bust, Enron2007‐9 Financial market meltdown

Examples: Major Financial Crises since 1980


Traditional Asset Allocation Approaches Ignore Tail Risk Events

Normal Distribution

“Fat-Tail” Distribution

GainsLosses

Higher Probability of Big LossesFr

eque

ncy

of E

vent

s

asset_allocation_review_12


SOURCE: PIMCO, Benoit Mandelbrôt: The (Mis)behavior of MarketsSample for illustrative purposes only.

Just how fat are fat tails?

Daily Change in DJIA 1916 – 2003 (21,924 Trading Days)

Daily Change (+/-)

Normal Distribution Approximation Actual

Ratio of Actual to Normal

> 3.4% 58 days 1001 days 17x

> 4.5% 6 days 366 days 61x

>7% 1 in 300,000 years 48 days Very Large


Risk is expressed in many ways

Advisor mindset

How did we get here?

Are we stuck in the old paradigm?


The Hierarchy of Distribution

Asset AllocationManager SelectionRate of Withdrawal

Is this the correct order?


Attribution during Distribution


Danger of paradigm

Why do we not consider proven alternatives? “Too expensive” “Unnecessary middle man” “It’s Stocks, Bonds and Cash – I can do better” “Redundant tax‐deferral” “I can do 5% withdrawals in my sleep”


The myth of withdrawals

Need some statement on ability to take 5% adjusted for inflation relative to longevityExample, There is an X% chance that a 65 year old will outlive their assets if they take a 5% withdrawal adjusted each year for inflationAttention grabberTransition to Wilshire


I think we need to add something about measurement. The accumulation paradigm has us measuring success against benchmarks like the S&P.

Distribution portfolios are easier to measure but success is harder to deliver. Distribution success is measured by portfolio longevity.How long will your money last at a given rate of withdrawal


Mathematics of Recovery

Bengen StudyTrinity Study‐4% ruleHarvard StudyAll concluded that in order to take inflation adjusted withdrawals from a volatile portfolio, you need to begin at 4% to ensure a portfolio life of 30 years.


Mathematics of Recovery

If you lose 25%, you need a 33% return the following year to get back to even.

However, if you are taking a 5% withdrawal, you need a 42.9% return to keep pace.

This assumes there are no fees


Sustainable withdrawal rates

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