May 2015

SA Insurance Conference Optimal asset allocation under SAM

Agenda

1. Investment challenges faced by SA insurers

2. Balance sheet management considerations

3. SAM as an economic capital framework

4. Deep diving into credit

5. Illustrative SAM efficient frontier

6. Concluding remarks

Investment challenges faced by SA insurers � Managing balance sheet volatility as a result of investment risk

� Economic and regulatory capital efficiency

� Interest rate and inflation protection

� Yield enhancement

� Managing liquidity

� Stringent reporting requirements under SAM

� Governance and resources to manage investment risks with a holistic balance sheet management mind set

Challenges we are aware of

Overarching Challenge

Investment strategy considerations

Expe

cted

re

turn

Economic risk

Expe

cted

re

turn

Economic risk

Liability matching

70%

Return seeking

30% Liability

matching 0%

Return seeking

100% Asset

allocation

Risk budgeting

Traditional approach BSM approach

SAM places emphasis on efficient capital management of investment portfolios

Additional challenges faced by SA insurers • SAM Standard formula approach: “One size fits all”?

• Scale of business and resources required to implement efficient balance sheet management?

The ‘elephant in the room’…

How important is this in the SA context? SAM QIS3 findings – attribution of Market Risk SCR

Life insurers Non-life insurers

FSB QIS3 results Source X

28%

100% 67% 4%

11% 14% 10% 2% 35%

14%

100%

61% 1% 10%

26% 20% 33%

A multi-disciplinary investment team and a core focus in the management of credit-backed portable alpha strategies

Asset class comparison

0%

10%

20%

30%

40%

50%

60%

70%

Mar

ket R

isk

SCR

Market Risk SCR per Asset Class (excluding diversification benefit) 0.7% 1.6% 4.0% 1.6% 4.5% 4.5% 5.0% 6.0% 6.3% Return above cash

100% SA Equities

30% SA Equities, 70% Money Market

100% Money Market

0%

1%

2%

3%

4%

5%

6%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

Expe

cted

Ret

urn

abov

e ca

sh

SCR

Traditional asset allocation

100% SA Equities

30% SA Equities, 70% Money Market

100% Money Market

10% SA Equities, 32% IG Credit, 28% HY Credit, 30%

Money Market

10% SA Equities, 49% IG Credit, 11% HY Credit, 30%

Money Market

0%

1%

2%

3%

4%

5%

6%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%

Expe

cted

Ret

urn

abov

e ca

sh

SCR

Optimised asset allocation

Addition of credit has improved insurers investment return per unit of capital

Mezzanine debt

Preferred equity

Common equity

Senior unsecured debt (including bonds)

Senior secured debt (including loans)

Highest recovery rate and security

Lowest recovery rate and security

Corporate capital structure SAM QIS 3

Capital charge

~15-43%

~15-43%

~43-50%

5-25%

5-25%

SAM perspective on investing across the capital structure

Consider seniority, security and diversity of credit relative to equity exposure

4% 5% 6% 5% 12% 5% 4% 4% 11% 11% 4% 6% 7% 7%

32%

7% 6% 3%

42%

25%

0% 9% 11% 0%

14%

12% 1%

0%

32%

3%

0

5

10

15

20

25

30

35

40

45

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

SOE (Govtguarantee)

(Mod Duration6)

SOE Bonds(non govt

guarantee)(Mod Duration

4)

Muni Bonds(Mod Duration

4)

Big 4 Banks(Mod Duration

3)

Banks (ex Big4) (Mod

Duration 2)

FinancialServices (Mod

Duration 2)

IG Corp Bonds(Mod Duration

2)

IG Corp Loans(Mod Duration

3)

HY Corp Bonds(Mod Duration

1)

HY Corp Loans(Mod Duration

4)

Num

ber o

f Iss

uers

in S

ecto

r

Cred

it Ri

sk S

CR (S

prea

d +

Defa

ult +

Con

cent

ratio

n)

Spread Risk Default Risk Concentration Risk Number of Issuers

Deep diving into credit Source of credit SCR per credit sector

Return above cash 77 118 194 137 295 149 159 162 400 450

* IG and HY Corporate loans proxied by Ashburton SACCIF

Deep diving into credit Impact of diversification on credit risk SCR

0%

10%

20%

30%

40%

50%

60%

70%

80%

1 2 3 4 5 6 7 8 9 10 11 12

Cred

it Ri

sk S

CR

Number of Investments

Effect of Diversification on Components of Credit Risk SCR of A-Rated Investments (5-year Maturity, Senior Unsecured)

Total

Spread Risk SCR

Default Risk SCR

Concentration Risk SCR

A multi-disciplinary investment team and a core focus in the management of credit-backed portable alpha strategies

Deep diving into credit

0%

10%

20%

30%

40%

50%

60%

70%

1 2 3 4 5 6 7 8 9 10 11 12

Cred

it Ri

sk S

CR (C

once

ntra

tion)

Number of investments

Effect of Diversification on Concentration Risk SCR (5-year Maturity, Senior Unsecured)

AAA/AA

A/BBB

BB/B

CCC/UR

0%

5%

10%

15%

20%

25%

30%

35%

40%

1 2 3 5 10 20

Cred

it Ri

sk S

CR (S

prea

d)

Maturity of Investment

Effect of Maturity of Investment on Spread Risk (Senior Unsecured, 10 Name Portfolio)

AAA

AA

A

BBB

BB

B

CCC

UR

Deep diving into credit Credit risk SCR vs. maturity

Deep diving into credit

0

50

100

150

200

250

300

350

400

450

500

0.00% 5.00% 10.00% 15.00% 20.00% 25.00%

Spre

ad a

bove

cas

h

Credit Risk SCR

SA Credit Co-Investment Fund

IG Secured

IG Unsecured

IG CCIF

Portfolio impact of diversification, ratings, security and maturity

Our belief on asset allocation for insurers

IG Credit [Govi + 0.5 -1.5% p.a.]

SOE [Govt + 0.25 - 1% p.a.]

Risk

Expe

cted

exc

ess

retu

rn o

ver g

over

nmen

t bon

ds

Government bonds 7-8% p.a.

How insurers allocate today Equities, property, commodities [Govi + 4 – 7% p.a.]

Sub-IG Credit [Govi + 3 – 5% p.a.]

Index tracking

Alternatives

Risk

How insurers will allocate

Government bonds 7-8% p.a.

Expe

cted

exc

ess

retu

rn o

ver g

over

nmen

t bon

ds Equities, property, commodities

[Govi + 4 – 7% p.a.] Sub-IG Credit

[Govi + 3 – 5% p.a.]

IG Credit [Govi + 0.5 -1.5% p.a.]

SOE [Govi + 0.25 – 1% p.a.]

Index tracking

Alternatives

SA Equity

Global Equity

Other Equity

IG Credit (unlisted)

HY Credit (unlisted)

Banks (ex Big 4)

Financial Services

IG Corporate

HY Corporate

Non Gov Guaranteed SOE

Municipality

Big 4 Banks

Property

Money Market

-1%

0%

1%

2%

3%

4%

5%

6%

7%

0% 10% 20% 30% 40% 50% 60% 70%

Expe

cted

retu

rn a

bove

cas

h

Market Risk SCR

Illustrative SAM efficient frontier

A multi-disciplinary investment team and a core focus in the management of credit-backed portable alpha strategies

Concluding remarks

1. SCR as per SAM can be a useful proxy for an economic capital measure

2. Balance sheet management mindset for investment management important in a SAM context

3. Credit is an efficient asset class to use within an insurers asset allocation

4. Diversification across seniority, security and number of exposures are crucial

5. Financial risk mitigation techniques may be useful for more capital efficient exposure to growth assets