Magazine article Risk Management

An Investment Manager Can Improve Captive Finances

Magazine article Risk Management

An Investment Manager Can Improve Captive Finances

Article excerpt

In a rapidly changing environment the task of administering an offshore captive's investment portfolio presents both L- challenges and opportunities. An investment manager can relieve the burden of meeting these demands and enable the risk manager to identify, understand and pursue the opportunities available. The range of products and services offered by most investment managers is complex and, to a large extent, has been developed in response to the business demands of offshore companies.

The role of an investment manager is to provide a risk manager with access to a wealth of information regarding his or her insurance company's assets and investment policy and interpret this information to present it in a meaningful form. To meet this challenge successfully, an investment manager must have first-hand knowledge of the underlying investment framework in the offshore insurance industry, keep abreast of innovations, trends and developments and have the knowledge and resources to provide in-depth advice to clients as opportunities arise.

Like many business functions, the complex task of controlling or managing a pool of insurance assets is comprised of three stages: planning, implementation and review. At each stage of the process, an experienced investment manager will have available the resources to identify, analyze and make recommendations on each of the major issues involved.


The nature and complexity of the investment strategy will depend to some degree on the range of eligible investment instruments available to the fund. Many offshore captives are restricted, often by regulatory, legislative or fiscal factors, to Eurodollar securities. Others have more broadly based investment horizons embracing U.S. taxable and tax-exempt fixed-income or holdings in equities or real estate.

The planning process may involve a comprehensive analysis of the risk return trade-offs of multiple asset classes or may consist of a simple set of maturity guidelines for a single currency fixed-income portfolio. In each case, the goal is to control the portfolio risk to provide an acceptable balance between required return over the long-term and short-term capital loss. In simple terms, risk can be thought of as the possibility of failing to achieve a required rate of return over a given time period.

Since most captive insurance portfolios are invested in fixed-income securities, the average maturity decision is usually the key element of the investment strategy. This decision represents a strategic objective and is quite distinct from a limited short-term tactical change in maturity applied by the investment manager to exploit anticipated interest rate movements. The strategic position should be determined according to the company's liabilities and risk tolerance, and should be conveyed to the risk manager as a suitable index benchmark.

Some captive insurance companies are invested exclusively in cash deposits. Cash instruments are highly liquid and provide no threat of capital loss and a known return to redemption. Not surprisingly, they are often considered the ideal low risk investment. However, this perception is misleading. Consider, for example, a set of insurance liabilities which have an average payout horizon of five years. Assume that these liabilities are estimable and are fully cov - "The task of controlling

a pool of insurance assets

comprises three stages" ered by cash deposits. If interest rates were to fall, the discounted value of the payouts would increase. At the same time, the future expected return on the cash portfolio would fall causing a mismatch between the assets and the liabilities.

The theoretical solution to this problem is to build a portfolio of fixed-income instruments with a stream of coupon payments and redemptions which are broadly in balance with future payouts. Variations in the present value of the liabilities arising from changes in interest rates will be matched by fluctuations in the market value of the portfolio. …

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