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15 managing institutional investor portfolios corporations or legal…

- - - - affecting factors:
        plan status
        sponsor financial status and profitability
        sponsor and pension fund common risk exposures - correlation
        plan features - early retirement / lump-sum distributions
        workforce characteristics - age of active relative to retired lives
      - asset/liability management:
        focus on interaction of assets and liabilities
        
        level of pension surplus volatility
        
        shortfall risk:fall below some min acceptable level over some time horizon / probability
      - min y-y volatility of future contribution payments
        min probability of making future contributions
    - - return desire higher than requirement:
        relating to future pension contributions / pension income
      - manage distict from retired-lives and active-lives portion
      - diversified
    - - affect issues:
        
        number of retired lives
        
        (corporation contributions) / (benefit disbursements)
        
        plan features such as option
      - → hold a buffer of cash or money market instruments
    - - factors：
        going concern / plan termination
        age of workforce and portion of active lives
      - multistage:
        active - average time to the normal retire age
        retired - average life expectancy
    - - usually exempt from taxation
    - - human and financial resources available to the plan sponsor
      - self-imposed constraint against investing in certain industries / regimes
    - - concerns:
        
        managing pension invest in relation to operating investments
        
        coordinating pension investments with pension liabilities
      - pension plan liabilities are interest rate sensitive
        →asset/liability management approaches
- - - - →tended to shorten the duration of liabilities
    - - borrow against the accumulated cash value
      - surrender cash value in order to reinvest at higher interest rate
      - →offer competitive accumulation rates or credited rates
    - - required to maintain an asset valuation reserve
      - moving toward risk-based capital (RBC) requirements
      - asset/liability risk considerations figure prominently
      - aspects of interest rate risk:
        valuation concerns - duration mismatch can lead to erosion of surplus → capital adequacy problem
        reinvestment risk - reinvesting at rate less than the original coupon or purchase rate
      - credit risk
      - cash flow volatility
    - - historically specified by the rates actuaries use to determine policyholder reserves
      - desires to earn a positive net interest spread
        (interest earn - credited to policyholder)
      - some using total return rather than interest rate spread
      - the need to grow surplus to support expanding business volume
      - segmentation of portfolios → sub-portfolio / multiple return objectives → promote competitive crediting rates
    - - address disintermediation and asset marketability risk
    - - unique time horizons and returns objectives of each lines of business / product
        →segmented portfolios
    - - must focus on after-tax returns
      - income divided into policyholders' share and corporate share
    - - eligible investments
        prudent investor rule
        valuation methods
      - constrains two critical aspects of portfolio management:
        asset allocation
        the universe of eligible investments
    - - the company size and sufficiency of surplus position
  - - - cash flow characteristics - low tolerance for loss principal or diminishing investment income - ratio of premium income / total surplus
      - common stock to surplus ratio - self-imposed limitations restricting at market value to some significant but limited portion
    - - factors:
        competitive policy pricing - in light of well-thought-of capital market assumptions and ability
        profitability - max return to the extent prudent ALM / surplus adequacy considerations / management preferences
        growth of surplus - ratio of premium to capital and surplus
        tax considerations - flexibility to shift between taxable and tax-exempt bonds
        total return management
    - - paramount consideration
      - flexibility under changing tax underwriting interest rate conditions
      - →maintains short-term securities
        attention to maturity and marketability
    - - factors:
        durations of liabilities shorter
        underwriting cycles affect the mix of taxable and tax-exempt
    - - between tax-exempt and taxable for new purchases and existing
    - - relatively permissive
      - US risk-based capital regulations - specify the min capital
    - - seek some degree of safety from assets offsetting insurance reserves
      - the structure of portfolio between tax account depend on underwriting experience and current tax policy
- - - - net interest margin
      - interest spread
    - - leverage-adjusted duration gap
        measures overall interest rate exposure
        DA-k*DL, k=L/A
      - position and aggregate Value at Risk
      - credit measures of risk - CreditMetrics