Download Investment Actuary - Iowa Actuaries Club

May 4, 2006
Iowa Actuaries Club
“What Every Actuary Should Know About Investing”
Scott Christensen, FSA, CFA, MAAA
Principal Financial Group
Investment Actuary
The Magic Letter “i”
Applications
Traditional Actuarial Formulas
– Future Value of an Annuity
 FVannuity due = C * [ ((1+i)n – 1 ) / i ] * (1+i)
 Etc.
Inputs into Actuarial models (Excel, PTS, TAS, ALFA, MOSES, etc.)
– Pricing Models
– Projection Models
– Etc.
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Investment Return Assumption
Source
The investment return assumption is based on the investment portfolio used to
back the liability
This is calculated based on the composition of the investment portfolio
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Asset Class
Yield
Portfolio
Weighting
Lehman U.S. Government
5.17%
10%
Lehman ABS
5.57%
5%
Lehman CMBS
5.69%
5%
Lehman MBS
5.97%
15%
Lehman Corporate
5.99%
50%
Lehman Yankee
5.78%
15%
Sample Investment Portfolio
5.84%
100%
Default Rates
Unknown Component to Investment Return Assumption
Default Rates
U.S. Speculative Grade Default Rate
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Default Rates (%)
12
10
8
6
4
2
0
Dec-81
4
Dec-84 Dec-87
Dec-90
Dec-93
Dec-96
Dec-99 Dec-02
Dec-05
Interest Rates
Unknown Component to Investment Return Assumption
Treasury Rates
Historical Yields on the 10 Year Treasury
18.0%
16.0%
14.0%
12.0%
10.0%
8.0%
6.0%
4.0%
2.0%
0.0%
Mar-50 Mar-57 Mar-64 Mar-71 Mar-78 Mar-85 Mar-92 Mar-99 Mar-06
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Corporate Spreads
Unknown Component to Investment Return Assumption
Historical Corporate Spreads
Corporate Index Spreads
300
OAS (BP)
250
200
150
100
50
0
Jan-90
6
Jan-92
Jan-94
Jan-96
Jan-98
Jan-00
Jan-02
Jan-04
Jan-06
Traditional Actuary vs. Investment Actuary
Differences – Types of Risks
Traditional Actuary
Investment Actuary
– Mortality
– Default/Recovery
– Morbidity
– Interest Rates
– Withdrawals
– Spreads
– Casualty
– Prepayment
– Etc.
– Liquidity
– Etc.
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Traditional Actuary vs. Investment Actuary
Similarities – Methods for Dealing with Risk
Investment actuaries take many of the same fundamental actuarial concepts and
apply them to the Investment realm
Some risks are included in pricing
Capital held for unexpected losses
Risk Mitigation
“Bridge the gap” between the actuarial and investment professions
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Role of an Investment Actuary
Typical Functions for Investment Actuaries
– Provide pricing inputs for product actuaries to cover investment risks
– Determine loss potential to calculate needed capital reserves
– Evaluate earnings at risk
– Calculate income statement volatility
– Establish risk management processes to measure, monitor, and mitigate risks
– Facilitate communication among the various business areas (investment
professionals, risk management, product development, pricing, management)
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Keys to Success
Expertise and credibility
Model development
Scenario generation
Communication
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Keys to Success
Expertise and Credibility
Elements of my personal educational and professional background that have been
beneficial in my career:
– Working with other Actuaries
 5 years in product areas
 FSA
– Working with Investment Professionals
 7 years in investments
 CFA designation
The combination of these types of skills allow an investment actuary to produce
valuable information utilized in both investment decisions as well as the product
pricing process
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Keys to Success
Model Development
Actuarial Software Packages (PTS, ALFA, MOSES, TAS, etc.)
– Building investment assets and derivatives to run in conjunction with
liabilities
– Building investment/disinvestment/derivative strategies
– Projecting cash flows and earnings
– Modeling a variety of economic scenarios
– Utilize models for investment risk quantification/analysis
Portfolio Credit Risk models
– Model credit risk
– Quantify correlations by securities
 By issuer
 By industry
– Measure correlations between asset classes
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Keys to Success
Scenario Generation
Your assessment of risk is contingent upon your estimation in the amount of risk
in the underlying capital market variables
Interest Rate curves, equity markets, fixed income indices, exchange rates, spread
levels, implied volatilities, foreign capital markets, etc.
Estimating the risk in capital market variables requires:
– Disciplined process
– Reliable historical data
– Subjective evaluation and decisions
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Keys to Success
Communication
Clear and effective communication is vital in multiple situations
– Presentations
– One on one discussions
– Recommendations and memorandums
Communication with the various areas of the business
– Investment professionals
– Corporate actuaries
– Product actuaries
– Accounting professionals
– Risk managers
– Relationship managers
All of these areas rely on the abilities of investment actuaries to aid in identifying,
quantifying, and assessing investment risks
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In Summary
“What Every Actuary Should Know about Investing”
Investment Return is not a static assumption. Impacted by many unknown
elements including defaults, future interest rates, etc.
Current capital markets are not providing much compensation for taking
investment risks. Companies are incented to take more risk to get more return.
These investment risks need to be quantified.
Investment actuaries take many of the same fundamental actuarial concepts and
apply them to the Investment realm (pricing, capital requirements, risk mitigation,
etc.)
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Biography
Scott Christensen- Investment Actuary
Scott is currently serving as an Investment Actuary for Principal Financial Group. He has been with the company since
1994 and has served in his current role since 1998. Prior to his role with the Principal, Scott worked with the financial
reporting area for the Group business unit as well as in the pricing area for the Pension business unit. He graduated from
Nebraska with a BS in Actuarial Sciences. Scott is a Fellow in the Society of Actuaries, a CFA Charterholder and a
Member of the American Academy of Actuaries.
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