Dick Rae, Chair of the IFoA’s Finance and Investment Board, rounds up the Board’s advice to actuaries for responding to the coronavirus crisis.
I, along with the rest of the F&I Board hope that you are keeping safe and well. Many of you probably feel well supported in your work by your organisation and by your colleagues. The F&I Board is conscious though that some of you may not enjoy that luxury.
Markets are global and the issues you experience will vary significantly depending on where you are in the world; between developed and emerging economies and markets and from country to country within those markets. Below are some thoughts and considerations that the F&I Board have compiled. We hope you find this helpful in these extraordinary times.
A framework for managing investment and investment-related risks
- Governance - Framework for making a communicating decisions
- ALM & SAA - ALM and risk budgeting contraints as inputs into SAA
- Implementation - Framework and philosophies that translate SAA into investment portfolios
- Operations - Operating risks that arise from portfolio implementation
- Measurement - Regular monitoring and measurement of financial and non-financial key performance indicators (KPIs)
- Reporting - Regular and timely reporting to stakeholders of relevant information
The nature of the current market disruption is that markets have been particularly volatile. This can heighten the need to move quickly but this does not diminish the need to involve stakeholders, follow governance processes and record actions (even if this is to do nothing). You may need to consider how well your current governance structures are placed to deal effectively with the need to take decisions in shorter timeframes than they may have been previously accustomed to.
Your investment strategy (ALM and SAA)
Given the extreme nature of the market event, it is important to evaluate investment strategies and their implementation and consider whether there are any actions required both within existing investment arrangements or indeed opportunities that may exist beyond the current investment arrangements. This may mean:
- Checking that your investment manager’s stated objectives/targets remain valid given the exceptional circumstances.
- Check asset allocation versus tolerance and if appropriate to rebalance to target weights.
- Revisiting and reconfirming past assumptions made in carrying out modelling both within assets and liabilities; correlations, volatility, return and other assumptions on the asset side as well as both financial and demographic assumptions related to the liabilities.
- Management actions need to be carried out to alter your asset allocation, portfolio construction and/or your implementation arrangements or it could be that the appropriate action is to retain your existing arrangements in respect of all the aforementioned.
- There is the possibility that emergency actions need to be taken (in which case one should be mindful of costs and timing whilst always acting with due care and attention.
- There is potential to take advantage of investment opportunities from dislocated markets that may not have otherwise arisen.
- Regulatory developments, specifically those announced to address this crisis may necessitate a change in investment strategy.
You will probably need to initiate additional forward-looking planning too and start the process to anticipate future actions in the event that market conditions continue to deteriorate.
- Here past sensitivity / scenario analyses may help inform your forward looking view whilst recognising that past sensitivity or scenarios may not be directly applicable to the current situation.
- In considering the most appropriate scenarios to focus on, it may, therefore, be necessary to consider scenarios outlined by recognised bodies entrusted with providing data and evidence to inform policy setting in the current pandemic.
In carrying out these actions, your investment managers views and input could be an important source of information and challenge to your own thinking. Equally their views should also be challenged by you.
During this time, companies may seek to exploit market conditions to further grow their business e.g. take advantage of wider credit spreads. Care should be taken to understand the implications that such growth may have under a variety of different economic and investment market scenarios. Consider too the impact arising from specific regulations passed in response to the crisis e.g. guidance on dividends.
Implementation and operations
Try to anticipate what issues might arise in connection with the COVID-19 pandemic. Unfortunately, it is possible you or your colleagues may fall ill. Service providers may not be able to provide a full or continuous service. Service levels may not be met.
Given the remote working situation, ensure that your asset managers and other key service providers are still able to provide services uninterrupted whilst meeting their compliance/operational processes.
Some examples of the issues that F&I Board members have encountered, or are thinking about, include:
- Authorisation: Check your approved signatory list doesn’t need extending.
- Instructions: “Wet” signatures and faxes may be required. Talk with your counterparts to explore alternative arrangements.
- Market data: Plan for situations where service and data provision is interrupted. What data is crucial to you and how can you mitigate any risks.
- Models: Check that models can still be run across virtual private networks. It may be necessary to make changes, for example where models are too unwieldy.
Measurement and reporting
Each market crisis has its own characteristics. This one involves a temporary suspension of normal economic behaviour. The newly formed Economics Member Interest Group will be looking at supporting you with relevant articles and other material over the coming months. The F&I Board will also send blogs where we think these may be relevant or of interest to you.
In the mean-time keep abreast of the current market environment:
- Talk regularly to your investment managers and advisors. Get a feel for the tone of the market as well as current trading conditions.
- Sign up to market updates/webinars from investment managers and chief economists. Don’t take their word as gospel but it will give you a sense of how the market in general is thinking.
Some of the issues to consider:
- Liquidity: trading in certain asset classes may dry up e.g. corporate bond markets. Bid/offer spreads widen and screen prices are less reliable.
- Valuations: be aware that asset valuations may be less reliable and be prepared to review your valuation processes.
- Volatility: check your strategy can ride the market volatility that you are experiencing. Buying options will be more expensive as can selling out of positions when the tone of the market is poor.
Policyholder/member behaviour could change through movements e.g. higher lapse rate, increased early retirement, potentially increasing the need for liquidity.
- Maintain / increase discussions with actuarial teams to understand potential impacts on liabilities despite current working conditions.
- Involve stakeholders, follow governance processes and record actions.
- Work with your investment managers and take advice where possible.
Pay particular attention to measuring and managing market risk
Needs will be affected by asset/liability considerations and balance sheet strength. The actions of unit-linked funds, pension funds, with-profit funds, annuity funds, general insurance and shareholder funds will vary.
Hedging strategies need special mention
- Rolling options or futures/forwards need more immediate attention. The cost of protection, the required regulatory treatment/capital benefit, the timing of the roll all need careful consideration and collaboration with other areas within your firm. Be clear on the governance framework you must follow.
- Longer term hedges need to be reviewed to check that they are performing as expected.
- Collateral and cash calls need to be anticipated and planned for and checks on collateral received (amount vs value and timeliness) can be just as important as ensuring collateral sufficiency.
- Valuations of complex derivatives may not reflect what could be considered a fair market value for a variety of reasons including market illiquidity.
- Be aware of the impact that reduced liquidity can have on your funds and potentially prepare for fund suspension. Identify funds at risk, monitor them and ensure the governance process is in place. Clearly, in the UK, this is a hot topic with the regulator and following past issues with property funds and the “Woodford crisis”.
- Changes to the constituents within indices (e.g. from fallen angels) can impact your asset allocation and how to manage from a trading / liquidity perspective.
Solvency II impacts
- The effect of credit migration will have an impact on SII capital and you may need a revised approach for bonds crossing over from investment grade to sub-investment grade especially for bonds within “Matching Adjustment” annuity portfolios.
- Check that your current valuation processes are still valid. Current practices around the valuation of property are a good example where a change of approach may be necessary. Heavily structured assets would be another example.
- Do you know what asset exposures you have within funds and structured products? Post the financial crisis regulation has aided this transparency. Check that you have the visibility you need.
As always, involve stakeholders, follow governance processes and record actions, work with your investment managers and take advice.
For many of you the above will be no more than a familiar check list but hopefully useful nonetheless. The F&I Board encourage you to engage with colleagues and fellow actuaries. If there is any way in which you believe the F&I Board can support you then please let me know. Email me on firstname.lastname@example.org.