US Treasury yields
5.2 5.1 5.0 4.9 4.8 4.7 4.6 4.5 4.4 4.3 4.2 4.1 4.0 3.9 3.8 3.7 3.6 3.5 3.4 3.3 3.2 3.1 3.0 2.9 2.8 2.7 2.6 2.5 2.4 2.3 2.2 2.1 2.0 1.9 1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 0.4
2008 2009 2010
Daily data 12/29/2006 – 10/20/2010
2 Year 10 Year
5.2 5.1 5.0 4.9 4.8 4.7 4.6 4.5 4.4 4.3 4.2 4.1 4.0 3.9 3.8 3.7 3.6 3.5 3.4 3.3 3.2 3.1 3.0 2.9 2.8 2.7 2.6 2.5 2.4 2.3 2.2 2.1 2.0 1.9 1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.0 0.9 0.8 0.7 0.6 0.5 0.4
J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O 2007
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governing monetary authority can restrict its activity. But most of Munder’s captive clients are very well capitalised and, in fact, after the financial storm of 2008, we ended up seeing a number of our captive clients sending dividends to their parent company because they were overcapitalised. So we didn’t experience any problems in terms of solvency or the under-capitalisation of our captive clients.
If a captive uses an investment manager for fi xed income, for example, at what point in its life cycle should it consider expanding its asset allocation?
Vandenbossche: As a captive matures, several things may begin to
What should a captive look for when hiring an investment manager? Michael Vandenbossche: They should look for a manager that
has an experienced investment team with a demonstrated track record within the captive insurance space. Specifically, the manager should have knowledge of collateral requirements and 114 trusts, and how they impact the proper portfolio structure. Expertise in this area includes familiarity with the domiciles, and knowing the captive’s managers, attorneys and other service providers within the given domicile. Additionally, the firm should have made a commitment in its infrastructure that services its captive clients, and within those structures should have a deep and knowledgeable compliance department, given the many rules and regulations to which captives are subject.
For most of our captive clients, their background is not on the
investment side, so it is important that the investment manager is also a good communicator and can articulate its investment philosophy, strategy and rationale for current positioning. It is important that it can provide market education and knowledge in addition to delivering its management expertise.
What are the costs involved when a captive hires an investment manager?
Goard: A captive should only expect to pay a fixed investment
management fee. There will be a custodian fee that the bank will charge, typically within the 2 to 5 basis point range, but unlike with a stockbroker, where transactions are charged on each process, an investment manager is paid on a net basis. So there aren’t really any additional fees. We charge a fee on the overall management of investments, not on a transactional basis. This ensures that we are always working in the best interest of the client. Investment management costs will differ by asset class. For example, some managers charge in the vicinity of 20 to 30 basis points for fixed income. In the equity markets, we’ve seen ranges from 60 to 120 basis points, again depending on the specific equity style and vehicle (mutual fund versus separate account). Whatever the fee structure is, it will vary depending on the manager; so it’s important to discuss costs upfront.
How will Solvency II impact the role of the investment manager? Vandenbossche: Solvency II will only affect investment managers
if the captive is deemed to be under-capitalised, at which time, the 48 CAYMAN CAPTIVE
occur. For example, they may experience premium growth, perhaps a surplus, their liabilities may become more predictable and their time horizon for investments may become longer. While the actual investable asset size will vary across captives, in our experience, captives greater than $20 million may begin to consider expanding their allocation, especially in cases where a surplus exists. This can develop in many forms, be it expanded fixed income instruments, US equities or even international equities, or alternative vehicles such as conservative hedge funds, in the most advanced cases. While this may seem counterintuitive, adding a higher-risk security to a low-risk portfolio can actually decrease the risk of the overall portfolio, while potentially increasing overall return. This is due to the low, or even negative, correlations that can occur among certain asset classes. Obviously, these choices generally occur outside the assets that are subject to specific trust and other collateral-related investment requirements, but a good manager will plan and execute a structure suitable for their client’s needs.
What are some of the key challenges being faced by your larger, more experienced captive clients?
Vandenbossche: Once a captive reaches a stage where multiple
managers and asset classes have been established in the portfolio, the greatest challenge becomes the administration and oversight of the aggregate investment portfolio structure. It becomes increasingly important for the captive plan to establish a formal investment committee, where members meet on a more frequent basis than the typical annual meeting—for example, quarterly. Investment committee members focus on monitoring the portfolio to assess and confirm that the overall portfolio structure is doing what they intended, and to investigate and rectify any potential issues that may arise. With increasing frequency, where multiple managers are involved, a captive may choose to hire an outside investment consultant to assist with these more complex plans.
Do you have any concluding thoughts? Goard: The final point we would make is that it is paramount when
developing an investment portfolio for the captive to understand both what the duration of its liabilities are, and its liquidity needs. And this involves working side-by-side with the actuaries to understand their expectations for claims paid and premium flow. Then, the investment manager should tailor a portfolio accordingly. In summary, having an experienced investment partner with demonstrated expertise in managing and servicing assets for captive clients is a critical component for success.
Ed Goard is chief investment officer, fixed income and Michael
Vandenbossche is a senior portfolio manager at Munder Capital Management. They can be contacted at:
egoard@munder.com and
mvandenbossche@munder.com
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