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Managing the investment portfolio of a multinational insurance companyUrban Angehrn Group Chief Investment Officer, Zurich Insurance Group

ETH Risk Center Seminar SeriesMay 28, 2019

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From an investment viewpoint, an insurance balance sheet is a balanced fund with leverage. This implies the importance of asset-liability management, of capital allocation and of risk control

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From an investment viewpoint, an insurance balance sheet is a balanced fund with leverage

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Typical insurance balance sheet

InvestmentAssets

Insurance Liabilities

Shareholders’ Equity

Other LiabilitiesOther Assets

Time

Cas

h-f

low

Illiquids

Equities

Bonds

Cash

Motor

Home

Life

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Adverse financial markets affect equities in the investment portfolio

9494

25 20

15 10

100

FixedIncome

OtherAssets

100

Equities

25

60

9

20

70

4

Balance sheet1 of an insurance company

Assets Liabilities Assets Liabilities

1 Balance sheet on an economic basis, at market values

Shareholders’Equity

InsuranceLiabilities

OtherLiabilities

4

60 70

Balance sheet1 after a 40% decrease in equity markets

-40%equities

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Fixed income assets may underperform long dated liabilities in a falling yield environmentThe difference in interest rate sensitivity between assets and liabilities is a source of risk

100

Assets Liabilities

100

Assets Liabilities

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25

60

5 years duration

9

20

4

Balance sheet1 after a 40% decrease in equity markets

Balance sheet1 after a 2% drop in interest rates

FixedIncome

OtherAssets

Equities

25

66

9

20

80

Shareholders’Equity

InsuranceLiabilities

OtherLiabilities

5

70

7 years duration

Disciplined process for managing investments relative to liabilities is vital

-2%Interest

rates

1 Balance sheet on an economic basis, at market values

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Asset-Liability Management (ALM) is about understanding liability sensitivities and managing assets relative to those

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• ALM is a key process in insurance investment management and requires thorough analysis of liabilities and their interest rate and currency sensitivities

• Market Risk assesses the risk that shareholders’ equity declines due to financial scenarios, like the ones in the example

• One outcome of ALM is a minimum risk investment portfolio relative to liabilities, i.e. a portfolio of financial instruments that most closely mirrors the sensitivities of the liabilities

• Insurers need to strategically determine the level of market risk they take, i.e. allocate capital to risk types

Asset-Liability mismatch

Unfavorable market movements

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Zurich’s risk taking is balanced between market and insurance risks

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44%

24%

8%

5%

12%

3%

4%

Market risk Life insurance riskRe-ins credit risk

Premium and reserving riskNatural cat risk Operational risk

Business risk

RISK BASED CAPITAL BY RISK TYPE – Q4 2018

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Strategic Asset Allocation optimizes investment returns (relative to liabilities) for a given level of market risk. Zurich’s SAA framework uses a small number of factors in order to have stable optima and to create a level playing field between asset classes

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MARKOWITZ MEAN VARIANCE OPTIMIZATION

The SAA determines a portfolio of asset classes that maximizes the investment return (relative to liabilities) for given market risk

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In practice, we use risk factors to represent asset classes and liabilities for the SAA

Illustration of the risk factor approach

1 Darker shades indicate higher exposures2 Short-term: 1 to 5 years3 Term structure: 10 to 30 year minus short-term bonds

Equity Risk (EQ)

Interest Rate Risk (IR)2

Term Structure Risk (TS)3

Commodity Risk (CO)

Credit (Spread) Risk (CR)

Liabilities Sovereign Bonds

Corporate Bonds

Real EstateEquities Hedge

Funds

Risk factors Translation into selected asset classes1

β

Few, broad and persistent factors are used to seek long-term risk premia

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Zurich’s SAA model in two steps

We first allocate to factors, then to asset classes

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The optimal exposures to beta risk factors are chosen

Optimize expected excess return while maintaining positive net liquidity term structure across all terms

Credit

G&GG

Real Estate

Cash

Equity

Mortgages

Hedge Funds

Private Equity

EQ IR TS CO CR

Equ

ity

risk

Inte

rest

rat

e ri

sk

Term

str

uct

ure

ris

k

Co

mm

od

ity

risk

Cre

dit

sp

read

ris

k

Step 1: Risk factors Step 2: Asset allocation

1Government and Government Guaranteed

1

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Hedge Funds

Private Equity

Real Estate

Mortgages

Equity

G&GG

Credit

EQ

Hedge Funds

Private Equity

Real Estate

Mortgages

Equity

G&GG

Credit

EQ

Hedge Funds

Private Equity

Real Estate

Mortgages

Equity

G&GG

Credit

EQ IR

Hedge Funds

Private Equity

Real Estate

Mortgages

Equity

G&GG

Credit

EQ IR TS

Hedge Funds

Private Equity

Real Estate

Mortgages

Equity

G&GG

Credit

EQ IR TS CO

Hedge Funds

Private Equity

Real Estate

Mortgages

Equity

G&GG

Credit

EQ IR TS CO CR

Hedge Funds

Private Equity

Real Estate

Mortgages

Equity

G&GG

Credit

EQ IR TS CO CR liquidity

Hedge Funds

Private Equity

Real Estate

Mortgages

Equity

G&GG

Credit

EQ IR TS CO CR liquidity alpha

IREQ TS CO CR+ + + +r – rf =

1Government and Government Guaranteed

+ λ α+

We decompose the expected returns of all asset classes in terms of our risk factors, liquidity and alpha

Expected excess returns

1

12

β

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Risk factor returns represent over 50% of the expected total investment returnLiquidity premium and α are important to enhance Zurich’s investment result

SAA: Strategic Asset Allocation

29%

Risk-free rate(rf)

Liquidity premium and α

54%

17%

SAA (ß)

Expected Total Investment

Return

100%

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Some issues of naïve SAA optimization and how Zurich addresses them

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Certain pairs of asset classes are highly correlated, leading to unstable optima

Factor approach and 2-stage optimization

Real estate values are appraised, hence return series don’t fully reflect the risk

Use returns of de-levered REITs1 to estimate betas

Hedge fund returns suffer from survivorship and other reporting biases

Factor approach, realistic ex-ante α, SAA-related benchmarking

Funding capacity for illiquid assets and illiquidity risk premia traditionally not captured

Liquidity term structure and returns embedded in 2nd step

Five factors are insufficient to understand and report market risk

Separate SAA model versus highly granular risk management model

1 Real estate investment trust

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Zurich’s sources of investment risk and return are well balanced

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1 Economic view before derivatives2 Risk drivers of Market risk (at Expected Shortfall 99% based on Monte Carlo simulation) show marginal contribution to the total Market risk

Risk drivers figures are based on best available information as of the date of this report and are subject to restatement3 PE = Private equity, HF = Hedge Funds 4 Credit risk consists of swap spread risk, credit spread risk and credit default risk

ASSET ALLOCATION AS OF Q4 20181 RISK DRIVERS AS OF Q4 20182

80%

8%

5%5%

2%

Fixed income Equities

Real estate HF & PE3

Cash

30%

15%44%

7%4%

Equity risk

Interest rate risk

Credit risk4

Real estate risk

Other

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Our ALM-focused investment strategy results in consistent and sustainable excess returns relative to liabilities

0%10%20%30%40%50%60%70%80%90%

100%110%

01/2002 01/0801/04 01/06 01/10 01/12 01/14 01/16 01/18

100.2%

68.2%

Investment return relative to liabilities, Q1 2003 – Q4 2018, economic view

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As a multinational Group, Zurich invests through regulated local insurance subsidiaries. This introduces important constraints and trade-offs that may not always be economic. It also implies the need for a well-structured decision governance and infrastructure

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Zurich Insurance is a multinational group that does business in more than 210 countries and territories

USD 51.6bnTotal revenues

USD 195bnInvestment portfolio

210Countries and territories

54,000employees

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Local capital market

conditions

Local regulations

Local capital requirements

Tax

Implementation constraints are important considerations for the real-life SAA

Investments are spread across ~200 balance sheets in 48 countries

Most balance sheets are regulated local insurance subsidiaries

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TO-BE GROUP STRATEGIC ASSET ALLOCATION

AS-IS GROUP STRATEGIC ASSET ALLOCATION

Illustrative example: increase in equity allocation by 1%

ILLUSTRATIVE

74%

6%

20%

Fixed income

Equities

Other

73%

7%

20%

Fixed income

Equities

Other

Increase in equity allocation by 1% implies increase in exposure by ~USD 2bn

Target unconstrained global equity

portfolio

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TO-BE GROUP SAA

Group Strategic Asset Allocation (SAA) is translated into local SAAs and specific portfolio mandatesThe process is iterative and requires substantial coordination

ILLUSTRATIVE

73%

Fixed income

20%

Equities

Other 7%

TRANSLATION INTO THE LOCAL SAA

85%

15%

10%

90%

95%

5%

90%

10%

5%

95%

0%

100%

Equities Other

SAA AS-IS SAA TO-BE

Bala

nce

sh

eet

1B

ala

nce

sh

eet

2B

ala

nce

sh

eet

3

Mandate

• US equities• USD 1bn

• EU equities• USD 800m

• EM equities• USD 200m

Group SAA implementation is subject to local constraints, capacity and governance

Local capital market conditions

Local regulations / tax

Local capital requirements

Target unconstrained global equity

portfolio

Bottom-up analysis

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The design of portfolio mandates requires several key elements to consider

Asset manager (internal or external)

Asset class and investment universe

Benchmark

Active or passive management

Tracking error

Concentration limits, quality restrictions and other risk management rules

Regulatory driven rules

Etc.

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Three lines of defense ensure risk management, risk control and independent oversight

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Group Investment Management owns market and investment credit risk

Group Risk Management ensures a consistent risk and control framework, provides independent challenge and monitors risk taking

Audit provides independent oversight and assurance

1

2

3

Board Committees, Management Committees, Regulators

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A strong infrastructure is imperative to manage the Zurich portfolios in an accounting and an economic view

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Mid

dle

ware

General Ledger

Sub LedgerAsset manager

Custodian

Fund manager

Bloomberg AIM

Bloomberg Data

Liabilities & Derivatives

IM Data Warehouse

SAP FAMClient 100 - Securities

GIDW Global Investment Data

Warehouse

Risk Platform

Barra factor model250k positions

20k simulations

SAP FICO

Business Warehouse

MMD1

1 Market and Master Data

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Zurich is committed to be a responsible investor

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Zurich has a holistic responsible investment strategy supported by ambitious targets

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Advancing Together

Innovation

Collaboration

Public advocacy

ESG Integration

Training

Information

Process integration

Active ownership

Impact Investing

Intentionality

Measurability

Profitability

Impact targets:

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Strong progress in delivering on our impact investment targets

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Summary

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From an investment viewpoint, an insurance balance sheet is a balanced fund with leverage. This highlights the importance of asset-liability management, of capital allocation and of risk control

Strategic Asset Allocation optimizes investment returns (relative to liabilities) for a given level of market risk. Zurich’s SAA framework uses a small number of factors in order to have stable optima and to create a level playing field between asset classes

As a multinational Group, Zurich invests through regulated local insurance subsidiaries. This introduces important constraints and trade-offs that may not always be economic. It also implies the need for a well-structured decision governance and infrastructure

Zurich is committed to be a responsible investor

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Thank you

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