Case study: Why IMT Insurance has reviewed its liquidity framework
Laurie Mardis, Investment Strategist at IMT Insurance, explains why the firm has reviewed its liquidity framework, what changes are being made, and how it will impact investment strategy
Sara Benwellposted on Thursday, April 01, 2021
Sara Benwell: What prompted you to review your liquidity framework?
Laurie Mardis: We began a review of liquidity over a year ago as part of a comprehensive assessment of stress testing.
My role as Investment Strategist is a new addition to the firm as the company continues to strengthen ties between the investment portfolio and the business.
"We began a review of liquidity over a year ago"
One of my goals has been to review all stress testing adjacent to the investment portfolio, not only to confirm robustness of the process but to ensure the outcomes are considered in business decisions.
Sara: What changes have you made and why?
Laurie: Our original liquidity plan was a static snapshot of tiered liquidity needs relative to sources. The single metric provided a simple view of liquidity but was blunt and quickly dated.
The new plan involves two metrics: a Liquidity Coverage ratio that reflects operating liquidity and an Asset Coverage Ratio that reflects portfolio liquidity.
This plan reveals where liquidity is insufficient as well as where it is excessive, and it tests liquidity under scenarios that incorporate adverse business and market results.
"Our original liquidity plan was a static snapshot of tiered liquidity needs relative to sources"
We have also incorporated early warning indicators to highlight potential future liquidity issues, and we have established pathways for addressing possible liquidity problems should they arise.
The plan is updated regularly and shared with senior management. These changes give us clarity and visibility to potential liquidity challenges.
Sara: How did the market downturn and low interest rates inform the decisions you made?
Laurie: The low interest rate environment continues to pressure insurance companies to effectively use every dollar available to them. While companies must have liquidity to meet obligations, they can’t afford to have too much liquidity sitting idle and earning nothing.
Our enhanced approach to liquidity has been confirmed by the extreme events of 2020.
The first quarter market crash tested our asset allocation boundaries but also offered opportunity. It was a real-world test of our evolving approach with added urgency to get the framework right.
Our analysis showed we had liquidity to spare but the quick rebound in markets prevented us from getting much of the excess liquidity invested.
"Our enhanced approach to liquidity has been confirmed by the extreme events of 2020."
Regardless, the information we gained from that period was incredibly valuable for fine-tuning our framework and it set us up well for the next liquidity test that summer.
The derecho was the most costly thunderstorm in U.S. history at over $7.5 billion, and it tore right through our footprint becoming IMT’s largest ever single storm.
The liquidity analysis prior to August suggested we were prepared, and our experience confirmed it. Although IMT was certainly challenged by the sheer volume and level of claims, we had no trouble meeting obligations and the portfolio remained untapped.
Sara: How will the new framework influence your investment strategy over the next five years?
Laurie: The new framework has highlighted excess liquidity in our portfolio, so we are working to redeploy that liquidity in less liquid, higher yielding assets.
It has also highlighted the value of our relationship with the FHLB of Des Moines. Having liquidity available through the FHLB gives us flexibility in our investment strategy, and should the yield curve eventually steepen, we may explore other investment opportunities utilising our relationship.
Sara: Are illiquids more attractive in the current market environment, and if so will higher pricing naturally follow as more insurers hunt illiquidity premia?
Illiquidity continues to offer yield premium, though the value has definitely compressed as investors compete for yield.
Given Fed support of the market, it seems likely that attractive spread opportunities from illiquid sectors will remain scarce until we see disruption of the current environment.