The top drivers for insurance portfolio construction

Enrico Conti, finance operations expert at BancAssurance Popolari, describes the seven core factors that insurance investors must consider when it comes to portfolio construction

Enrico Contiposted on Tuesday, July 14, 2020

How many key points do we need to keep in mind when we manage an insurance portfolio and what should be the top priorities?

We must focus in a range of distinct but correlated factors, specific to life portfolio known as Segregated Funds, ‘Fonds en Euros’ in France or ‘Gestione Separata’ in Italy.

Every time we make a buy or sell operation when building a portfolio, we must at least catch the following points.

The yield

The choice for a trade starts with the embedded yield of the financial instrument.

Depending on income, duration, issuer, country risk, tactical opportunity, etc.… and many other specifications we need to compare to a similar or equivalent solution.

The risk profile

We need to examine the financial risk points on a standalone investment (CDS – credit default swap; OAS – Option Adjusted Spread; YTW – Yield to worst; Rating outlook; scenario simulation), considering the possible and hypothetical stress, and then for the do the same for the portfolio as a whole.

For the market risk under Solvency II rules, the business mix and the investment solution in different asset classes calibrate different SCR related specific sub-modules measured by the standard formula.

This indicates how safe (corporate investment grade – high quality) or risky (equity, type of funds not covered by look through specification, corporate high yield) the financial instrument is.

Where there isn’t a direct capital charge such as for government bonds, it’s important evaluate their volatility for the impact in Own Funds calculations - which is needed for the final SCR ratio.

For example, the Italian government bonds predominantly invested at scale by the Italian insurance companies swing the SCR ratio , during a spread stressing period. For this reason, it’s necessary to build the right asset combination.

The legal constraints – Italy.

In Italy, for the Segregated Funds there exists a specific set of rules issue by the Authority IVASS (refering to Regolamento 38/2011), and for the general investment it’s promulgated under Regolamento 24/2016, on line with the EIOPA Guidelines.

The rules refer to governance, management, control and risk monitoring aspects, and when managing assets we need to follow those principles. This is the structure the Company’s investment policy must be based on.

The policy investment limits

The Company defines its own investment policy which specifies in detail the limitations, thresholds, constraints for quantitative and qualitative assets classes, sub-module for country risk, concentration, liquidability, rating group, and everything that we consider necessary for the investment rules.

So, he correspondence of all these checks is required under an investment solution and trade,

The accounting views

Every trade requires an accounting record, with its specific effect, and it’s important to know the consequences involved. The combination analysis will use these topics, with a view for the financial statement and the portfolio as a whole.

Local (IT) gaap. By principle, it’s fundamental to identify the use destination for a financial instrument, such as to leave until maturity (durable), rather than take the opportunity to sell (not durable).

That distinction generates a different accounting treatment, and the decision about its accounting destination on the general ledger implies different financial statement results.

IFRS9. Responding to the international principles, referring to a specific business model, the accounting destination will vary between FVOCI and FVPL, with relative effect.

Valuing a bond, by the result in the SPPI test that indicates the knowledge cash flow-in by the coupon and the refund, will follow the accounting destination with impact on balance sheet (FVOCI) or income statement (FVPL) at the market level variations.

The principle also qualifies the impairment value with different staging levels that measure the forward-looking probability of default (PD) in one-year or in life-time.

When analysing these financial statement outcomes, it is important in the trading to look for, as far as possible, instruments that pass the SPPI test, and with quality recognition on stage 1 where the PD is in one year.

All these attention points will surely give a good result for the financial statement and must be kept in mind when managing assets.

The ALM analysis and projection

One of most important drivers in portfolio trading, is the Asset Liability Management.

Here minimum guarantee and medium fees is based on the integrated asset management depending on the liability’s conformation.

The scope of the ALM projection is to achieve a strategic asset allocation portfolio, with the goal of a break-even point in the cash flow matching (inflows and outflows), duration mismatch (asset/liability), and the financial margin for the Company.  

The indications in portfolio construction given by the ALM analysis is fundamental for the asset classes allocation, and to specify the types of financial instrument measured for quantitative and qualitative issues.

The qualitative specification

A final factor to be considered in trading and in portfolio construction, could be a subject like ESG, that limits the universe for comparable bonds.

In this case. when screen similar and apparently analogous bonds for yield or rating or duration,  one might have a green light, that canalizes the final solution.

Another example could be a sub-sector solution inside the macro sector opportunities, that qualifies one instrument better than another.

In this summary by points, it’s shown how many aspects are hiding in a single trading operation, and how each is an important factor in the investment process, giving a choral view about the portfolio’s construction.


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