As an Insurance Company is one that can underwrite both short term and long term insurance products, it needs to maintain a conservative posture that ensures that investments are sound enough to withstand adverse market conditions and meet the expectations of investors, rating agencies and regulators. This explains why principal preservation is the most important overall portfolio objective. Total return based on risk adjusted basis is the second most important objective of the portfolio.

Overreliance on fixed deposits and other interest-bearing instruments is avoided as the current situation of very low yields can materially reduce investment income. Even in a rapidly rising interest rate environment, the high rates pressurize asset values, capital levels and, if driven by inflation, cause adverse development in reserves.

Principal preservation is necessary to ensure that the Company withstand adverse market conditions while still meeting the expectations of rating agencies and regulators. Yet as per part of contingency planning, volatile and uneven financial markets as well as a low interest rate environment can made it difficult to generate a sufficient total return on Company’s portfolios that can add to existing financial cushions and satisfy investors. Lower investment returns can make it necessary for the Company to write its insurance business at higher returns, a reality that requires further discipline in insurance product pricing.

To cope with these potential market sensitivities, contingency strategies should be developed to navigate these risks that include different asset and liability matching choices, following a slightly more aggressive investment strategy, and outsourcing management of asset classes to benefit from specialized strategies and expertise. The portion of investment assets in equities and cash which can be liquidated to satisfy liquidity obligations. These contingency funding strategies have to be developed with a dual goal of targeting higher returns and maintaining appropriate levels of risk that will satisfy a broad constituency that includes investors, rating agencies and regulators.

The Company should follow the following guidelines for its liquidity requirements:

  • To cover liability of Technical Provisions without Reinsurance recoveries, the company should invest in assets as appropriate to the nature and duration of its insurance liabilities;
  • Investment decisions are in the best interest of all policyholders and beneficiaries; and
  • Taking into account any policy objectives disclosed by the Company.

To keep this objective, investments can be made in liquid assets such as:

  • cash and cash-equivalent instruments;
  • time deposits;
  • readily tradable securities;
  • shares in publicly listed companies;
  • Liquid corporate or sovereign bonds.

Funds for at least 3 times the monthly average cash outflow must be kept in above mentioned class of assets.

Matching is the process of constructing an investment portfolio which replicates the timing and amounts of future liability outgo. If such a portfolio exists, then the Insurance Company can have a reasonable expectation that their invested assets will be sufficient to meet their obligations.

The key areas of liability outgo uncertainty to consider are:

  • Timing of payments
  • Nature of payments (inflation linked, random nature)
  • Currency of payment

Duration matching should be utilized for matching assets to liabilities as this ensures that assets are as sensitive to movements in interest rate as liabilities. General insurance liabilities are matched on a pool of homogenous policies that have similar claim frequency and severity distributions and loss payment pattern. From the loss payment pattern, expected total claim amounts and cashflows are generated to arrive at duration figures for liabilities.

Duration for assets is calculated from the Modified Macualay method. The Modified Macaulay duration calculates the weighted average time before an asset holder would receive the asset's cash flows sufficient to cover the price at which the asset was bought or sold.

To contain operational issues, operational policies for the implementation of the investment strategy should include:

  • Identification of who is authorised to undertake asset transactions;
  • Any restrictions on portfolio managers, for example, risk limits within the overall investment policy;
  • The selection and use of brokers;
  • Details of custodial arrangements;
  • The methodology and frequency of the performance measurement and analysis;
  • The agreed form and frequency of transaction reporting; and
  • In the case of outsourcing, a contract setting out the policies and procedures;

Under investment guidelines, the company should set out a multi-asset or a balanced mandate detailing requirements of required return, risk acceptance level, time horizon, and proposed asset allocation, for example, of 60% and 40% into sukuks and shariah-compliant equities (which should be periodically reviewed).

Limitation such as maximum permissible exposure and minimum credit rating levels should be applied along with restrictions such as no borrowing permissible, shariah compliant investment and prohibition of derivatives usage except to hedge currency and/or related risks where necessary.

The company must set in place Strategy & Follow Up committee that reviews matters relating to investment management in case of non-compliance to the mandate.

The overall investment strategy adopted should be geared towards maintaining liquid investments such as cash and bank balances (including deposits) for short-term needs of liquidity given the nature of the main lines of business. Furthermore, investments in for example, sukuks and listed equities through an asset manager and in unlisted equities and property can help augment investment returns to the company.

Main risk exposures lie with the outsourced asset manager who may be adopting various tactical positions to ameliorate investment returns. Secondly, term deposit investments are rolled over at maturity that may lead to low investment returns due to falling deposit rates.

The Strategy & Follow Up Committee of the Board should review the performance of the asset manager quarterly. The asset manager usually makes a presentation to the committee of performance and makes recommendations as to the strategy for the next quarter. The recommendations are discussed and decisions made. The manager’s performance should be measured against a benchmark (Islamic S&P for the region).