Financial investment risk disclosures
The following describes Amlin's investment risk management from a quantitative and qualitative perspective.
The Group has two main categories of investments. The first category is the premiums held in order to meet future claims ("insurance"). The other category is the Group's capital. This supports the Group's underwriting but otherwise it does not have specific attaching liabilities.
Risk management
Investment frameworks
Amlin manages its investment funds in accordance with investment frameworks that are set by the Boards of Amlin plc and its subsidiaries. These frameworks determine investment policy and the management of investment risk and are reviewed on a regular basis.
The Investment Management Executive comprises the Chief Executive, Finance Director, Underwriting Director and Chief Investment Officer. They meet monthly to determine investment tactics to ensure that asset allocation is appropriate for current market conditions and is in accordance with the investment frameworks. The Investment Management Executive appoints and monitors the external managers for different asset classes who manage the investments on a day-to-day basis.
The Investment Advisory Panel, which consists of external investment professionals as well as members of Amlin's Investment Management Executive, meets quarterly. The Panel has delegated responsibility to monitor and critique investment strategy and tactics. Group Audit and Compliance provide additional advice on investment regulation.
Risk tolerance
Risk tolerance is driven by the underwriting cycle. In hard underwriting market conditions the preservation of capital is paramount in order to support the insurance business and, therefore, investment risk tolerance is low for corporate assets. Conversely, the risk tolerance for the premium funds under these circumstances will be relatively high due to strong cash flows. In a soft underwriting market the opposite applies.
Strategic benchmarks
The strategic benchmark for capital assets is set by using a Value at Risk (VaR) model, to determine the optimum asset allocation for the current risk tolerance and to ensure that appropriate solvency levels are maintained. The strategic benchmark for insurance funds is set by the duration of the liabilities in each currency. In both cases the investment frameworks provide tactical ranges around the benchmarks to provide sufficient flexibility to ensure that the appropriate risk/reward balance is maintained in changing investment markets. Investment policy takes account of the need to have funds available to meet payments as they become due.
Asset allocation
Assets are allocated to each asset class by moving funds to or from the relevant specialist fund managers. The asset allocation at the year-end is shown below.
| |
Syndicate
£m |
31 Dec 2005 Corporate
£m |
Total
£m |
Syndicate
£m |
31 Dec 2004
Corporate
£m |
Total
£m |
 |
| Equities |
- |
116.2 |
116.2 |
- |
90.1 |
90.1 |
| Bonds |
1,038.0 |
104.1 |
1,142.1 |
624.4 |
84.0 |
708.4 |
| Other liquid investments |
171.9 |
713.6 |
885.5 |
384.4 |
167.2 |
551.6 |
|
| Total |
1,209.9 |
933.9 |
2,143.8 |
1,008.8 |
341.3 |
1,350.1 |
|
| |
% |
% |
% |
% |
% |
% |
| Equities |
- |
12 |
5 |
- |
26 |
7 |
| Bonds |
86 |
12 |
53 |
62 |
25 |
52 |
| Other liquid investments |
14 |
76 |
42 |
38 |
49 |
41 |
|
| Total |
100 |
100 |
100 |
100 |
100 |
100 |
|
The corporate assets are currently invested in a mixture of equities and liquid funds (such as short dated bonds of less than one year). Of the assets above £583 million (2004: £nil) is supporting Amlin Bermuda and £277 million (2004: £252 million) are charged as Funds at Lloyd's to support the Syndicate's underwriting which places certain restrictions on the way such assets can be invested. The restrictions on Funds at Lloyd's define acceptable asset categories and asset concentration limits for charged assets.
Premium funds need to be sufficiently liquid to ensure settlement of claims and are typically invested in tradable bonds or cash. The assets held by the syndicate are held in trust funds and as such have to be managed in accordance with the various trust deeds. Certain amounts have to be kept in regulated funds with adjustments made periodically. This limits the freedom to move funds between portfolios and between cash and other assets.
Additionally overseas deposits have to be held for regulatory purposes in overseas jurisdictions to permit the Group to underwrite. They are invested in bonds and cash. The main components of these are the Australian, Japanese and South African Trust Funds, plus additional US deposits which for 2005 predominately relate to Lloyd's related underwriting. In the future it is expected that overseas deposits will be required for the Amlin Bermuda operation. All of the current Lloyd's deposits are managed by the Corporation of Lloyd's Treasury Services in accordance with applicable regulations. Personal reserve funds (PRF) are also managed by the Corporation of Lloyd's on behalf of the corporate members of the Group.
A breakdown of the asset classes is given below.
| |
Syndicate
£m |
31 Dec 2005 Corporate
£m |
Total
£m |
Syndicate
£m |
31 Dec 2004
Corporate
£m |
Total
£m |
|
| Global equities |
- |
116.2 |
116.2 |
- |
90.1 |
90.1 |
| |
|
|
|
|
|
|
| Bonds |
|
|
|
|
|
|
| Government securities |
736.7 |
14.5 |
751.2 |
329.1 |
8.4 |
337.5 |
| Government index-linked securities |
5.5 |
- |
5.5 |
11.1 |
- |
11.1 |
| Government agencies |
13.9 |
- |
13.9 |
17.6 |
- |
17.6 |
| Supranational |
- |
- |
- |
- |
- |
10.5 |
| Asset backed securities |
23.6 |
- |
23.6 |
15.1 |
- |
15.1 |
| Mortgage backed securities |
73.4 |
- |
73.4 |
29.4 |
- |
29.4 |
| Corporate bonds |
184.9 |
89.6 |
274.5 |
222.1 |
65.1 |
287.2 |
|
| |
1,038.0 |
104.1 |
1,142.1 |
624.4 |
84.0 |
708.4 |
| Other liquid investments |
|
|
|
|
|
|
| Money market instrument/CDs |
52.9 |
61.2 |
114.1 |
38.9 |
58.6 |
97.5 |
| Cash and cash equivalents |
52.4 |
13.2 |
65.6 |
17.2 |
30.4 |
47.6 |
| Money market funds |
66.6 |
639.2 |
705.8 |
328.3 |
78.2 |
406.5 |
|
| |
171.9 |
713.6 |
885.5 |
384.4 |
167.2 |
551.6 |
|
| |
1,209.9 |
933.9 |
2,143.8 |
1,008.8 |
341.3 |
1,350.1 |
|
The global equity fund at 31 December 2005 can be broken down by industry sector and geographical area as follows:
| Industry |
£m |
|
|
| Cyclical consumer services |
26.7 |
|
| Financials |
23.2 |
|
| Industrials |
4.6 |
|
| Non-cyclical consumer services |
30.2 |
|
| Resources |
16.3 |
|
| Technology |
3.5 |
|
| Utilities |
3.5 |
|
| Other |
8.2 |
|
|
| |
116.2 |
|
|
|
|
| |
Region |
£m |
|
| |
United Kingdom |
37.2 |
| |
USA and Canada |
12.8 |
| |
Europe (ex UK) |
38.3 |
| |
Far East |
20.9 |
| |
Emerging markets |
7.0 |
| |
|
|
| |
|
|
| |
|
|
|
| |
|
116.2 |
|
|
Investment management
The investment portfolios are managed by external investment professionals under the direction of Amlin's Investment Management Executive. Specialist managers are appointed for the different asset classes. The managers are monitored on an ongoing basis and are reviewed periodically using specialist investment consultants, currently Watson Wyatt Worldwide. Selection is based on a range of criteria that leads to the expectation that the managers will add value to the funds, whilst keeping within the strict guidelines.
The managers have discretion to manage the funds on a day-to-day basis but must operate, and are monitored to ensure adherence under the investment guidelines to ensure compliance with the regulations and Amlin's investment frameworks. In particular, the guidelines provide rules governing such factors as: eligible assets, minimum holdings in cash and government bonds and maximum exposures to non-government assets, single issuers, and credit. The bond managers are also given tactical duration ranges, within which they can position the funds compared to the benchmarks depending on the outlook for markets.
The managers at 31 December 2005 were:
| Manager |
Mandates |
|
| Aim Global |
Euro and US dollar liquid funds |
| Alliance Capital |
Sterling bonds and sterling liquid funds |
| Barclays Global Investors |
Sterling, Euro and US dollar liquid funds |
| Citibank |
US dollar liquid funds |
| Goldman Sachs Asset Management |
Sterling, Euro and US dollar liquid funds |
| HSBC Asset Management |
Sterling, Euro and US dollar liquid funds |
| Insight Investment Management |
Sterling bonds and sterling liquid funds |
| Taube Hodson Stonex Partners |
Global equities |
| Weiss Peck & Greer Investments |
US and Canadian dollar bonds |
| Western Asset Management |
US dollar and Euro bonds |
| Union Bank of Switzerland |
Canadian and US dollar liquid funds |
The total syndicate (100%) and corporate funds under management with each manager as at 31 December 2005 can be analysed here
Fair value
All Amlin's investments are marked to market. The prices are obtained by the fund managers and custodians using recognised market sources. In the case of equities this will be from the appropriate stock exchange. In the case of bonds this will be from a recognised price provider. Prices are checked by Amlin for reasonableness by using Bloomberg data feeds.
Valuation risk
Amlin's earnings are directly affected by changes in the valuations of the investments held in the portfolios. These valuations vary according to the movements in the underlying markets. Factors affecting markets include changes in the economic and political environment, risk appetite, interest rates and exchange rates.
These factors have an impact on all Amlin's investments and are taken into consideration when setting strategic benchmarks and tactical asset allocaion. The impact of interest rates and exchange rates are discussed in more detail below.
History has shown that whilst equity investments offer higher returns than bonds over the long-term, their prices are also more volatile. The historic volatility and correlations of the asset classes in which Amlin is invested are used in our value at risk (VaR) model when determining strategic asset allocation for the corporate assets. VaR is a statistical measure, which calculates the possible loss over a year, in normal market conditions. As VaR estimates are based on historical market data this should not be viewed as an absolute gauge of the level of risk to the funds.
The price of holdings can also vary due to specific risks, such as corporate strategy and balance sheet structure, which may impact individual equity as well as corporate bond holdings. This is mitigated by holding diversified portfolios, as specified in the investment guidelines given to the fund managers. These limit the exposure to any one company. In addition the equity mandate limits the exposure to any one geographic region or industrial sector.
If the value of Amlin's equity portfolio was to fall by 10% the impact on the overall assets as at 31 December 2005, pre-tax, would be a decline of £11.6 million.
Interest rates
The value of Amlin's bond holdings is subject to fluctuations in investors' interest rate expectations due to the impact on bond yields1. The sensitivity of the price of a bond is indicated by its duration2. The greater the duration of a security, the greater its percentage price volatility.
Amlin manages the interest rate risk of its premium assets by setting the duration ranges of its portfolios with reference to the duration of the liabilities. Due to the short tail nature of much of Amlin's underwriting portfolio this means that the duration of the assets is at the shorter end of the yield curve. Cash is raised, or the duration of the portfolio reduced, if it
is believed that yields may rise, and therefore capital values fall. The capital assets currently hold short dated bonds, as they are being managed against a cash benchmark. The duration of the bond and cash portfolios as at 31 December 2005 was as follows:
| |
31 December 2005
|
31 December 2004
|
| |
Years
Assets |
Liabilities
Years |
Assets
Years |
Liabilities
Years |
|
| Corporate |
0.2 |
- |
0.3 |
- |
| Syndicate |
|
|
|
|
| Sterling |
2.2 |
2.5 |
2.6 |
2.3 |
| US dollars |
2.8 |
3.1 |
2.6 |
3.0 |
| Euro |
2.5 |
3.0 |
2.8 |
3.0 |
| Canadian dollars |
2.1 |
3.2 |
2.5 |
3.0 |
|
An indication of the potential impact on the value of these funds of changes in the yield curve due to unexpected changes in underlying interest rates is given below:
| Bonds - 31 December 2005 |
|
Syndicate |
|
Corporate |
|
Shift in yield
(basis points) |
Sterling
% |
US$
% |
CAN$
% |
Euro
% |
Sterling
% |
US$
% |
Net
(reduction)
increase in
value
£m |
|
| 100 |
(2.4) |
(2.8) |
(2.1) |
(2.2) |
(0.5) |
(0.1) |
(28) |
| 75 |
(1.7) |
(2.0) |
(1.6) |
(1.7) |
(0.4) |
(0.1) |
(20) |
| 50 |
(1.2) |
(1.4) |
(1.1) |
(1.2) |
(0.2) |
(0.1) |
(13) |
| 25 |
(0.6) |
(0.7) |
(0.5) |
(0.6) |
(0.1) |
- |
(7) |
| -25 |
0.6 |
0.7 |
0.5 |
0.6 |
0.1 |
- |
7 |
| -50 |
1.2 |
1.4 |
1.1 |
1.3 |
0.2 |
0.1 |
14 |
| -75 |
1.8 |
2.1 |
1.6 |
2.0 |
0.4 |
0.1 |
21 |
| -100 |
2.4 |
2.8 |
2.1 |
2.7 |
0.5 |
0.1 |
28 |
|
| Bonds - 31 December 2004 |
|
Syndicate |
|
Corporate |
|
Shift in yield
(basis points) |
Sterling
% |
US$
% |
CAN$
% |
Euro
% |
Sterling
% |
Net
(reduction)
increase in
value
£m |
|
| 100 |
(0.8) |
(2.7) |
(3.1) |
(2.5) |
(0.2) |
(20) |
| 75 |
(0.6) |
(2.0) |
(2.4) |
(1.9) |
(0.2) |
(15) |
| 50 |
(0.4) |
(1.4) |
(1.6) |
(1.3) |
(0.1) |
(10) |
| 25 |
(0.2) |
(0.7) |
(0.8) |
(0.6) |
(0.1) |
(5) |
| -25 |
0.2 |
0.7 |
0.8 |
0.4 |
0.1 |
5 |
| -50 |
0.4 |
1.4 |
1.6 |
1.3 |
0.1 |
10 |
| -75 |
0.7 |
2.0 |
2.4 |
2.0 |
0.2 |
16 |
| -100 |
0.9 |
2.7 |
3.1 |
2.6 |
0.2 |
21 |
|
The maturity dates of the Group's bond holdings at 31 December 2005 can be analysed as follows:
| |
Syndicate
£m |
Corporate
£m |
Total
£m |
|
| Less than 1 year |
112.1 |
104.1 |
216.2 |
| 1-2 years |
225.2 |
- |
225.2 |
| 2-3 years |
147.4 |
- |
147.4 |
| 3-4 years |
143.2 |
- |
143.2 |
| 4-5 years |
290.6 |
- |
290.6 |
| Over 5 years |
119.5 |
- |
119.5 |
|
| |
1,038.0 |
104.1 |
1,142.1 |
|
Liquidity
It is important to ensure that there are sufficient funds to meet claims as they fall due. This is managed on a daily basis to make sure that adequate liquid funds are available to meet expected settlements due. Cash buffers are held in excess of these requirements. In addition, the syndicate guidelines require at least 25% of the funds to be held in government bonds and/or cash equivalents. If a major insurance event occurs the investment strategy is reviewed to ensure that sufficient liquidity is available in the corporate funds.
Liquidity in the event of a major disaster is tested regularly using internal cash flow forecasts and realistic disaster scenarios.
Cash flow
The policy of limiting the extent that the duration of assets can differ from the liabilities helps to reduce the risk that there is a cash flow mismatch. As discussed above, the corporate assets are not matched to liabilities.
Foreign exchange
Regulations require that local currency assets be held for any currency that makes up 5% or more of Amlin's total premium income.
Local currency assets are held for the sterling, euro, US dollar and Canadian dollar liabilities. As Amlin presents its financial statements in sterling it is subject to currency risk until the overseas profits are converted into sterling for subsequent distribution. Further currency exposure arises when business is written in non-accounting currencies. These transactions are converted into sterling at the prevailing spot rate once the premium is received, so there is exposure to currency movements between the exposure being written and the premium being converted into sterling. Payments in non-accounting currencies are converted at the time a claim is to be settled; therefore Amlin is exposed to exchange rate risk until the settlement is paid.
It is Group policy to mitigate foreign exchange risk by systematically converting profits earned overseas into sterling. Given the inherent volatility in some of our business a cautious approach is adopted on the speed and level of sales, but we seek to extinguish all currency risk on earned profit during the second year after the commencement of any underwriting year.
The intention is to time the currency transactions in order to optimise the conversion rates with the intention of achieving the average exchange rate or better for the year. This approach is part of Amlin's risk management strategy as it avoids the inherent dangers of 'lumpier' sales. It is not the intention to take speculative currency positions in order to make currency gains. Cumulative sales to 31 December 2005 were as follows:
| |
US dollar
|
Euro
|
Canadian dollar
|
Year of account |
Total
(millions) |
Average
rate |
Total
(millions) |
Average rate |
Total
(millions) |
Average
rate |
|
| 2005 |
14 |
1.70 |
- |
- |
- |
- |
| 2004 |
110 |
1.84 |
31 |
1.45 |
9 |
2.32 |
| 2003 |
271 |
1.81 |
40 |
1.48 |
18 |
2.24 |
|
| 31 December 2005 |
395 |
1.81 |
71 |
1.47 |
27 |
2.27 |
|
Amlin will occasionally transact currencies on a forward basis. These are carried out with leading banks, so as to limit the counterparty risk. The transactions are not designed as specific hedges and therefore realised and unrealised gains and losses are recorded in the profit and loss account of the period in which they occur. As at the end of December 2005 Amlin had no forward contracts outstanding.
Other
Amlin's investments are subject to credit risk as discussed below, but otherwise no other investment risks were identified as at 31 December 2005.
|
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