SOA Health Conference Using Federal Hom e Loan Bank Program to Im - - PowerPoint PPT Presentation

SOA Health Conference

Using Federal Hom e Loan Bank Program to Im prove Returns

Risk Management for Health Insurers

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Traditional Risk Management Practices and Controls Capital Management ERM EC

Cash flow / liquidity management Medical cost management Risk selection RBC Rating agency capital models Moving from qualitative to quantitative

Optimizing risk adjusted returns across competing models and frameworks is complex and challenging.

Health Industry RBC Breakdown

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% Total 2010 RBC after Covariance Benefit H0 ‐ Affiliate Asset Risk 13.89% H1‐ Invested Asset Risk 4.31% H2‐Underwriting Risk 79.39% H3‐Credit Risk 0.27% H4‐Business Risk 2.14% Total Risk 100.00%

Fixed income, 0.99% Common stock, 1.62% Other, 1.70%

Sim ilar situation under AMBest BCAR; net investm ent charges slightly higher under S&P capital m odel due to absence of covariance benefit.

Risk is hea v ily concentra ted in “und erw riting” risk: …..but inv estm ent stra tegy ca n m a ke a significa nt im p a ct on return…

Health Industry Investment Strategy Focused on Liquidity

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Quartile Cash, % invested assets Bonds <1yr maturity, % invested assets Median Assets ($M) 1st 55.9% 21.8% 167.0 2nd 24.8% 19.9% 257.5 3rd 9.0% 12.0% 322.2 4th 1.4% 7.3% 451.6 Median 17.8% 12.8% 259.2

…Investm ent strategy tends to focus on liquidity. Industry m edian cash plus bonds m aturing in less than one year as a percentage of invested assets is 30 .6%.

 Health insurers with more than $100M in assets (278)  Ranked by cash plus bonds maturing in less than

• ne year as a percentage of invested assets

 Larger companies tend to hold less cash

Source: SNL Financial

… but at what cost?

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Quartile Cash, % invested assets Bonds <1yr maturity, % invested assets Median Assets ($M) Net Yield 1st 55.9% 21.8% 167.0 0.8% 2nd 24.8% 19.9% 257.5 2.1% 3rd 9.0% 12.0% 322.2 2.6% 4th 1.4% 7.3% 451.6 3.1% Median 17.8% 12.8% 259.2 2.2% For exam ple, a hypothetical health insurer… Cash $ 50M (20%) Total Assets $ 250M Surplus $ 150M Net Income $ 12M ROE 8.0% ROA 4.8% Cash $ 25M (10%) Total Assets $ 250M Surplus $ 150M Net Income $ 13M (+8%) ROE 8.7% ROA 5.2%

Reduce allocation to cash by $25M, increase allocation to investment assets with blended net yield of 4%.

Source: Analysis using SNL Financial data

FHLB Programs

 The Federal Home Loan Bank (“FHLB”) is a government sponsored enterprise (“GSE”) that was formed in 1932 to improve the availability of funds to support home ownership.

• The fundamental business of the FHLB is to provide a readily available, low-cost source of

funds in a wide range of maturities to meet the demands of its members.  Twelve FHLB regional banks structured as cooperatives owned and governed by their member financial institutions, which include commercial banks, thrifts, credit unions and insurance companies.

• As of 12/ 31/ 11 there were 260 insurance company members of the FHLB nationwide, but

included only 6 health insurance companies.  FHLB provides low cost borrowing secured by eligible collateral.  As of 12/ 31/ 11 there were $47 billion in advances

• utstanding to the insurance company members of the

FHLB.

Median borrowing capacity of health insurers is ~ 21% of invested assets.

6 Insurer Mem bership, by Type

FHLB Membership Requirement

 To join a member must be a federally or state regulated financial institution, must originate or invest in residential mortgages or mortgage backed securities, and must be “financially sound”.  Additionally, the member must purchase “membership” stock as required by the regional FHLB.

• Typically the required amount is equal to a certain number of basis points multiplied by

either the institution’s total assets (5bps to 15bps) or total mortgage related assets (20bps to 100bps).  To borrow (obtain an advance), the member needs to purchase additional stock, called “activity stock” and pledge eligible collateral.

• The amount of activity stock required to be purchased varies by regional FHLB typically

ranging from 4% to 5% of the member’s aggregate advance amount outstanding.

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FHLB Membership Requirement (continued)

 FHLB stock is nonmarketable and redeemed at par by each regional bank.

• Each regional FHLB returns excess profits to its members in the form of dividends.

 FHLB stock is accounted for as unaffiliated common stock on Schedule D of the statutory financial statements.

• Since the stock is only redeemable at par, it is not subject to market volatility and often

carries lower risk based capital charges than common stock.  The member must pledge assets equal to the member’s aggregate advance amount plus an applicable overcollateralization amount (“haircut”).  Typical eligible collateral includes: US government and agency securities, mortgage backed securities, and whole mortgages.  Pledged assets are still owned by, and investment income flows to, the institution member and the institution may substitute collateral at any time.

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Advances

 Standard types of advances include fixed-rate, variable-rate, amortizing, and convertible with maturities ranging from one day to 20 years.  Custom advances are available that include interest rate caps, floors, collars, calls or puts.  The FHLB also provides members with letters of credit and other financial products.

FHLB Fixed Rate Advance and Treasury Curve (March 20 12) Corporate Bond Yields Com pared with FHLB Advance Rate (March 20 12) 9

FHLB Advisory Services

 Montshire Advisors provides the following advisory services to assist you in evaluating and implementing a FHLB program:

• Evaluate your eligibility
• Estimate your current and future borrowing capacity
• Analyze your financial benefit.
• Analyze your regulatory and rating agency capital impact.
• Assist you in completing your FHLB membership process.
• Advise on options on collateral lien structure.
• Identify outsourced investment management and reinsurance opportunities for funding

agreements.

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About Montshire Advisors

 Montshire Advisors is a solution oriented advisory firm serving the insurance industry. Our focus is on implementing select strategies to increase risk adjusted returns, improve liquidity, and optimize financial strength.  Montshire’s primary focus is on three proven and widely applicable solutions:

• Corporate owned life insurance programs as a tax and capital efficient investment platform for insurers.
• Federal Home Loan Bank membership and programs to access low cost and spread based lending
• Captive reinsurance structures to reduce required capital for business with uneconomic levels of reserves or

capital.  Montshire is well positioned to offer corporate finance advice and solutions in many other areas given the firm’s breadth of experience. In particular we are working with clients in the following areas:

• Assisting an asset manager to launch a registered insurance fund with a quantitative ETF-based dynamic

asset allocation strategy and get the fund placed on variable product platforms.

• Assisting producer groups in evaluating producer captive reinsurance transactions and new product
• pportunities.

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