© 2005 towers perrin may 18, 2005 investment principles – session with the cas investment...

May 18, 2005

© 2005 Towers Perrin

Investment Principles – Session with the CAS Investment Committee

2005 CAS Spring Meeting – Phoenix, AZ

Curtis Gary Dean, Distinguished Professor, Ball State UniversityFrançois Morin, Principal, Towers PerrinTodd Rogers, Director – Finance and Operations, CAS

2© 2005 Towers Perrin

Agenda

Background

CAS Investment Policy

Recent Activities

Basic Investment Principles for Personal Investing

Presentation Date

Consultant's Name


Background


Background

CAS functions as a non-profit organization under section 501(c) (6) of the Internal Revenue Code of 1954

Per CAS Constitution, “Funds of the CAS shall be devoted exclusively to advance the body of knowledge of actuarial science applied to property, casualty and similar risk exposures.”


Background – cont’d

February 1986 – Board approves Investment Policy U.S. Treasury Notes only Maturity not to exceed five years

1995 – Finance Committee reviews policy and makes following recommendations Split funds into Operating Expenses and Surplus Allow investments in commercial paper/bonds Recommendations are not approved Board approves increased investment term to 10

years



April 2000 – Finance Committee presents a series of modifications to Executive Council Split assets into 3 funds (Operating, Short-Term,

Long-Term) Allow broader variety of instruments Obtain services of an advisor for asset allocation

Board approves the allocation of some portion of the Long-Term Fund into equities and commercial bonds

Board opts for a low-cost option of index funds instead of hiring investment professional

Finance Committee charged with allocation between funds



CAS Investment Committee formed in late 2000 Manage CAS investments within prescribed policy Recommend changes for consideration by Board Committee reports to VP – Administration


Committee Roster

Curtis Gary Dean (Vice Chair) – Ball State University

Richard Meuret – America First Insurance

François Morin – Tillinghast

Paul LeStourgeon – Towers Perrin Reinsurance

Nathan Schwartz – Benfield

Rich Zatorski (Chair) – Guard Insurance

Deborah Rosenberg (ex officio) – New York Ins. Dept.

Todd Rogers (Staff Liaison) – CAS

Presentation Date

Consultant's Name



10



Operating Fund The purpose of this fund is to provide sufficient cash

to meet the normal financial obligations of the CAS over the next 12 months.

Short-Term Fund The purpose of this fund is to meet CAS expenses

expected to occur between 12 and 24 months.

Long-Term Fund The purpose of this fund is to meet the CAS

expenses occurring as the result of unanticipated activities, to improve the return on funds held for expenditure over the next two to ten years, and to manage investment risk.

11


CAS Balance Sheet as of September 30, 2004Assets

Cash $1,293,453Marketable Securities 3,634,448Other 304,913

Total Assets 5,232,814

LiabilitiesDeferred Exam Fees $714,605Deferred Meeting Fees 251,130Accrued Expenses 670,782

Total Liabilities 1,636,517

Net AssetsUnrestricted - CAS Surplus $3,312,043Unrestricted - Other 243,093Restricted - Temporarily 41,161Restricted - Permanently 0

Total Net Assets 3,596,297

Total Net Assets and Liabilities 5,232,814

Forecast CAS Surplus FY 2005 3,026,812FY 2006 3,301,792

These two items represent the amount that is invested by the CAS in the three investment funds.

The CAS Surplus is used to allocate the money between the three funds.

12


Split of Assets Between the Funds

CAS Surplus 80 % of minimum of current or next 2 years’

projected CAS Surplus in Long-Term Fund Remainder in Short-Term Fund

Remaining Investable Assets 40% in Short-Term Fund 60% in Operating Fund

Operating Fund Balance must be greater than 20% of current year’s

operating expenses (approx. $1 million)

13


Asset Allocation – Constraints by Class

Investment Instrument

Operating Fund

Short-term Fund

Long-term Fund

CASH 30% 20% 10% U. S. GOVERNMENTS 100% 100% 100% CERTIFICATES OF DEPOSIT 100% 100% 75% MONEY MARKET MUTUAL FUNDS 100% 100% 50% OTHER FDIC INSURED BANK DEPOSITS 0% 100% 50% INVESTMENT GRADE BOND MUTUAL FUNDS 0% 50% 50% EQUITY MUTUAL FUNDS (LOW COST PASSIVELY MANAGED INDEX FUNDS) INTERNATIONAL EQUITIES NOT TO EXCEED 25% OF THE LONG TERM FUND.

0%

0%

80%

14


Positions as of March 31, 2005

Market ValueOperating Fund

Cash $907,083Treasuries 627,042 No investment should exceed 2 years

Total 1,534,125

Short-Term FundTreasuries $1,230,177 No investment should exceed 5 yearsVanguard ST Invest Grade Bond Fund 397,935Vanguard Total Bond Index Fund 0

Total 1,628,112

Long-Term FundTreasuries $20,702 No investment should exceed 10 yearsVanguard Total Bond Index Fund 607,937Vanguard S&P 500 Index Fund 1,377,989Vanguard Total Stock Market Fund 153,062Vanguard Total International Index Fund 261,759

Total 2,421,450

5,583,687

15


Rebalancing Rules

CAS follows a dollar-cost averaging process

Potential that target mix will get out of line because of capital appreciation

Long-Term Fund Rebalancing Rules 75% equities/25% bonds

— Rebalance when equities outside of 70%-80% Equities should be 87.5% domestic/12.5% foreign

— Rebalance when domestic outside of 85%-90% Active rebalancing can be delayed by up to three

months if current result is thought to be temporary

Presentation Date

Consultant's Name


Recent Activities

17


Asset Allocation for Long-Term Fund

Investment Committee wanted to confirm that the asset mix that had been implemented for the Long-Term Fund was optimal

Used an optimizer to determine the efficient frontier for the portfolio given the constraints specified by the CAS Investment Policy

Performed in July 2003

Concluded that current mix (70% domestic equities, 10% international equities, 20% bonds) was appropriate

18


Asset Allocation for Long-Term Fund – cont’d

Efficient Frontier - 5 Year Time Horizon

10 9

8 7

6

5

4

3

2

12.69

3.69

4.69

5.69

6.69

7.69

0.66 1.16 1.66 2.16 2.66 3.16 3.66 4.16 4.66

Standard Deviation

No

min

al C

om

po

un

d R

etu

rn

Efficient Frontier Current Portfolio

19


Asset Allocation for Long-Term Fund – cont’d

Efficient Frontier - 5 Year Time HorizonEfficient Portfolios Alternate Portfolios

Risk/Reward 1 2 3 4 5 6 7 8 9 10 CurrentCurrent Eff-Risk

Current Eff-Reward

Standard Deviation 0.66 0.95 1.45 1.97 2.47 2.94 3.43 3.92 4.40 5.02 3.16 2.75 3.16Nominal Compound Return 2.69 3.78 4.61 5.32 5.94 6.49 7.02 7.50 7.95 8.39 6.28 6.28 6.74Reward PercentilesMinimum 0.59 0.89 0.27 -0.28 -0.79 -1.27 -1.79 -2.64 -3.61 -5.51 -2.80 -1.08 -1.4110th Percentile 1.85 2.58 2.74 2.65 2.62 2.67 2.57 2.42 2.23 1.94 2.21 2.66 2.6025th Percentile 2.24 3.12 3.55 3.90 4.20 4.39 4.63 4.81 4.95 4.87 4.08 4.35 4.4850th Percentile 2.69 3.78 4.62 5.27 5.89 6.40 6.91 7.36 7.78 8.16 6.21 6.19 6.6375th Percentile 3.16 4.43 5.62 6.69 7.71 8.56 9.43 10.25 11.04 11.96 8.49 8.23 8.9290th Percentile 3.52 4.98 6.55 7.97 9.17 10.32 11.50 12.66 13.73 15.02 10.34 9.84 10.83Maximum 4.82 6.56 9.11 11.32 13.55 15.64 17.77 19.97 21.95 26.51 14.95 14.82 16.37

Asset AllocationsLgCap_Stk 0.0 4.2 10.2 15.5 20.4 25.0 29.9 34.1 39.0 25.1 46.0 23.1 29.1LehAgg_Bnd 0.0 50.0 50.0 50.0 50.0 50.0 44.3 35.7 27.5 20.0 15.0 50.0 48.9Intl_Stk 0.0 4.6 9.9 14.4 18.5 22.1 25.8 30.1 33.5 54.9 4.4 20.7 22.0IntGovtBnd 100.0 41.2 29.9 20.1 11.1 2.9 0.0 0.0 0.0 0.0 34.6 6.2 0.0

20


Which Index for International Equities?

In 2001, Investment Committee diversified its portfolio by investing in international equities

At the time, the selected index was the Vanguard European Index Fund Limit exposure to Japan due to perceived risks in

the banking sector Rising Euro (general consensus at the time) might

provide hedge for European equities when translated back to dollars

In 2003, Investment Committee revisited these assumptions and explored the possibility of investing into a broader index

21


Which Index for International Equities? – cont’d

Concluded that the Vanguard Total International Fund provides greater diversification Even though the Total International Fund has

substantial exposure to Japan (about 19%), investment limits imposed by our asset allocation model drops our exposure to Japan to only 2.4% of our overall equity allocation (7/8 US and 1/8 International)

Investment Committee decided the best approach would be to exit the European fund entirely, and enter the Total International Fund all at once

22


Which Index for Domestic Equities?

In 2001, the Vanguard S&P 500 Index Fund was chosen as the index to invest in domestic equities

In 2004, the Investment Committee had discussions to start using a broader index for domestic equities Philosophically, it makes sense that we should be

investing in the broader market to diversify risk Data to support this statement is difficult to obtain

In October 2004, the Investment Committee approved an initial investment into the Vanguard Total Stock Market Index

23


Revised Split between Funds

In early 2004, the Committee researched alternative investment strategies with the intention of increasing the yield on assets in the Operating Fund and the Short-Term Fund

Very few options available given the maximum investment maturity of 2 years in the Operating Fund

Committee recommended a change in the distribution of invested assets between the two funds Short-Term Fund now includes 40% of remaining

investable assets

Approved by the Board, effective with the 2005 fiscal year

24


Investment Strategy for theShort-Term Fund and the Operating Fund

The Committee recently had discussions about the feasibility of developing an asset allocation model for the Short-Term Fund and the Operating Fund

The objectives of these two funds are dramatically different than the objective for the Long-Term Fund Their objective consists of a balancing act of

ensuring that sufficient cash is available to meet cash flow needs, while at the same time maximizing returns.

The Committee decided to continue its current process of managing these funds Make decisions each meeting based on the yield

curve and cash flow projections

25


CAS Cash Flow

Net Cash Flow from Operations

(800)

(600)

(400)

(200)

0

200

400

600

800

2001

2002

2003

2004

2005

Adj Avg

2001 410 (82) (288) 25 140 265 (224) (51) (385) (125) (93) (37)

2002 492 (7) (238) (55) 133 225 144 (29) (563) (70) (18) 195

2003 375 11 (323) (22) 118 475 (102) (14) (522) (53) 231 111

2004 335 39 (599) (28) 244 569 111 (182) (626) (174) 308 369

2005 79 273 (454) (53) 259 0 0 0 0 0 0 0

Adj Avg 426 14 (283) (8) 172 436 51 (31) (490) (83) 174 225

Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sept

© 2005 towers perrin may 18, 2005 investment principles – session with the cas investment...

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