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The Actuary The magazine of the Institute & Faculty of Actuaries
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With-profits investment strategy

T he paper by the Investment Strategy Working Party introduces a dynamic investment strategy that can be used by life offices to control the risks in their with-profits funds. The strategy can be used to manage the fund’s equity exposure and is based on the concept of a theoretical equity backing ratio (tEBR) this is the proportion of the fund that can be invested in risky assets such as equities and property. The tEBR indicates how onerous guarantees are and the dynamic strategy proposed involves rebalancing the assets of the fund so that the equity exposure is close to the tEBR.
The dynamic investment approach would lead to a better outcome in the tails of a distribution than would be achieved with the same initial equity exposure without rebalancing. Conversely, it would lead to a poorer outcome in the centre. This is because the tEBR falls following poor equity returns and rises following good equity returns. Therefore, the dynamic strategy protects investors from sustained poor equity returns and enables investors to benefit from sustained good equity returns.
The paper investigates the impact of the dynamic strategy on controlling the risks faced by a life office by investigating its position assuming it followed a dynamic strategy, and comparing the results to those on alternative strategies. Work has also been carried out using a stochastic model to project a future position.
Applying the results of the investigations helps to forecast:
– probabilities of ruin;
– future levels of tEBR;
– size and timing of future cashflows;
– affordability and sustainability of future bonus strategies.

Model office
The working party established a model office, ‘Trio Life’, for its investigations. The office had written a range of with-profits products, which, through the product features and bonus declarations, had built up significant guarantees over the last 25 years. The results presented at the conference generated an interesting discussion about the product features that had led to onerous guarantees and the extent to which this had led to additional risk for the office in certain years.

Discussion
There was a debate on the linkage of strategies such as those set out by the working party with principles and practices of financial management (PPFMs). It was noted that some offices are now following methodologies that are close to the ideas touched upon in the paper. However, it was suggested that the extent to which the detail of strategies is disclosed might vary widely. The view was expressed that a balance needs to be sought between providing useful information and the extent to which actions may potentially be limited by PPFMs. How changes in asset volatility could affect the investment strategy of an office was also discussed.
It was generally agreed that following the approach set out in the paper would allow an office to understand how to control and manage risk better.
The paper can be found on the profession’s website at www.actuaries.org.uk/files/pdf/proceedings/life2004/Spiers.pdf

05_06_03.pdf