Asset-Mix Strategy: Needed For Variable Products
By John M. Bragg
To serve the public, the insurance industry needs a long-term asset-mix strategy. The strategy must be workable. And heres the hard part: It must be salable to the public.
By an asset-mix strategy, I mean a mix of three-month Treasury bills, long-term Treasury bonds and common stocks. This mix needs to be adjusted regularly according to not only the customers risk tolerance and needs, but also according to the changes in the business cycle.
Many insurers now offer asset allocation and automatic rebalancing programs with their variable insurance policyholders, of course. Some also offer life-cycle investment strategies. But such modeling does not go far enough because many clients end up putting their money in a group of funds and then leaving it in there, no matter what happens in the economy.
There needs to be a pre-established review process for clients, so that their variable investments choices are continually updated. This pre-established plan would lay out what to do if certain economic conditions should appear.
If the industry is successful, it can help its customers avoid some of the extremes of the yield roller coaster, such as has occurred in recent times (see Chart I for an example).
This asset-mix strategy will help the variable policies cut across the key sectors in the convergence market–insurance, securities and banking–and its implementation will help even out performance for customers.
Sometimes, it seems that real convergence is about impossible. To illustrate, see Chart II, which shows the historical attitudes of players in the convergence scene. They are quite divergent.
In general, insurers believe in being guarantors and in offering safety and year-to- year stability. Given that, the industry also wants to maximize yield.
So lets talk a little bit about common stocks, which are supposed to maximize yield. Between 1993 and 2002, their average yield was very good (11.2%). But year-to-year stability was terrible; their yield in 2002, for example, was a killer (-22.1%). (Statisticians would say that their standard deviation, 20.7, was too high!)
So what would an ideal asset-mix strategy look like? It would be compatible with our long-term views, would achieve the long-term yield of stocks and yet would have far greater stability–that is, it would have a much lower standard deviation than that of stocks.
Such a strategy would have to be formalized and applied without benefit of foresight. (Hindsight is perfectly okay.)
Can such a strategy be attempted? I have been following one such strategy, which I call the Prudent Mixture Strategy (PMS), since 1985. The results are in Chart I. (The PMS operates on the basis of currently discovered business cycle mood). As the chart shows, the managed PMS strategy outperformed stocks (11.9% vs. 11.2%) over the 10-year period. It had a far lower standard deviation (11.3 vs. 20.7). It outperformed long bonds also, in both respects.
However, there were poor-performing years, as well. In the horrible year of 2002, it only yielded 1.9%, but it did avoid that 22.1% drop in the stock market! (It permitted only 25% in long bonds, which happened to star in 2002).
Im not touting the Prudent Mixture Strategy. Its just an example of the kind of pre-determined strategy that I believe the industry needs to use in asset modeling for variable life and annuity accounts. Other pre-determined strategies could work as well.
Having such a strategy will help the companies help their variable insurance customers overcome the effects of the roller coaster.
In my opinion, the companies and their agents should no longer have a strategy of not offering a formal program in this area. A strategy that recognizes the business cycle should be an essential option in every variable product.
The question is, could the industry sell its variable products on the basis of its own proven and pre-sold asset-mix strategy, one that recognizes changes in the business cycle?
That is not a given. But at least the business would have something new to offer clients–and the strategy would provide clients with a regular reminder to revisit investment options as the business climate changes. This could be an attractive option that might help increase future sales.
John M. Bragg, FSA, ACAS, MAAA, is actuarial consultant at John M. Bragg and Associates, Atlanta; past president of Society of Actuaries; and past CEO of Life Insurance Company of Georgia. You can e-mail him at firstname.lastname@example.org.
Reproduced from National Underwriter Life & Health/Financial Services Edition, May 26, 2003. Copyright 2003 by The National Underwriter Company in the serial publication. All rights reserved. Copyright in this article as an independent work may be held by the author.