Investment Principles – Session with
the CAS Investment Committee
2005 CAS Spring Meeting – Phoenix, AZ
May 18, 2005
Curtis Gary Dean, Distinguished Professor, Ball State University
François Morin, Principal, Towers Perrin
Todd Rogers, Director – Finance and Operations, CAS
© 2005 Towers Perrin
Agenda
 Background
 CAS Investment Policy
 Recent Activities
 Basic Investment Principles for Personal Investing
© 2005 Towers Perrin
2
Background
© 2005 Towers Perrin
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.”
© 2005 Towers Perrin
4
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
© 2005 Towers Perrin
5
Background – cont’d
 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
© 2005 Towers Perrin
6
Background – cont’d
 CAS Investment Committee formed in late 2000
 Manage CAS investments within prescribed policy
 Recommend changes for consideration by Board
 Committee reports to VP – Administration
© 2005 Towers Perrin
7
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
© 2005 Towers Perrin
8
CAS Investment Policy
© 2005 Towers Perrin
CAS Investment Policy
 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.
© 2005 Towers Perrin
10
CAS Balance Sheet as of September 30, 2004
Assets
Cash
Marketable Securities
Other
Total Assets
Liabilities
Deferred Exam Fees
Deferred Meeting Fees
Accrued Expenses
Total Liabilities
Net Assets
Unrestricted - CAS Surplus
Unrestricted - Other
Restricted - Temporarily
Restricted - Permanently
$1,293,453
3,634,448
304,913
5,232,814
$714,605
251,130
670,782
1,636,517
$3,312,043
243,093
41,161
0
Total Net Assets
3,596,297
Total Net Assets and Liabilities
5,232,814
Forecast CAS Surplus
© 2005 Towers Perrin
These two items represent
the amount that is invested
by the CAS in the three
investment funds.
FY 2005
FY 2006
The CAS Surplus is
used to allocate the
money between the
three funds.
3,026,812
3,301,792
11
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)
© 2005 Towers Perrin
12
Asset Allocation – Constraints by Class
Investment Instrument
CASH
U. S. GOVERNMENTS
CERTIFICATES OF DEPOSIT
MONEY MARKET MUTUAL FUNDS
OTHER FDIC INSURED BANK DEPOSITS
INVESTMENT GRADE BOND MUTUAL FUNDS
EQUITY MUTUAL FUNDS (LOW COST
PASSIVELY MANAGED INDEX FUNDS)
INTERNATIONAL EQUITIES NOT TO EXCEED
25% OF THE LONG TERM FUND.
© 2005 Towers Perrin
Operating
Fund
30%
100%
100%
100%
0%
0%
Short-term
Fund
20%
100%
100%
100%
100%
50%
Long-term
Fund
10%
100%
75%
50%
50%
50%
0%
0%
80%
13
Positions as of March 31, 2005
Market Value
Operating Fund
Cash
Treasuries
Total
Short-Term Fund
Treasuries
Vanguard ST Invest Grade Bond Fund
Vanguard Total Bond Index Fund
Total
Long-Term Fund
Treasuries
Vanguard Total Bond Index Fund
Vanguard S&P 500 Index Fund
Vanguard Total Stock Market Fund
Vanguard Total International Index Fund
Total
$907,083
627,042 No investment should exceed 2 years
1,534,125
$1,230,177 No investment should exceed 5 years
397,935
0
1,628,112
$20,702 No investment should exceed 10 years
607,937
1,377,989
153,062
261,759
2,421,450
5,583,687
© 2005 Towers Perrin
14
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
© 2005 Towers Perrin
15
Recent Activities
© 2005 Towers Perrin
Asset Allocation for Long-Term Fund
 Investment Committee wanted to confirm that the
asset mix that had been implemented for the LongTerm 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
© 2005 Towers Perrin
17
Asset Allocation for Long-Term Fund – cont’d
Efficient Frontier - 5 Year Time Horizon
Nominal Compound Return
10
9
7.69
8
7
6.69
6
5
5.69
4
4.69
3.69
2.69
1
0.66
3
2
1.16
1.66
2.16
2.66
3.16
3.66
4.16
4.66
Standard Deviation
Efficient Frontier
© 2005 Towers Perrin
Current Portfolio
18
Asset Allocation for Long-Term Fund – cont’d
Efficient Frontier - 5 Year Time Horizon
Efficient Portfolios
Risk/Reward
Standard Deviation
Nominal Compound Return
Reward Percentiles
Minimum
10th Percentile
25th Percentile
50th Percentile
75th Percentile
90th Percentile
Maximum
Asset Allocations
LgCap_Stk
LehAgg_Bnd
Intl_Stk
IntGovtBnd
© 2005 Towers Perrin
Alternate Portfolios
Current Current Eff10
Current Eff-Risk Reward
5.02
3.16
2.75
3.16
8.39
6.28
6.28
6.74
1
0.66
2.69
2
0.95
3.78
3
1.45
4.61
4
1.97
5.32
5
2.47
5.94
6
2.94
6.49
7
3.43
7.02
8
3.92
7.50
9
4.40
7.95
0.59
1.85
2.24
2.69
3.16
3.52
4.82
0.89
2.58
3.12
3.78
4.43
4.98
6.56
0.27
2.74
3.55
4.62
5.62
6.55
9.11
-0.28
2.65
3.90
5.27
6.69
7.97
11.32
-0.79
2.62
4.20
5.89
7.71
9.17
13.55
-1.27
2.67
4.39
6.40
8.56
10.32
15.64
-1.79
2.57
4.63
6.91
9.43
11.50
17.77
-2.64
2.42
4.81
7.36
10.25
12.66
19.97
-3.61
2.23
4.95
7.78
11.04
13.73
21.95
-5.51
1.94
4.87
8.16
11.96
15.02
26.51
-2.80
2.21
4.08
6.21
8.49
10.34
14.95
-1.08
2.66
4.35
6.19
8.23
9.84
14.82
-1.41
2.60
4.48
6.63
8.92
10.83
16.37
0.0
0.0
0.0
100.0
4.2
50.0
4.6
41.2
10.2
50.0
9.9
29.9
15.5
50.0
14.4
20.1
20.4
50.0
18.5
11.1
25.0
50.0
22.1
2.9
29.9
44.3
25.8
0.0
34.1
35.7
30.1
0.0
39.0
27.5
33.5
0.0
25.1
20.0
54.9
0.0
46.0
15.0
4.4
34.6
23.1
50.0
20.7
6.2
29.1
48.9
22.0
0.0
19
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
© 2005 Towers Perrin
20
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
© 2005 Towers Perrin
21
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
© 2005 Towers Perrin
22
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
© 2005 Towers Perrin
23
Investment Strategy for the
Short-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
© 2005 Towers Perrin
24
CAS Cash Flow
Net Cash Flow from Operations
800
600
400
2001
2002
2003
2004
2005
Adj Avg
200
0
(200)
(400)
(600)
(800)
Feb
Mar
Apr
May
Jun
Jul
Aug
(288)
25
140
265
(224)
(51)
(385)
(125)
(93)
(37)
(238)
(55)
133
225
144
(29)
(563)
(70)
(18)
195
11
(323)
(22)
118
475
(102)
(14)
(522)
(53)
231
111
335
39
(599)
(28)
244
569
111
(182)
(626)
(174)
308
369
79
273
(454)
(53)
259
0
0
0
0
0
0
0
426
14
(283)
(8)
172
436
51
(31)
(490)
(83)
174
225
Nov
Dec
2001
410
(82)
2002
492
(7)
2003
375
2004
2005
Adj Avg
© 2005 Towers Perrin
Sept
Jan
Oct
25