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3 steps: How CIOs can use accounting and operations to prepare for yield-enhancing investment opportunities

  • steven castleton headshot

    Authors

    Steven Castleton

    Managing Director
    Financial Services

    Insurance | Kennett Square, PA

  • aaron jacob headshot

    Authors

    Aaron Jacob

    Director
    Financial Services

    Insurance | Denver, CO

Summary

Amid market volatility and all-time low interest rates, insurance CIOs can position their organizations to act and execute on yield-enhancing investment opportunities by preparing strategies, technical capabilities, and operational processes in advance.

Key takeaways

  • For an insurance company to act on new investment and risk mitigation strategies, you must first be organized and structured in your approach.
  • Assembling a working group of leaders from accounting, treasury, risk management, investments, and operations can serve to vet ideas and remove logjams.
  • Derivative working groups and CIOs should carefully outline three to five new strategies for consideration that could be critical to the organization’s future success.
  • The result of this work should be a handful of ready-to-execute strategies you can call upon and readily implement when needed.

As an insurance CIO, you are decades into a persistent low-rate environment. Your search for yield is never ending and recent market volatility amid all-time low interest rates forces you to become even more creative. Seeking new yield-enhancing investment opportunities can introduce new risks, impact operations, and create a need for specialized expertise to originate, manage, and hedge assets.

Though the search for yield is critical, constraints on how you invest are tight. Careful evaluation of each new investment is key, and new investments are carefully scrutinized. The need to preserve capital and protect the health of the business requires that you properly evaluate credit risk and mitigate market risk to within acceptable tolerances. This thorough process enables you to avoid hasty decisions.

Yet, many market opportunities have a short shelf life. To act on yield-enhancing economic strategies, your organization needs to be ready to act when windows of market opportunity open. Being prepared to act and execute on an investment strategy is different than beginning the oft-times arduous process of evaluating and getting approval for a new investment opportunity. CIOs whose organizations are ready to perform and execute on market opportunities will be best positioned to take full advantage of yield-enhancing investments. Robust readiness is a strategic advantage. As some have said, when it is time to perform, the time to prepare is over.

As derivatives advisors, one common thread we observe is that investment opportunities that introduce market risks that need to be hedged take additional time to execute. Investments that are not hedged require a detailed impact assessment across at least five key functions:

  • Policies and governance

  • Capital planning

  • STAT and GAAP accounting and reporting

  • Tax

  • Operations

Beyond these five functions, for investment opportunities that require active hedging of market risks, you should consider adding the following four functions:

  • Counterparty management and execution

  • Derivative valuations

  • Hedge accounting

  • Collateral

In addition to thoroughly considering the impact across these key functions, insurers must also carefully review each new strategy with at least four critical stakeholders: boards of directors, investment committees, regulators, and auditors. But the need to carefully consider the impact of a new investment and potential related hedging strategy need not result in delayed execution or missed economic opportunity due to closing market windows. By taking the following three steps now, your organization can reduce your time to market and act and execute on new investment opportunities when the new market opportunities arise — enabling your team to extend your strategic advantage.

Step 1. Create a derivatives working group

The first step to readying your organization for market opportunities is to get the right people talking. For an insurance company to act on new investment and risk mitigation strategies, you must first be organized and structured in your approach. A derivatives working group creates a powerful space for an empowered team to communicate and vet ideas, and anticipate and remove logjams.

For a derivatives working group to be effective, it must contain a cross-functional group of stakeholders, including leaders from accounting, treasury, risk management, investments, front office, collateral, middle and back office operations, and even the CIO and CFO. Without representation from these critical areas, the derivative working group lacks the perspective and authority to fully vet new ideas and market opportunities on behalf of the organization.

The right time to bring these individuals together is before you need derivatives — well in advance of the next market crisis. Rather than being forced to react to unanticipated market swings, maintaining a derivatives working group enables insurers to proactively engage in thought leadership and identify ways to capitalize on market opportunities as they arise — rather than reflect on what could have been if the organization had been ready.

Step 2. Take inventory

As a next step, insurers should prepare for market opportunities by thoroughly and honestly evaluating your current state. As the derivative working group gets up and running, you must take inventory of your organization’s capabilities — including strengths and weaknesses, areas of expertise or the lack thereof. The group needs to understand the organization’s objectives and priorities and honestly evaluate if they have what it takes to execute on strategies and meet those objectives.

Step 3. Identify and assess new strategies

The final step for insurers to ready themselves for the next wave of market opportunities is to identify and assess new strategies. Derivative working groups and CIOs should carefully outline three to five new approaches for consideration that could be critical to the organization’s future success. You should then socialize this handful of strategies across the organization to ensure they are fully vetted. The result of this work should be a handful of ready-to-execute strategies you can call upon and readily implement when needed.

To prepare these strategies for potential execution during a short-lived market opportunity, derivative working groups should carefully analyze each potential approach through the lens of the key functions and stakeholders identified above. Your organization must also consider the technical capabilities and operational processes necessary to efficiently implement a new strategy within a short timeframe. This readiness exercise could include an assessment of the technology solutions and partnerships that provide efficiencies for strategy execution and ongoing operational support.

By following these critical steps, your investment leadership team will have the tools and buy-in needed to capitalize on market opportunities, identify and execute strategies for additional yield generation, and create increased value for your organization.

About Chatham Financial

A leader in debt and derivative solutions, Chatham Financial serves clients across industries including insurance, asset management, financial services, banking, private-equity, real estate, and corporates. We work with clients to develop, execute, and operationalize financial risk management strategies aligned with their objectives. Our solutions include expert advisory services in all phases of derivative operations, and technology offerings that enable clients to scale their programs efficiently.


Contact our team

Let us know how we can help you manage your financial risk to help your business thrive.

About the authors

  • Steven Castleton

    Managing Director
    Financial Services

    Insurance | Kennett Square, PA

  • Aaron Jacob

    Director
    Financial Services

    Insurance | Denver, CO


Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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