Our overriding investment goal has remained unchanged from Day 1: “Don’t lose your money”.
This was particularly difficult to do in 2008 – something that is evident from the unprecedented investment losses suffered by the insurance industry – but we are very proud to say that we achieved our goal. In fact, we produced a total investment return of 3.1 per cent.
Our tolerance to risk on investments is very low by industry standards. Our primary investment objectives are to preserve capital and provide adequate liquidity to support the Group’s payment of claims. A secondary objective is to maximise total risk-adjusted return, with low volatility.
Lancashire has three investment portfolios: “core”, “core plus” and “surplus”. The Group’s investment guidelines regulate the composition of each portfolio. The “core” portfolio contains at least enough funds required to meet cash flow needs following an extreme event plus loss reserves. Assets in excess of those required to settle potential insurance liabilities in an extreme event may be held in the “core” portfolio, the “core plus” portfolio or in the “surplus” portfolio.
Our portfolio mix illustrates our philosophy. Fixed income investments and cash account for 99.7 per cent of total invested assets. Duration is short at 1.8 years and average credit quality is high at AA+.
As is the case in all areas of Lancashire, we try to be nimble in our investment strategy. We apply common sense as much as anything else, often disagreeing with conventional wisdom on the state of the economy. We do not place much credence on a ‘black box’ approach to investment strategy.
That said, investing is inherently unpredictable; not all of our decisions have been right and sometimes the timing has been wrong, but some of the larger decisions have worked out well. Back in the second half of 2007 we concluded that the investment markets were going to experience tough times. Since then we have made several key defensive decisions to address credit risk and interest rate risk, while maintaining an acceptable yield albeit low by historical standards:
- Q4 2007: Exited non-agency structured product classes including CMBS, RMBS and ABS classes
- Q1 2008: Significantly reduced exposure to financial sector corporate bonds, including selling all Lehman Brothers holdings. Increased weighting in Treasuries
- Q2 2008: Remained defensive, including increasing allocation to cash to 39 per cent of total assets
- Q3 2008: Continued to reduce equity holdings from 5 per cent to less than 1 per cent by December 2008
- Q4 2008: Reduced weighting in Treasuries and increased weighting to FDIC backed corporate debt, Agency debt and Agency MBS.
| As at 31 December 2008 |
$m |
% |
$m |
% |
$m |
% |
$m |
% |
| |
Core |
Core plus |
Surplus |
Total |
| Available for sale |
|
|
|
|
|
|
|
|
| – Short-term investments |
101.5 |
6.4 |
9.9 |
0.6 |
52.2 |
3.3 |
163.6 |
10.3 |
| – U.S. treasuries |
148.3 |
9.3 |
15.8 |
1.0 |
27.6 |
1.7 |
191.7 |
12.0 |
| – Other government bonds |
27.7 |
1.7 |
11.4 |
0.7 |
15.0 |
0.9 |
54.1 |
3.3 |
| – U.S. government agency debt |
39.5 |
2.5 |
15.5 |
1.0 |
59.5 |
3.7 |
114.5 |
7.2 |
| – U.S. government agency mortgage backed securities |
180.9 |
11.3 |
82.2 |
5.1 |
351.3 |
22.0 |
614.4 |
38.4 |
| – Corporate bonds |
138.3 |
8.6 |
52.0 |
3.2 |
113.2 |
7.1 |
303.5 |
18.9 |
| – Corporate bonds – FDIC guaranteed(1) |
108.8 |
6.8 |
14.6 |
0.9 |
30.0 |
1.9 |
153.4 |
9.6 |
| – Convertible debt securities |
– |
– |
– |
– |
0.2 |
– |
0.2 |
– |
| Available for sale |
745.0 |
46.6 |
201.4 |
12.5 |
649.0 |
40.6 |
1,595.4 |
99.7 |
| At fair value through profit and loss |
|
|
|
|
|
|
|
|
| – Convertible debt securities |
– |
– |
– |
– |
4.0 |
0.3 |
4.0 |
0.3 |
| Total fixed income securities |
745.0 |
46.6 |
201.4 |
12.5 |
653.0 |
40.9 |
1,599.4 |
100.0 |
We have no plans to change our investment philosophy in the foreseeable future. We will continue to monitor the macro environment very closely, and at this time we are not optimistic about the ability of the world economy to rebound in 2009. Until we have a high degree of confidence that the worst is well and truly past we are more likely to take defensive investment actions than not.