What goes into designing a captive's investment strategy?
Liquidity comes first, then bonds matched to when claims fall due.
According to Jack Meskunas, Managing Director at Oppenheimer, liquidity is extremely important in a captive, particularly where claims are frequent and small. He describes a progression from a cash buffer for operating bills, into fixed income of varying maturities, with bonds timed to mature roughly when claims are expected. He is blunt that holding everything in a money market would be the wrong answer.
Meskunas frames the design question with a deliberately absurd version of it. If the only thing a captive cared about was paying claims, he says, you would hold everything in a money market and own the world's most expensive savings account, since you would be paying captive fees around what amounts to a deposit.
So liquidity is a floor rather than a strategy. There needs to be a certain amount of it, and for immediate needs that can be as simple as a money market fund.
Key takeaways
Liquidity matters most where claims are frequent and small.
A cash buffer covers operating bills so investments are not sold to pay them.
Bond maturities are typically matched to when claims are expected to fall due.
Above that sits operating cash, so the captive is not selling investments to pay rent, the actuary or the accountant. Then typically fixed income: corporate and government bonds of varying maturities.
The organising idea is asset liability matching. Where claims are expected in a given year, the aim is to have bonds maturing that year to pay them. Meskunas gives a property example where losses may cluster in winter as pipes burst, and notes property is short tail, meaning claims need paying quickly rather than waiting years for litigation to settle as they might in a casualty line.
How the portfolio is layered
Each layer answers a different question about timing.
- 01Money market for immediate needs.
- 02Operating cash so investments are not sold to pay bills.
- 03Fixed income of varying maturities.
- 04Maturities matched to expected claim timing.
From the conversation
Jack Meskunas
Managing Director, Oppenheimer
“liquidity is extremely important in a captive, particularly for those high frequency, low severity types of claims”
Transcript
Read the full transcript 42 turns
So, when you're, when you're designing an investment strategy,
what, really goes into, the, into the program design? How do you target the returns you're
looking to achieve and the liquidity you're looking to achieve? Well, liquidity is extremely
important in a captive, particularly for those high frequency, low severity types of claims.
There needs to be a certain amount of liquidity in the captive. And, that can be as simple as
a money market fund for certain immediate needs. I, speak a lot of con, at conferences and
we sort of had a very. And on the news, you're, the, cover of what was the
captive, insurance times. Yeah, the, that was great. I love that. But it was funny,
because at the last conference that I spoke at in, Chicago, there was sort of this debate about
liquidity. And I said, listen, if the only thing you're captive cared about, the only thing was
paying claims, you would have all of your money in a money market. And you would have the world's
most expensive savings account. Because you would have all these fees around a money market account.
You could just take your money and put it in a money market account. So clearly, that's not the,
optimal way to invest a captive's assets. So, now you say, okay, well, what's next after a
money market? You've got a certain amount to cover bills. You don't want to have to sell investments
to, you know, to pay your rent or to pay, or to pay your, actuary or to pay your accountant.
So, you have a certain amount of cash. Then you have typically fixed income investments, bonds,
and corporate bonds, government bonds, and a varying maturities. And you try to do ALM,
asset liability matching. If you know that certain claims are coming up, or you feel, or
historically, there's a certain amount of claims each year, you know, the idea would be to have
a number of bonds that mature each year to pay those, claims.
That makes perfect sense to me. So, in our program, hypothetically, we may have more claims in the
winter because pipe's bursting. So, in a program like that, like us, you would design assets to
match that liability duration. And, property is short tail. You know, you can't, it's not a
casualty line where you can sit to, wait for litigation to settle the claim. These are claims
that need to be paid right away. Right. And so, and so, and because of that, right, it's not like
medical malpractice where, you know, it could be a lawsuit that goes on for 10 years. Right. You
have a pipe burst. That person needs that to be paid to fix that pipe. Of course. And so,
it's, really critical that the assets in the captive are liquid. The,
portfolios that I design, the vast majority of the assets are liquid daily. Now, that doesn't
mean that, doesn't mean that they mature daily. They could be bonds that mature in three
years, four years, five years. They could be equities, which of course, don't have any maturity
date. But they trade on a daily basis so that if there was a claim that had to be paid,
if something hadn't matured at that particular moment, it could be sold. It could be liquid. And,
the, and the, and the money settles the next day. For captives that are more mature and as they
get, as they get bigger and bigger, they get more mature, they have more surplus, that's where you
can take a little bit more risk. You can buy equities. You can even buy structured products
or hedge funds. But under, and they may have say monthly liquidity or quarterly liquidity,
that's not for 80% of your captive. That's for 5% of your captive or something like that. So,
but the idea is that that's a way to add alpha to add extra performance into the returns
by having a small allocation to higher grossing, higher yielding potentially investments
for the captive
The views expressed are those of the featured guest, drawn from a recorded conversation, and reflect their own professional experience. Nothing on this page is insurance, tax, legal, or investment advice. Consult your own advisors about your specific situation.
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