But with long-term liabilities defining their promise of protection, life insurers face the most onerous regulations on their investments. They not only strive to keep their equity portfolio comparatively lower and their mortgage and private debt investments relatively higher than P&C companies, but they also have to contend with risk-based capital and other measurements for the investments they make that P&C and health carriers do not (see Rules and Regulations).

Regardless of their market niche, most insurers have two common objectives for their investment management technology. The first is the ability to track and manage one or more portfolios within the confines of investment restrictions, whether those restrictions are imposed by regulatory bodies, rating agencies (such as A.M. Best, Standard & Poors, and Moodys Investors Service), or by even stricter internal rules an insurer may have adopted.

As is true for any national insurer, were regulated by all 50 states, says Louis Lombardi, senior vice president and actuary at Phoenix Life Insurance (Hartford, Conn.). But were also domiciled in New York, which, by far, has the most vigorous regulations that some other states have modeled. When we look at our portfolio, we have to make sure were in compliance with all their guidelines, whether theyre for the use of derivatives, the percentage of assets we can have in equities, the investment grade of those assets, or the ability to satisfy diversity requirements among industries.

Compare these restrictions to other financial services firms, such as mutual fund companies, suggests William C. Stone, president and CEO of SS&C Technologies, a provider of investment management technology. A fund cares only about its total return. But a [life] insurance company is constrained. If it buys a common stock, 20 percent of the market value of that stock is a capital charge. Whereas, if it buys a treasury investment, only one percent is a capital charge. That affects how much surplus a company has to have to operate its business, says Stone.

Therefore, an insurer may be rich in pure dollars but short on statutory surplus, either due to its equities position or rapid written premium growth. You need to have a capital allocation process to tell you the optimal portfolio mix, then you need to compare that and rebalance to get as close to optimum as you can. Its reasonably sophisticated as to how they go about that process, Stone explains.

In addition to managing their investment mix, the second equally cumbersome task insurers face is the ability to produce quickly and automatically the myriad reports various bodies require. These range from the voluminous Schedule D financial reports to the differing asset allocation and capital position statements required by any of the 50 states that may regulate a particular insurer.

Insurers reports are very different from those traditional asset managers produce, says Ira Strassberg, a managing director for business consulting and systems integration firm BearingPoint, Inc. (formerly KPMG Consulting). Theyre measured based upon GAAP or statutory earnings as opposed to a total return philosophy.

A Complex Decision

With the degree of complexity created by both investment restrictions and reporting requirements, some insurers have chosen to outsource their investment management completely. For example, Farmers Insurance Group (Los Angeles) has relied on Deutsche Bank asset management since 1998. Laszlo Heredy, vice president of Farmers, reports it was a long, complicated, and convoluted series of events, involving mergers and transitions that drove this corporate-level decision.

Insurers that choose to keep their investments in-house almost universally use some technology to manage them, whether or not that technology represents a dedicated investment management platform or an extension of an underlying financial system. Key vendors in the investment management technology space include SS&C as well as Princeton Financial Systems and SunGard.

Jefferson Pilot Financial, a Greensboro, N.C.-based writer of life insurance, annuities, and group benefits, looked primarily to reporting requirements when it installed Princeton Financials PAM system in the mid-1990s. It has continued to upgrade the system over time and is still committed to the platform, currently using the mortgage and securities modules. Our reporting goals require us to track investments in risk-based-capital buckets as well as gains and losses for AVR [asset valuation reserve] and IMR [interest maintenance reserve]. IMR is particularly problematic because of requirements to amortize realized gains over time, explains Rick Smith, assistant vice president, investment accounting and administration.

Our goals in selecting a system were summarizing data for risk-based- capital measurements, summarizing data for our asset liability models, meeting reporting requirements, and ease of use, says Phoenixs Lombardi. Once you put aside regulation, the economic dimension affected our decision. We do not take any investment/liability mismatch risk whatsoever, says Lombardi. That is, Phoenix ensures the terms of the assets it invests in match the terms of the associated liabilities, rather than purchasing a shorter-term investment and gambling on an eventual greater return.

On one hand, Phoenix needs to capture financial data daily down to the policyholder level and then summarize it, allowing the insurer to assess, for example, whether 20 different policyholders purchased $1 million of insurance each versus one policyholder purchasing $20 million, Lombardi explains. On the other, it needs to evaluate on at least a biweekly basis whether the overall structure of its assets matches its cumulative liabilities. We also plan to use the system to allocate investment income to our product segments, he says. Currently, our subsystem feeds our general ledger, and the general ledger feeds a database. That sequence is fraught with problems.

The carrier also chose Princeton to meet its investment management needs and is currently installing PAM either to replace or interface with the seven different management systems it currently uses for investment management and regulatory reporting, Lombardi says. The system will also be fed by a half dozen different administration platforms and four different investment subsystems, most of which were developed in-house. A key part of the new architecture will be to create databases, either SQL or DB2, to replace the VSAM files the insurer currently utilizes for creating reports, allowing it to do faster querying and to create subservient databases.

Most agree a warehouse is essential to an effective investment management system. Its important to have fast, easy access to the data and to update the database without going through a nightly cycle as older systems require, says Stone. To make the type of investment decisions required in todays marketplace, ad hoc reporting that is based on real-time data is critical.

The primary problem for most insurers is the income statement, says Strassberg. They need systems to project future income and what could impact that on a statutory and GAAP basis. That can be a challenge given the different types of asset classes they have. From a tech perspective, you often have source systems feeding a data warehouse reporting system, as well as analytical engines running off of the data warehouse.

Jefferson Pilot, which also uses an auxiliary system, BondEdge, for fixed income analytics and forecasted cash flows, is building a data warehouse that will allow it to perform time-series financial analysis. Our goal is to be able to look at all asset types in one view, Smith says.

Were also particularly concerned about meeting the reporting requirements of rating organizations, says Lombardi. In the past, wed report to them once a year, but now theyre meeting with us about three to four times a year because they got a bit of a black eye with the Enrons and Global Crossings. Theyre looking for a continuous dialog, and theyre requesting data in more detail and more frequently.

Keeping Updated

Just as many individuals have come to rely on tax preparation software to keep track of the myriad nuances and changes to tax law, insurers look to their investment management vendors to be regulatory consultants, keeping them current with the changing reporting requirements as well as state-specific and NAIC-driven capital and investment measurements. If an insurer were to custom-develop an application, it would continually need to update it and maintain it, says Donie Lochan, vice president within the global financial services group at Cap Gemini Ernst & Young. That is difficult, time-consuming, and expensive.

Building something internally, or going with a product not dedicated to the insurance industry, would be difficult. Princeton has a staff dedicated to tracking whats going on at the NAIC. So we rely on Princeton to get our training regarding whats going on for statutory reporting. Thats worked out well, Smith says.

Insurers do have to customize and update investment management systemsor rely on their vendors to do soto address internal investment guidelines above and beyond the NAIC. In the compliance tool, you can set up individual state or provincial tools, says Scott Ferrante, chief operating officer at Princeton Financial Systems. For instance, sometimes fraternal groups own insurance companies and perhaps dont want their portfolios to have any sin stocks in themno tobacco, no liquor. Or an insurer may set a level of industry concentration, such as not wanting more than five percent auto stocks.

Morgan Stanley prepared default experience by the various life insurance companies, so weve been benchmarked against that, Lombardi says. They needed to know how much exposure we had to the airline industries, for example. We have a lot of requests like that from investment bankers we need to respond to.

Another goal of insurers has been to use investment management technology as a facilitator of straight-through processing (STP) of investment transactions. Without STP, there is an existing disconnect between the analysis of a needed portfolio change, the purchasing of investments to accomplish that change, and the recording of the resulting new investment mix.

Jefferson Pilot has integrated its PAM system with Bloombergs trading system to achieve STP for trade transactions. When our portfolio managers execute a trade on Bloomberg, it feeds directly and immediately to PAM, says Smith. PAM also interfaces with the BondEdge system as well as the Hub Data market update service the carrier uses. Jefferson Pilot also uses an actuarial software package from Tillinghast-Towers Perrin to perform additional business analytics on PAM data.

Tillinghast allows us to look at the sensitivity of our liabilities and the sensitivity of our assets in conjunction with each other, Smith explains. We can run hundreds of interest rate scenarios, and we can analyze the results for the cash flow testing were required to do, including mandated testing and Jefferson Pilots own internal asset liability management guidelines that are more stringent than statutorily required.

The insurer plans to extend the STP capabilities to other divisions within the investment realm, such as where the insurer uses third-party investment managers for certain high-yield bond trading. We have a manual process in place for interacting with those managers. Therefore, one of our goals for 2003 is to get them up and running on Bloomberg, so if they execute a trade on our behalf, it feeds directly into PAM without any re-entry on our end, Smith says.

Ahead of the Curve?

Conventional wisdom has it that insurers are behind their counterparts in other financial services industries when it comes to the adoption and use of technology. Whether thats true in investment management is arguableopinions were evenly divided among the sources who spoke on this subject. Consensus, however, is found in the belief that an insurers need for an investment management system is greater (particularly in life insurance) than in other financial services sectors due to a combination of complexity of investment requirements, the long-tail liabilities, and the manner in which insurers have historically matched their assets and liabilities.

Unlike a mutual fund, assets underlying a specific insurance product span different asset classes, and because companies invest in securities or assets not publicly quoted on a regular basis, aggregating all that information and running a risk analysis of what happens if interest rates or equity prices change is a challenge, says Strassberg. Insurance companies need better integration than other asset management companies, and they havent gotten there yet.

On the plus side, we dont have to worry about producing an NAV [net asset value] report every day as a mutual fund company would, and because our focus on investments is buy and hold, we have more of a stable niche in the market, says Smith. I believe the vendors we have chosen are all committed to our market segment. Theres a real community within our industry of using the same products, doing the same work, and were coalesced around that product. Its almost something that sets us apart; its something the vendor has to be mindful of.

Indeed, insurers that have adopted investment management systems have found them to be indispensable, and some even see a silver lining in the current technology spending cloud. Three years ago, the demand was so great that vendors couldnt keep up, Lombardi says. Right now, theres such a lull in spending, weve found we can actually put in better technology at a cheaper price.

Rules and Regulations

Risk-based capital. The NAIC risk-based capital system has two key components. The first is a formula that sets a minimum capital level and compares it to a companys actual capital level. The formula considers, among other factors, the default risk of various assets, the risk of interest rate changes, and the underwriting risk based on an insurers book of business and experience. The second component is a model law reflecting this formula that nearly all states have adopted at least in part.

AVR/IMR. Asset valuation reserve (AVR) is the surplus charge a carrier must take depending upon the type of investments it has purchased and reflects the risk of default on those investments. Interest maintenance reserve (IMR) is the surplus charge a carrier must take against the risk of interest fluctuation.

Basket provisions. Rules individual states set that determine how many investments an insurer may have in a particular asset class.

Other measurements. Third-party rating organizations require information that measures insurers investments against industry norms and peer companies. Insurers may also establish more restrictive investment guidelines. Other organizations have created additional measurement standards, such as the Casualty Actuarial Societys Dynamic Financial Analysis, which projects surplus results under various economic scenarios.

Market Woes, Modeling Solutions

After watching the value of stock-driven retirement accounts, mutual funds, and individual equity holdings tumble over the last couple of years, most of us would be happy to find some technological cure-all for what ails our sinking portfolios. Insurers bottom lines also have been impacted by market downturns, but differently than individual investors and other business because of their particular investment mix.

As one P&C CFO remarked (speaking anonymously after smarting from reviewing a third-quarter investment analysis), personal investors have about 20 percent bonds, 80 percent stocks. In the insurance spectrum, its the reverse. Thats the only upside; knowing our results would have been far worse had we invested more aggressively in equities.

Investment selection is even more conservative in the heavily regulated life insurance industry, where capital charges for stock holdings keep equity positions even lower. Thats where the P&C companies take the risks in the stocks they do hold. Life companies go up on the risk spectrum by buying private debt instruments and mortgage loans, thereby sacrificing liquidity in the event market conditions change, says Ira Strassberg, a managing director for the consulting firm BearingPoint, Inc.

Regardless of industry segment, insurers using investment management technology rely on these systems to identify quickly, either via regular or ad hoc reports, how changes in interest rates and stock and bond market swings affect their bottom lines. In turn, these results support the established ways they have been selecting investments.

Our investment professionals and actuaries come to our unit to see what sort of liabilities we are putting on the books, says Louis Lombardi, senior vice president and actuary at Phoenix Life Insurance. At a minimum, this happens on a biweekly basis; more often, it happens daily, he explains. We need to know what kind of money is coming in the door from our customers. Is it money-market money, or is it 10-year fixed-income investments? That determines what assets we need to match those liabilities, and thats where the real pressure comes in.

In fact, whats perhaps of greatest importance to insurers is the ability to model the condition of their investment portfolio under differing potential market conditions, something that is required by life insurance regulation but which enterprising insurers in all industries are using more frequently than required. Jefferson Pilot, for example, uses an actuarial package from Tillinghast-Towers Perrin, reports Rick Smith, assistant vice president, investment accounting and administration, to analyze returns under any number of interest rate scenarios. SS&Cs PTS system and Princeton Financials Frontline offer similar functionality.