Nina Röhrbein asked Henrik Olejasz Larsen (pictured), CIO of Denmark’s Sampension, about the challenge of offering policies based on contrasting investment strategies
The DKK111bn (€14.9bn) life insurance entity Sampension provides pensions insurance to four different customer groups. White-collar workers employed by Danish municipalities make up the first and largest group; this is followed by the reinsurance of pension liabilities of civil servants in Danish municipalities, while the third group is made up of white-collar workers working for the Danish government. The smaller, fourth group consists of a number of small schemes, including some private sector employees, the largest of whom are employed in the printing business.
The conditions of the different schemes are negotiated between labour unions and their employers.
The actual choice for employees depends on the individual scheme, but in general they are obliged to have a minimum level of insurance and certain retirement pension benefits. If they want to, they can opt for further insurance, such as disability insurance or one that benefits their children.
Employees can also elect to invest one-third of their premium through a unit-linked scheme, although only a small number of Sampension’s members currently do this. The unit-linked scheme presently has DKK145m in invested assets.
One of Sampension’s major products is a traditional guaranteed life annuity. It is defined contribution but with a guarantee component, as the pension benefits in nominal terms are pre-determined and based on the size of the contribution. This investment product dominates Sampension’s balance sheet, making up more than 85% of its liabilities.
Since 2007, Sampension has also offered a non-guaranteed lifecycle product, which is also a life annuity. All new employees will be part of it and it makes up just under 15% of Sampension’s liabilities.
The two products also come with completely different investment strategies.
“The guaranteed life annuity product has small reserves so it has to invest according to a conservative investment strategy, which reflects the nominal guarantees included in the product,” says Henrik Olejasz Larsen, CIO at Sampension. “Therefore, its asset allocation comprises much fixed income but little active risk. The lifecycle product is based on three different building blocks, equities, fixed income and alternatives, which are combined according to age.”
Fixed income investments plus interest rate hedges currently make up 77% of total assets of the guaranteed life annuity product, with a credit bond portfolio adding another 8%. Less than 6% is invested in listed equity, slightly over 2% in unlisted equity, 6% in real estate and 1.5% in forestry and global macro hedge funds together.
The internally managed fixed income portfolio is predominantly Danish and European sovereign paper, and Danish mortgage backed bonds. “We do not distinguish between Danish and German bonds. They bear the same risk limits as the Danish krone is closely linked to the euro,” says Larsen. “The tactical view determines which types of instruments are used. But we have a home bias in equities, with Danish equities making up 15% of our listed global portfolio.” Sampension’s listed equities are managed through Danish mutual funds in which it is the sole investor.
The real estate portfolio is made up of direct, predominantly Danish, property, but does include international real estate. These are mainly invested through funds. While the property portfolio was evenly split between direct and indirect real estate investments 12 months ago, it is now slightly overweight Danish real estate due to a better performance in that part.
Sampension started forestry investments six years ago. It invests in international forest management funds under the advice of a Denmark-based external advisory company, the International Woodland Company. Forestry has been Sampension’s best-performing asset class with an annualised return of 5.7% between 2004 and the end of July 2010. In comparison, macro hedge funds - which are managed in Sampension’s own fund of funds under the investment advice of Credit Suisse - returned an annualised 4.8% between 2006 and the end of July 2010.
The asset allocation of the guaranteed life annuity product has changed in recent years. This has resulted in risky assets constituting a smaller part of the overall allocation. Listed equity, in particular, was reduced from around 15% in 2007 to below 6%, in favour of fixed income.
“This is primarily a result of the sharp risk reduction that became necessary in 2008 but also due to an increase in the value of the total assets, with the fixed income assets and liabilities rising on the back of falling interest rates,” says Larsen.
An increase in exposure to listed equity is unlikely as Sampension intends to maintain the product’s conservative profile. “We will instead offer clients who want a riskier allocation the move to the lifecycle product,” Larsen adds. “When our members transfer from the guaranteed life annuity to the non-guaranteed lifecycle portfolio, they will take more of the riskier assets with them so we use that process to balance the risk a little bit better.”
In 2009, Sampension undertook a publicity campaign which resulted in approximately DKK10bn of reserves moving from the guaranteed life annuity to the lifecycle portfolio. It is currently conducting a new campaign. “We do not yet know the results, but, over the coming three months, we will be offering selected members of our guaranteed portfolio the chance to move to the lifecycle one,” says Larsen.
The strategy behind the lifecycle portfolio is that members invest in riskier and more inflation-resistant assets when they are young, with the allocation gradually becoming more conservative as they near retirement age. The average asset allocation consists of 29% listed equity, 3.5% unlisted equity, 9% bonds with some credit risk, 13% real estate, 4.5% forestry, 2% global macro hedge funds with the remaining 37.5% in traditional fixed income with limited credit risk.
The youngest groups have an asset allocation of 50% equities, 30% alternatives and 20% fixed income. From the age of 35, the exposure to riskier asset classes is continuously reduced until the employee turns 65. At this point, they will have an allocation of 60% fixed income, 20% listed equity and 20% alternatives, predominantly real estate. The portfolio retains a mixture of assets in all age groups for diversification benefits.
“We recently made some smaller changes to some of the funds in the lifecycle portfolio,” says Larsen. “Our fixed income portfolio, for example, which started out conservatively with very little credit risk now includes investment grade credit.”
Sampension has made use of derivatives since 2001 in the guaranteed life annuity portfolio to hedge the interest rate risk. In other words, it has a dedicated hedging portfolio, which hedges off the market value changes of the liabilities. Sampension has used swaps, swaptions, repo-financed government bonds and bond futures to manage its fixed income interest rate risks, but it also uses equity futures and other equity derivatives.
“The sharp fall in long-term interest rates this August would have lost us several times our equity value if we had not hedged our interest rate risks,” admits Larsen. “In the non-guaranteed product, we use futures to manage traditional day-to-day interest rate risk but not nearly to the same extent as the use of derivatives in the guaranteed environment because it has no hard liabilities.”
The hedging portfolio has also had a huge impact on Sampension’s annual returns because if interest rates fall, the amount of assets it has increases due to the market value change of its interest rate-hedging portfolio.
Sampension generated a return of 2.1% in the guaranteed life portfolio in 2008, which was made up of -12.7% from the core investment portfolio and +14.8% from the interest-hedging portfolio. In 2009, the annual return was 1.7%, consisting of the 7% achieved in the core investment portfolio and -5.3% in the interest rate hedging portfolio. The expected return forecast for 2010 entering the year was 3.3% in the guaranteed and 6% in the lifecycle environment but the outlook is currently better for both environments.
In the future, Sampension is likely to derisk more, primarily by reducing illiquid portfolio risk in the guaranteed product and developing its lifecycle pension strategy as its major flagship product.
“The guaranteed product will eventually become a run-off product,” says Larsen. “Many life insurance companies will change their liabilities due to the introduction of Solvency II. By putting severe capital requirements on risky assets, Solvency II makes it very expensive from a capital point of view to write guarantees, which will influence new products.
“We are in the middle of an internal Solvency II project, which is trying to prepare us for the regulation coming into force in 2012. We are also participating in the quantitative impact study 5 (QIS 5) of the EU Commission to measure all the possible quantitative effects of the current Solvency II proposals. Another parallel project concerns the more qualitative governance elements of Solvency II where, for example, we have to set up an organisation for our own risk and solvency assessment.”