Access to cash and cash-equivalents has come into greater focus in the wake of recent market events and regulatory changes. Regulators around the world have been asking investors to hold more liquidity and/or placing greater emphasis on existing rules.
This has created a delicate balancing act for investors, as they weigh up their potential liquidity needs and wider asset allocation choices. It is no easy task, but one that can be approached through a combination of scenario analysis and good liquidity-risk governance.
For many investors, a liquidity pool may just mean cash deposits with banks and/or government bonds. While such an allocation may be intuitive, it is not necessarily optimal. Investors need to consider whether the liquid assets they hold are right for their needs.
Liquidity optimisation for insurers takes a detailed look at this question, illustrating how one of our clients worked with us to build a bespoke liquidity portfolio. The investor in question, a multi-line insurer, had potentially significant and unpredictable cashflow needs. As well as meeting the demands of the operating segment, there was also a need for robust liquidity laddering in the reserve and strategic liquidity segments of the client's portfolio, to allow prompt replenishment of operating liquidity in case a major liquidity call occurred.
The paper sets out how multiple different parameters were considered, underpinned by the search for through-the-cycle-yield exceeding cash rates for a portfolio worth over £1 billion and subject to UK Solvency II requirements. Appetite for interest-rate risk and spread duration, currency exposure and hedging requirements were all taken into account.
Learn more about how we worked to understand our client's requirements, then design and build an optimised portfolio factoring in liquidity, capital-stability, yield and capital-efficiency considerations. Drawing on our own bespoke datasets of risk and return assumptions, we used our proprietary MATLAB-based liquidity optimisation tool to generate portfolios with differentiated profiles. Some exhibited similar liquidity characteristics, but different potential to generate excess return.
Liquidity optimisation for insurers underlines how important it is to have a sophisticated understanding of liquidity risk and liquidity assets, and how that specialist knowledge might be combined to meet practical considerations and regulatory requirements, in yield-enhancing ways.