Investment Risk Manager: Act like An Owner, not Like a Manager

My boss walked in and said that we needed to terminate our annuity reinsurance treaty with an entity that I will call Bigco (this happened in July).  Senior management had deemed that we should do it, and in days we visited Bigco, assuming that the actuary in question would approve a termination of the treaty where:

  • There was no termination provision.
  • There was a guaranteed minimum return to the reinsurer.
  • The reinsurer had participation in the upside of profits.

Who negotiated such a treaty?  Very one-sided, and Bigco needed to deploy capital, not contract it.

Could a negotiating position be worse?  Yes, it could, just wait.

When we got to Bigco, we talked with the actuary for a little while, and then he handed us over to the head of M&A.  Uh-oh, he sized up the situation perfectly, and denied our request, unless we were willing to pay considerably above book value to repatriate the assets.

We went home depressed, and a few months after that my boss was summarily fired.  In those days, September was the firing time.  You can imagine what that did for morale.  Personally, I expect my boss was fired because he was most similar the the CEO, and had done things well in managing his line of business.

One day the chief actuary came to me and said, “We have to terminate that treaty.”  I explained to him the backstory, that we had offered to buy it back at an ROE of 9%, and Bigco was demanding 6%.  I said to him, “I’ve already compromised the 10% ROE objective of our company, I don’t want to go further.  I’m free to walk away, right, if we can’t get a decent price?”  He said, “No, the deal must be done.  Under no circumstances can you walk away.”

The sad thing was that any termination of the treaty would positively affect management bonuses.  (That was the real target.)

I had a strong sense that I should always serve the ultimate owners of the firm — the dividend receiving policyholders.  But this was at variance from that.

So, with the weakest bargaining hand that I can imagine, I used the following strategy.  I did nothing.  Nothing. Nothing until early December, where I called the M&A guy at Bigco and and told him, “I’ve had a change of heart.  I’ll accept an ROE of 6.9%.  That’s my final offer!”  This was ticklish because I *had* to get the deal done.

He bit on the offer, and I pressed him saying that between this time and the closing, my market value adjustment formula would rule.  He agreed.  (He probably had a profit goal as well, which was what I was counting on.)

But, he didn’t look closely at the Market Value Adjustment formula.  I gave him one that was volatility-loving, that would adjust of the greater of the absolute value of the yield changes in 3-month T-bills or 30-year Treasury Bonds.  Don’t criticize the guy too much, the Federal Reserve fell for the same tactic on GICs they bought from us.

Before the deal closed, the Fed started tightening monetary policy, and the Market Value Adjustment got us out at an ROE of 9.1%.  What a win, and for the policyholders.  Management got more as well, and I got almost nothing.

I took risks trying to do the right thing, praying the God would help me, and in this case, it worked.  Can you be more righteous than your management team?  In most cases, no, but in this case I succeeded.

I would say to all, try to serve the interests of owners rather than management.  Act like an owner, not like a manager hauling down a fat salary.

By David Merkel, CFA of Aleph Blog