Should Life Insurance Companies Invest in Hedge Funds?

Thomas Berry-Stölzle, Hendrik Kläver, and Shen Qiu

Discussion by Monica Marin

Ph.D. Candidate, Finance

University of South Carolina

Objective to Investigate: Should life insurance companies invest in hedge

funds?

How much to invest?

Impact of insurer’s characteristics: Liability Structure Capitalization Restrictiveness of Accounting System

Summary Model: a life insurance company offering contracts

with a cliquet-style interest rate guarantee

Extension to Kling, Richter, and Ruβ (2007), by incorporating 3 correlated AR(1) GARCH(1,1) processes

Monte Carlo Simulations for different asset allocation strategies

Calculate Markowitz efficient frontiers

Findings Benefits from investing in hedge funds:

Expected portfolio return is increased Portfolio volatility is reduced

Benefits are greater when: The interest rate guarantees are higher Insurer’s capital is lower

Higher expected returns in the case of event-driven hedge funds

Comments & Suggestions Provide some statistics on the actual investment in

hedge funds by life-insurance companies

Explain why you are generating the correlated AR(1) GARCH(1,1) processes

Striking result: high percentage of hedge funds (70%-90%) in the portfolio!

Table 2

Mean Return & Std. Deviation (Convertible Arbitrage)

Returns & Standard Deviations

6.00%

6.50%

7.00%

7.50%

8.00%

8.50%

9.00%

0.00% 5.00% 10.00% 15.00% 20.00% 25.00%

StDev

E(R

)

Comments & Suggestions (Cont.) In addition to the survivorship bias, also

acknowledge the backfill bias (Malkiel & Saha (2005))

Hedge fund returns have on average a relatively low standard deviation. Report additional moments (skewness, kurtosis) in

Table 2.