Who Do You Work For?

When I was an actuary running a GIC desk inside a medium-sized insurer in the 1990s, I quickly learned about creditworthiness.  My company, for the sake of accounting convenience, placed all GICs in a separate account.  Now the state of domicile did not have a law that said that guaranteed products in separate accounts have protection from the assets in the separate account, and the company if the assets in the separate account fail.

So, when no one would buy the GICs, because an A1/A+ insurer was no longer good enough, in 1997, I shut the line down.  I looked into credit enhancement — the cost was too high.  I asked the CEO for a guarantee — he refused (he did not understand much generally, except how to line his venal pockets).  I did what was best for the company, given the limitations of the management team, and closed the line of business.

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My goal as an actuarial businessman was to make profits with modest risk for my ultimate owners, who were the mutual policyholders.  Once I faced a situation where there might be easy profits — writing floating rate GICs.  So, I went to my models and tried to figure out how we could make money safely while our interest rates would shift every three months.  I came to the conclusion that there was no safe way to do so, and so I walked into the office of my boss and told him so.  He surprised me by supporting my thesis, and in his usual back-of-the-envelope way, explained to me in a few minutes why it had to be so.

A few weeks later, he informed me that an actuary from Goldman Sachs (yes), would be dropping by to tell about one of their new derivative contracts that would enable us to write floating rate GICs profitably.  The meeting day came, and I validated the expectations of my boss.  The year was 1993.  I asked the actuary from Goldman what happens if the yield curve inverts.  He answered honestly, “This strategy blows up when the yield curve inverts.”  Score a small victory for me.  I gave myself points for avoiding trendy bad ideas.  Over the next twelve months, two major insurers and one investment bank would announce billion-dollar blowups from following that strategy.

After the blowups, I went back to the buyers of floating-rate GICs, and asked them if they would accept a lower spread over LIBOR.  The response was a firm “no.”  So much for that market.

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Shortly after the visit from the Goldman Sachs actuary, interest rates began to rise.  I had benefited from falling rates for some time, and I had gotten a bit lazy, because the investment department could buy investments, and I could wait to sell my GICs.  After all, with rates going down, time was on my side.

Now, there was one odd thing about the company that I worked for.  They left the hedging decision in the hands of the line actuary and not at the investment department (no joke).  I had control of interest rate policy for my line of business.

1994 started out bad for me.  The rest of the industry went wildly competitive selling GICs, and I was way behind my quota.  What was worse, I had a lump of maturing GICs that left my line of business short of cash.  Our Treasurer gave me a curt phone call that my line of business had forced the company to draw down on its line of credit.  (The Treasurer was the only person in the firm that could have blended in easily at AIG.)

I considered my options.  I could sit on my hands, and the wrath of Senior Management would grow.  Or, I could write business with subpar profitability.  With the yield curve so steep, I wrote a bevy of barbell GICs that the buyers mispriced.  They would compare a GIC with half maturing in one year and half in five to a three year GIC.  With a steep yield curve, that was the wrong decision.

I sold a bunch of those barbells to get out of my cash hole, and then began cutting bargains, and selling like mad, as I concluded that the residential mortgage-backed market was pushing up interest rates.  I sold my quota early that year, and the investment department dawdled (at my request), waiting to put cash to work at higher rates, and improving credit quality as well.  It was the best year we ever had, amid the worst year for the bond market in 60+ years.

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I don’t recommend handing over interest rate policy to those that manage the line of business.  That is too dangerous a thing to do.  I didn’t undersatand that at the time, so I did the best that I could, which was pretty good.  Sadly, the same was not true for the actuaries at the other two lines of business — they assumed rates would stay low.

I tell these three stories to illustrate the ethical choices one faces when working in a financial business.  Will you act in the best interests of your ultimate owners, or will you serve the management, or worse, yourself?

We can lay the blame for mismanagement at the doors of the company managers of financial companies.  But lower level managers have their share of blame as well.  Did they follow the short term economic incentives given by their companies, or did they do what was right for their owners.

When working for investment firms at later dates, I would tell the junior analysts these stories, and I would ask them, “What do you think they gave me as a bonus?” (for my work that protected the company and made very good money?)  They would always guess high.  I never received more than a couple of thousand dollars, and I was happy with it.  I did my job to do what was right in my field, not to make excess money.

And so I would say to my peers in financial services… have you done what is right?  Have you served the best interests of shareholders?  Not you, your boss, your CEO…  You have a choice, as I do.  Life is too short to work for unethical firms.  Find a place where you can ply your trade ethically and competently.  I am grateful to my current firm for having such a place today.