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Communications and Marketing

“Curious behavior”

Stewart Foley wrote an article on asset management in the insurance industry, which was printed in the March 2016 issue of Best’s Review.

The magazine is the leading monthly publication covering the insurance industry. Here is the article: 

Curious Behavior:
Asset management in the insurance industry may be on the cusp of change.

By Stewart Foley

Compared to insurance companies, every other major class of institutional investor outsources a much higher percentage of its assets, has much broader diversification, is much more concerned about investment performance and is unconcerned about “book yield.”

Let’s consider each of these differences. Other institutional investors:

• Outsource a much higher percentage of their assets. An Insurance Asset Outsourcing Exchange survey found that a primary barrier to outsourcing is “loss of control.” That’s certainly a valid concern given that an insurance company’s investment portfolio is an integral part of its insurance operation.

An insurer that outsources the majority of its assets, therefore, probably needs an asset management firm sensitive to its specific insurance needs. 

Those needs are determined by the company’s operating environment, lines of business, capital and tax position, the whole works. Carefully crafted investment policy guidelines, coupled with insurance management expertise and extensive insurance-centric tools, can help to ease concerns about loss of control.

• Have a more diversified portfolio. The overwhelming majority of insurance company assets are invested in investment grade bonds. Reasons for that include forecastable cash flows, low default risk and favorable capital treatment. The standard thinking is that this is the lowest risk asset class for insurers. But that is slowly changing. One element of resistance is “familiarity bias.” People tend to like what they know, which leads to under-diversification. Rock-bottom interest rates have increased the risk to this asset class, resulting in lower investment income for bearing increased interest rate risk. Is a fresh look at the outsized allocation to investment-grade fixed income needed for prudent risk management?

• Are much more concerned about investment performance. Investment performance isn’t even in the top five criteria insurance companies use to select asset managers, according to Insurance Outsourcing Exchange research. How can that be? It turns out a firm’s reputation, insurance industry expertise and investment process handily trump outright performance. It’s not that performance doesn’t matter, but alone it won’t carry the day. Understanding the industry’s operating environment, including regulatory, RBC, tax and capital implications of a particular strategy are key considerations when hiring a manager.

• Are unconcerned about bookyield. Book yield is a statutory accounting concept that means you earn the yield at which the bond was purchased for the life of the bond. Should interest rates fall, the market value of bonds rises and vice versa. But not so in statutory accounting, which permits investment grade bonds to be held at cost, not market. 

It’s difficult to gauge how much, if any, economic value is lost by the industry with our book yield focus. But we’re the only ones who do it this way— maybe for good reason. This is hallowed ground in the industry. But given our current options to boost investment income, would a fresh perspective yield more favorable results? 

Is change afoot? The protracted period of low interest rates has made it more challenging to meet investment income objectives. Industry investment allocation data shows that insurers’ stalwart investment-grade bond allocations are giving way to a broader array of risk assets. The rationale for those decisions is as varied as the companies themselves but typically not based on performance alone. Will insurance companies’ portfolios morph toward their institutional brethren? Only time will tell.