Many investors know or have heard that asset allocation (or portfolio design) accounts for more than 90 percent of portfolio performance. But as an insurance company, what kind of performance is your asset allocation delivering? More importantly, what kind of performance does an insurer need?
Traditional asset allocation has the potential to achieve a specific return for a given level of targeted risk. While this may be enough for a different type of investor, it has not been shown to be comprehensive for insurers. Just because a targeted return is achieved doesn’t mean an insurer’s objectives are achieved.
Insurers intuitively recognize that all business functions must coordinate to achieve the company’s mission and primary objectives.
For example, what would happen if actuaries advised, and upper management agreed, that underwriting standards should be changed, but marketing and agencies weren’t informed? This may be an exaggerated scenario, but the outcomes would be similar to setting a company priority for stable growth of surplus while the investment portfolio is designed to deliver liquidity and low capital usage. The objective and the underlying reality would be mismatched.
This is essentially the dynamic that many insurers face with traditional asset allocation.
Objectives-Based Asset Allocation®
Unlike traditional asset allocation, our methodology, Objectives-Based Asset Allocation®, or OBAA®, is based on addressing the critical needs of all insurers and helping them achieve their business objectives. It’s an approach that we have developed over our more than three decades working with insurers.
OBAA® moves asset-class optimization to the correct place in the process, after the business objectives are considered. The end result is a solution that directly aligns the portfolio with critical company priorities while also providing forward-looking analysis to help ensure market challenges are met.
Having an asset manager well-versed in the ins and outs of the industry goes a long way toward the success of an insurer's investment portfolio. There are numerous industry-specific considerations for an appropriate asset allocation.
First, given the unique investment needs of insurance companies, portfolio design should include all characteristics of the insurer: size, business lines, capital, financial strength ratings, growth rates and trends.
Second, insurers have strategic plans for the business, and the portfolio should also be guided by a forward-looking, multi-year plan that clearly demonstrates how it will help support key objectives over time. Point-in-time analyses do not tell an insurer how surplus may grow over time or at what point net investment income will likely reach company targets.
Additionally, asset allocation should dynamically incorporate new data. Market expectations and insurance company characteristics and regulatory frameworks shift and evolve regularly.
Insurers need an asset manager and a sound, sophisticated methodology that will help their portfolio weather the storm of potential market challenges.