Addressing questions including: Do we have an asset allocation strategy? Does it support our business plan?
Over 90% of your company’s investment performance and returns will be determined by the asset allocation.
- Equities versus Fixed Income
- Fixed Income Sector and Duration
Thus, choosing the correct asset allocation is probably the most important investment decision you’ll make. Nowadays, it seems that every investment professional you meet has a solution to asset allocation for insurers. We take a slightly different view, focused on achieving your company’s goals and objectives – not some theoretical efficient frontier gobbledygook.
Here’s why the traditional approach to using efficient frontier analysis does not work for insurers:
1. Efficient frontier is great for solving the investment problems of pension funds. Every consultant we know of has Pension clients, so they are apt to use this approach. Big mistake. pension funds don’t have to deal with short-term statutory earnings issues, or risk based capital, or arbitrary regulatory flats, or rating agency biases. Pension funds typically aren’t leveraged; they don’t have to deal with policyholders and competitively offering products. Pension funds are only a big problem when their long-term obligations start to swamp investment performance. Insurance companies have to operate in a significantly shorter time frame.
2. Efficient frontier analysis assumes that asset returns, and their corresponding volatility and correlation are stable. Potentially a big error. These historical results are closely related to what period of time is used to measure them. They have little to do with projected economic scenarios… the possible futures in which we will all operate. Oh, and let’s not forget; we insurers really want to know what happens in the worst case – in such a case correlations between markets tend to increase (e.g. one world market sneezes, the others catch a very bad cold.)
3. Efficient frontier analysis assumes the insurer is equally concerned with excessively positive as well as negative returns (called volatility, or standard deviation.) We have yet to meet an insurance CEO who wanted to fire a money manager for getting excessively good returns.
- Asset allocation analyses are performed considering all of the unique constraints and objectives of insurance companies. The regulators limit certain asset classes, the rating agencies frown on other types of asset concentrations, while your Board may have certain biases. All the while, you must stay focused on meeting the company’s goals and objectives.
- Asset allocation is performed with a focus on maximizing income (return) on risk-adjusted capital; SAA uses an asset allocation approach called ROE Investing™. This analysis provides detailed asset allocation strategies designed to maximize return on risk adjusted capital for any given product line. The analysis is performed over different interest rate and economic scenarios.
- Asset allocation is integrated with your product strategies. SAA believes that any asset allocation analysis must be tested inside an asset / liability management model to determine how asset and product strategies will interrelate to impact your bottom line.