Next Generation Investing for Mutual Insurers

As part of NAMIC’s 2019 Virtual Education series, “Investment Opportunities and Challenges on the Horizon,” Strategic Asset Alliance and Vanguard analyzed the developing demographic changes, as well as the regulatory and technological trends, that will impact the asset allocation decision-making and investment process of mutual insurance companies.

Key Highlights:

  1. Technology continues to change the way business is conducted and products/services are provided. In turn, how can regulators keep up with these advancements (i.e. insuretech or blockchain)?
  2. Mutual insurers using the Bloomberg Barclays U.S. Agg. as a benchmark will notice that the duration of the index has increased, while yields keep dropping. Given those changes, is it time to reconsider this widely used benchmark’s applicability to your insurer’s investment process?
  3. Robo Advisors and passive investing are becoming more prominent, while investment management fees continue to fall.
  4. As investment opportunities change, your mutual insurer’s investment policy should be flexible enough to account for such changes.
  5. Data will only be easier to access – it will be important to turn that data into information that will improve the overall investment process.
  6. ETFs, which report like bonds and have the bond-like accounting treatment of systematic value, instead of marketing to market value, are becoming more common with mutual insurers.
  7. Due to the systematic value accounting of Bond ETFs, mutual insurers see very little impact of related market value volatility on their statutory financial statements.
  8. Fund investments provide various benefits to mutual insurers (i.e. diversification, liquidity, efficiency, low cost), but with some drawbacks (i.e. additional education, regulatory considerations, liability matching).
  9. Globally diversified portfolios are becoming more and more common.
  10. While interest in ESG investments increases, it is still in its infancy. Most mutual insurers are establishing a view on ESG vs. putting into practice.

Further (condensed) details can be viewed below or: View Full Webinar

Global Hard Trends

Strategic Asset Alliance: Looking at hard trends, which are trends that strongly impact the economy and society, three different areas are key: Demographics, Government Regulation and Technology.

If you look at the average age, it’s getting into the 30’s and early 40’s going forward. This is more pronounced in the developed countries.

Government Regulation:
Regulators continue to be behind an increasingly accelerating curve. I’m reminded of a discussion at the recent A.M. Best meeting, where a regulator was quoted saying, “insurers that are trying new things should have some sort of sandbox to try different things.” The response of an insurance commissioner was, “companies do not need sandboxes; they need to act like adults and stay within the regulatory framework.” There’s an ongoing discussion about how regulators can keep up with advancements like insuretech.

Also, Cybercrime is something that continues to grow and become more pervasive over time. While there are opportunities for legitimate businesses and business people, there are also opportunities for the criminal element.

Finally, the use of high-speed data analytics continues to grow.


Dematerialization – what I mean by that is each of the products and services that are tangible are now becoming a separate service. Think of Uber or Lyft instead of driving your own car. Amazon can replace the need to go to the store.

Cloud: We now have infinite use of storage and in turn, infinite uses of technology.

Networks: Ultimately, every piece of technology we own will have a sensor in it, which makes copious amounts of data available. This has huge implications for P&C insurers, especially, but also on the life side.

All of these technological hard trends leave an opening for many unintended consequences.

Capital Market Hard Trends

Strategic Asset Alliance: Debt has greatly increased over time. Government debt has increased quite a bit. In the U.S. alone, levels of corporate debt to GDP rival the levels of where we were before the last great financial recession. This has to be addressed one way or another and is one of those hard trends we will have to see play out.

A lot of insurers use the Bloomberg Barclays U.S. Aggregate as a benchmark (or one of the benchmarks) they follow for the biggest investment they own, which is core fixed income. Looking at the index back 20 years, the duration of the bond market has increased quite a bit and the yields have dropped nearly 200 basis points.

Right now, if you are benchmarking against the Barclays Agg. – you really are building in added interest rate and credit risk, which you may or may not be comfortable with. Your duration is creeping up, but the question is, “is that really happening to the reserves?” I would doubt it. We’re dealing with low interest rates right now and investment managers say it can’t get any lower, but I’m not so sure about that.

A lot of mutual insurers have risk assets, most of which is in U.S. equities. Even though the U.S. makes up 38% of the global equity markets, most insurers (80%-90%) are in U.S. securities, which is something to keep in mind when looking at trends.

Investment Management Hard Trends

Strategic Asset Alliance: In lieu of personal advisors, robo advisors in regards to asset and wealth management are becoming increasingly more prominent. However, with high tech must come high (personal) touch, so having a personal component is something to always consider with this trend.

Passive investing (funds that are indexed) is growing. In 2007, indexed ETFs and mutual funds made up 15% of the market. A decade later it is now 35% of the market.

You can predict returns and make reasonable guesses, but there is one negative return we know we are certainly getting: Manager Fees – which have actually gotten lower over time.

Vanguard: We couldn’t be happier that fees continue to get lower. Fees have been too high for too long, and still we think they can go lower. Given our mutual structure, when fees go down that means our assets have grown; so everybody wins.

SAA: We continue to see downward pressure on manager fees. Anyone who hasn’t had that discussion with their manager in the last 4 or 5 years, it wouldn’t hurt to ask about fees.

How is your Investment Process Addressing these Trends?

Strategic Asset Alliance:

Asset Allocation: the key is to get unbiased advice. Managers do a pretty good job of AA, but they have an agenda. An independent view is incredibly important.

Enterprise risk management modeling vs culture.

Board & Staff Education: Everybody has data – it is important to turn that data into information that can the be used to improve the overall knowledge of the investment process.

Investment policy flexibility: this is important as investment opportunities change; your insurer should be able to address these different investments.

Staffing, Technology Platforms, Investment Accounting & Reporting: do you have the right internal staff, investment manager(s), advisor and systems in place for your insurer’s investment process to be successful?

Common Mutual Insurance Co. Investment Strategies

Vanguard: Mutual insurance company portfolios are typically composed of two core areas, stocks/fund investments and bonds, with NAIC-designated fixed income ETFs becoming a more common third component.

Stocks and fund investments make up about 10-20% of mutual insurance portfolios; most commonly part of that risky bucket.

Bonds are usually the biggest bucket and represent 80%-90% of the portfolio.

Bond ETFs (exchange traded fund) have been around for 15 years. ETFs are a fund investment owning a portfolio bond trading on the exchange. It reports like a bond, but has the accounting flexibly to choose systematic value or market value treatment. This means you can account using fair value like a stock or book value like a bond.

Why Do Mutual Insurance Cos. Use ETFs?

Vanguard: Before discussing what systematic value accounting “is,” let’s start with “why” it works – within a portfolio of bonds there are stated maturity dates; this applies to a bond ETF. Each bond has a stream of cash flows and then repays principal at maturity. So each month you receive a combination of principal repayment and interest income; a bond ETF does the same thing for you.

Given the similarities, regulators noticed that if the Bond ETF sponsor was willing to provide cash flows of all the individual bonds in the portfolio, a bond like methodology could be created to potentially lessen volatility on an insurer’s statutory filings. That is known as systematic accounting.

How Does Systematic Value Accounting Work?

Vanguard: Good news – your accounting software will do all of this for you. In the event your accounting software does not have this capability, it can easily be done on an Excel spreadsheet.

  1. Obtain the fixed income ETF cash flow spreadsheet, which is a free file.
  2. Use the IRR feature of Excel to calculate the effective book yield (referencing the schedule of cash flows provided).
  3. Multiply that book yield by the previous month’s book value. Divide by 12 to get a monthly effective interest.
  4. Compare effective interest to the actual distribution of that month. The difference is added or subtracted to the original book value. As a result, you’ve calculated the systematic value.

When looking at systematic value in practice, the price value of an individual bond may have fluctuations of 10% over two years. Comparatively, the book value remains relatively unchanged over that same time period.

Systematic Value accounting allows for very little impact of the long-term financial statement, which can be beneficial for mutual insurers holdings products for a long period of time.

Benefits and Drawbacks of ETFs for Mutual Insurers


The Benefits:

Diversification: an ETF acts essentially as an entire portfolio in one security

Liquidity: ETFs are traded daily on an exchange and are liquid any time the market is open.

Efficiency: mutual insurers have many priorities. ETFs give mutuals more time to focus on everything else, which means less time discussing investments

Low Cost: ETF management fees average only 11 basis points; or $11 for every $10,000 you invest. While the lowest cost products are offered at only 2 or 3 basis points.

The Drawbacks:

Education: Your Mutual Insurer might need to change the investment policy to allow for flexibility. That would likely require Board approval and additional education as part of that process. There would also need to be a mindset change to move from cash securities to fund investments.

Regulatory: All states allow you to invest in ETFs, but certain states have rules governing how much and in what asset type.

Liability Matching: Fund investments that don’t mature might cause trouble for your actuaries. ETFs might better serve as a complement rather than your entire strategy.

Other Trends: Shifting Away from “Home”

Vanguard: Investments are looking a lot more global. In 2001, 12% of U.S. portfolios were globally diversified. In 2017, that number grew to 29%. Investing globally can be expensive and cumbersome (i.e. having to understanding global tax laws, currency exchanges, proper custodian, etc.). Since ETF providers already have to do all of those things, global exposure is more easily available through ETFs.

Other Trends: Environmental, Social, Governance Investing

Vanguard: ESG investing is becoming a bigger buzz word. Environment social governance

Environmental: think of renewable energy, habitats, wild life, etc.

Social: This considers, “if this fund does well, at what cost does it have to society?” For example, health related stocks like tobacco sales.

Governance: How a board or management is running the company you might be investing in. For example, are they following best practices, transparent, approach to board diversity, etc.)

In terms of demand, 94% of Millennials have a high demand for ESG investing, while high demand is less prominent for Generation X (50%), Baby Boomers (3%) and the Silent Generation (0%).

While interest in ESG investments is increasing, most are not acting with an ESG view. Most companies are recognizing they should have a plan and view on ESG (and if it even fits within their investment process). Most insurers are at the stage of having a stance on the issue. At least a paragraph within the investment policy.

Strategic Asset Alliance: ESG or any new way of investing for insurers starts with the big guys. ESG started with societal pressures and the largest of investors needing to address it and be part of the policy. Over time that is going to be a lot more common. It is still in its infancy as to how insurers will approach it.

Source: Strategic Asset Alliance, Vanguard Institutional Investor Group
The information contained herein has been obtained from sources believed to be reliable, but the accuracy of information cannot be guaranteed.

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Vanguard ETF Shares are not redeemable with the issuing Fund other than in very large aggregations worth millions of dollars. Instead, investors must buy and sell Vanguard ETF Shares in the secondary market and hold those shares in a brokerage account. In doing so, the investor may incur brokerage commissions and may pay more than net asset value when buying and receive less than net asset value when selling.

Bond funds are subject to interest rate risk, which is the chance bond prices overall will decline because of rising interest rates, and credit risk, which is the chance a bond issuer will fail to pay interest and principal in a timely manner or that negative perceptions of the issuer’s ability to make such payments will cause the price of that bond to decline.

Diversification does not ensure a profit or protect against a loss.

Stocks of companies based in emerging markets are subject to national and regional political and economic risks and to the risk of currency fluctuations. These risks are especially high in emerging markets.

All investing is subject to risk, including possible loss of principal.

Investments in stocks or bonds issued by non-U.S. companies are subject to risks including country/regional risk and currency risk.

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