Outsourcing Investments

Considering the Issues from an Asset Management Perspective

2017 Report | AAM

Peter Wirtala, CFA | Insurance Strategist

What are insurance companies most concerned about when it comes to outsourcing investment?

As part of our 2017 Insurance Asset Management for Insurers Report, seventeen US-based insurers with a minimum of $1 billion in assets under management were surveyed on three commonly cited issues.

Here is what they disclosed and what AAM's response was.

Issue #1

Carriers believe that small and mid-sized asset managers lack the internal resources to take on a large mandate.

“When you look across the various asset classes and mandates in your investment strategy, you want to establish a stable of investment partners across the range from smaller niche players to those managers with a large global footprint. Ideally, you want to have manager diversification in your team.”

Rip Reeves, Chief Investment Officer, AEGIS

Counter-intuitive as it may sound, there is an optimal range for the size of an insurance asset manager, and it is entirely possible to be too big. A firm that’s too small will lack internal resources and scale, but a firm that’s too large will lack flexibility and nimbleness to trade opportunistically and access markets with limited liquidity (a description that fits a growing swath of the bond market ever since the financial crisis).

For most companies, the decision to outsource any aspect of their business depends on numerous factors, many of which boil down to a desire to focus internal resources on core competencies while off-loading ancillary functions to third parties. Insurance asset management is no different; a carrier might have extensive knowledge of the markets in which they write insurance, but lack significant expertise in the investment markets.

Why Insurance Companies Outsource Investment Management:

Need for investment expertise not available internally
Need for specialized strategies and expertise
Need access to resources not available internally
Increasing challenge of meeting investment performance goals
Increasing complexity of investment management issues
External management will reduce costs
← Few outsource for cost reasons
Difficult to find/retain qualified internal staff
Retirement of key internal staff

Other issues driving the outsourcing decision include:

Realization of economies of scale inherent in the investment function
Access to technology and data services that may not be cost-effective to purchase internally
Access to the benefits of an outsourced Chief Investment Officer (OCIO)
Enhanced performance and access to experienced, investment professional specialists
Ability to network with other insurance company clients providing access to best practices
Expertise in the intersection of investment strategy with AM Best ratings, RBC ratios, taxes, state regulations, and other related concerns
Added flexibility in staffing and expense control for an insurer
Upgraded reporting capabilities
Improved service

Why outsource investing?

Insurers might reasonably view investments as a “non-core” function, so outsourcing allows the carrier’s finance team to focus on core competencies like underwriting, reserving, new product design, and so on.

Partnering with an insurance investment manager gives an insurer access to a wide scope of resources and services, including broad investment expertise, asset allocation across various asset classes, dynamic financial analysis, extended research capabilities, sophisticated modeling capabilities, and upgraded service and reporting. Additionally, by outsourcing the investment management function, carriers incentivize their manager to deliver strong returns, responsive service, and constant improvement in their overall offering, in order to maintain the business and seek to grow assets over time.

We maintain that managers like AAM are optimally sized to execute tactical purchase and sale programs, while still having the scale necessary to offer strong fundamental research, best execution on trades, a high degree of client service, and access to cutting-edge technological systems and resources. A properly sized asset manager can take advantage of opportunities that smaller managers aren’t offered and that larger managers often disregard due to the scale of the significant assets that they need to employ in the markets. The result for these boutique managers is highly customized portfolios that truly represent the best ideas of the firm’s investment professionals.

Our solution: Split the mandate

AAM contends that when insurers contemplate the prospect of outsourcing to an asset manager, splitting the mandate and engaging boutique/niche firms for part of the assignment is an excellent way to complement the services provided by larger firms. Splitting mandates between a large company and a boutique firm exponentially expands access to investment opportunities, best ideas, additional thought leadership, more research capabilities and offers a perspective that otherwise might not be available to the insurer.

In terms of managing portfolios, larger firms need to maintain a broad, multi-discipline investment view in order to satisfy the needs of their diverse client base requiring managers to compete internally for resources. As a result, large manager’s focus may be diluted as compared to a firm the size of AAM that concentrates exclusively on investing for insurance companies. However, if the insurer splits the mandate between AAM and a larger firm, that dilution of focus can be significantly dissipated.

Issue #2

Carriers who manage their investment portfolios internally face a drought of qualified investment talent.

“Purely based on cost, we could never replicate the skills, expertise and experience that others have outside with our asset base. It takes many billions of further dollars before that would be reasonable to do in-house.”

Joshua Neuman, Chief Investment Officer, Ironshore

A critical aspect to any successful business is the ability to attract, develop and maintain high caliber talent. Historically, insurers have been challenged in their ability to attract good investment professionals away from the investment management industry because asset management firms offer the prospect of more diversity in terms of experience, favorable compensation, equity participation and provide opportunities for promotion and career progression within the investment profession.

And today it is becoming even more challenging because the demographics of the workforce are dramatically shifting. Within the next 10 years, Millennials will comprise the majority of the labor pool and this group is motivated by variables that are different from the past. They seek environments that offer empowerment, flexibility and purpose and they are defined by a desire to have rapid career progression.

According to leading global executive search and talent advisory firm Sheffield Haworth: “Millennials are talented, dynamic workers and their influence on – and contribution to – the asset management industry will only intensify. Attracting, retaining and developing millennial talent are key to every firm’s success – not just as a function of hiring, but also to keep abreast of important competitive changes, thinking and nuances impacting the future of asset management.”

Why boutique firms have the advantage when it comes to talent

Boutique firms like AAM are ideally situated to attract talent by being able to offer dynamic, engaging environments with high-quality tools and opportunities for creative, entrepreneurial work. Niche firms offer employees a degree of autonomy and provide clients with easy and direct access to key employees.

Additionally, one of the strongest ways an investment manager can properly incentivize employees and avoid agency problems is by encouraging significant employee ownership, something that a boutique firm is ideally scaled to do. This encourages employees to build a long-term career with the firm and with it a record of successful, mutually beneficial client relationships.

Professional advancement in the investment management industry is often not a matter of formal promotions and title changes, but of growth in the volume and size of assets being managed. A firm that rewards strong performance with increased responsibility and autonomy will be well positioned to attract and retain top talent even in today’s competitive marketplace.

Issue #3

The participating insurers understand that stability and long-term focus are key to successful investment strategy, and are concerned that external investment managers may experience turnover in ownership, employees, or investment philosophy that cause disruptions in the portfolio.

“Consistency and performance away from fees are paramount to allocation decisions.”

Aaron Diefenthaler, Chief Investment Officer, RLI Corporation

This issue is a constant focus of successful asset managers. When evaluating an outsourced investment manager, attention should be paid not only to fees and performance but also to the stability of the company’s talent pool, ownership structure, and ongoing operations, regardless of size. Boutique and niche asset managers can align employee interests directly with that of the client and can infuse organizational stability through meaningful ownership incentives.

Almost every Request for Proposal (RFP) issued by insurers seeking an investment manager requests information about the longevity and tenure of the investment professionals at the firm and the truth is that the client is directly impacted in terms of service by more than just the Portfolio Managers. There are many people in an organization that significantly contribute to the quality of service delivered. Companies with the ability to offer significant ownership stakes and other incentives can attract and retain high quality, young investment talent who are searching for a stable, long-term, and potentially lucrative career path.

Historical Growth of Outsourced General Account Asset

Source: Outsourcing Monitor. * 2014 year-end estimate is projected from June 2014 manager-reported assets under management (AUM) from The Insurance Investment Outsourcing Report 2014, published jointly by the Insurance Asset Outsourcing Exchange, Insurance AUM and Insurer AM. 2009-2013 yearend estimates from IAM Annual Surveys and Insurance Investment Outsourcing Report, adjusted for non-participants in those surveys. In 2013, insurers outsourced about 16.5% of general account assets for investment management. That percentage is forecasted to increase to about 20%, or about $1.4 trillion, by 2019, according to the Outsourcing Monitor.

Key Takeaways

Engaging a dedicated insurance asset manager could be an attractive option because it allows the carrier to overcome the complexity of the investment function and the challenges of developing and executing an investment strategy internally. Also it could boost earnings due to savings from significant economies of scale coupled with long-term outperformance. And while some insurers have a preference for very large, “name- brand” asset managers, there are significant benefits from partnering with a firm with the scale to trade nimbly and opportunistically for clients, while still possessing sophisticated resources and delivering a high degree of service. At AAM we believe we are ideally positioned to provide customized, client-driven investment solutions, exclusively for the insurance industry.

At AAM, we make it a priority to understand our clients’ unique needs and strategic goals. To gain a deeper perspective on how we can help your organization reach your goals, click below for a custom analysis.

As part of the report, our partner also conducted a roundtable that included five insurance industry experts. This panel covered the most important factors to consider when looking to outsource portfolio management to an asset manager or third-party. Key quotes from this roundtable are included in this report, and the full transcript can be found here.

Disclaimer: There are several important income and balance sheet items that are excluded from the analysis above, which may cause the figures shown to differ from other reported industry statistics. In particular, we do not include any consideration of dividends (policyholder or stockholder), other income/expense categories like financing charges, or taxes. These can all be material to financial results, but due to their discretionary and/or non-operating nature we have excluded them as outside the scope of our current purposes.

Peter Wirtala, CFA | Insurance Strategiest

Peter A. Wirtala, CFA is an Insurance Strategist at AAM with nine years of investment experience. Pete’s responsibilities include conducting analysis of client liabilities and operational projections for development of customized investment solutions and performing dynamic tax analysis using modeling software and financial market data to identify optimal allocation to municipal securities.