From: Captive International
The most interesting, and potentially threatening, changes to the investment market outlook for insurance companies have to do with asset class behaviour. This will have important implications for captive insurance strategic asset allocation, says Carl Terzer of CapVisor Associates.
A strategic asset allocation (SAA) is an investment strategy whereby the insurer sets target allocations for various asset classes and rebalances the portfolio periodically. This is the single most important decision a captive’s board or investment committee makes on behalf of the investment programme.
The asset allocation decision, as opposed to the selection of an investment manager, accounts for more than 90 percent of the programme’s investment return of the strategic time horizon (Figure 1).
What worked in the past simply will not perform in our new investment environment”Carl Terzer, CapVisor Associates
The allocation of mixed asset classes should be designed to produce optimal investment performance: put simply, to achieve the highest return for the lowest risk. The target allocations are based on factors such as the investor’s risk tolerance, investment objectives and time horizon. The “strategic” time horizon is generally accepted to be longer term (exceeding a single business, economic or interest rate cycle) and typically implies a 10-year forward-looking period. Of course, underwriting history, accounting, regulatory and other considerations should be factored into the analysis.
Generally, small to mid-sized insurance companies do not utilise the analytic systems which optimise asset allocations to produce the best risk-adjusted returns. Too many captives simply revert to an 80 percent investment-grade bond and 20 percent equity portfolio mix for their investment programmes. An optimised investment programme will typically contain between three and eight low or uncorrelated asset classes.