Non-life insurers may be taking risks inefficiently through investment strategies that lack appropriate asset diversity and show poor liability-matching characteristics. according to a Watson Wyatt report.
In addition, the firm believes that these companies' confidence in low-risk active management to deliver outperformance, after fees, could be misplaced.
Kevin Carter, European head of investment consulting at Watson Wyatt, said: “Given general insurers are experts in risk diversification as applied to insurance principles it is somewhat surprising that this skill has not been widely applied to their investment decision making.”
The report, entitled 'Risk budgeting for insurers', suggests insurance companies may not be considering all aspects of investment risk and as a result, in the event of adverse investment conditions, may have insufficient assets to pay claims.
Kevin Carter said: “Historically there has been little emphasis on investment arrangements. However increased market complexity, more sophisticated regulation and common sense are focusing more insurance minds on good risk taking.
"But many are still those ignoring fundamental investment principles, such as taking risk only where it is rewarded, diversifying sources of risk as much as possible and, if risk must be taken, taking it only where expected return is highest.”
According to the report, a typical insurance company that is invested in UK gilts with some equities may be taking undue risk, for very little return. This is because the gilts are often a poor match for liabilities, while the big bet on equities ignores the possibilities of other return-seeking assets.
In addition, employing one active manager contributes to the total risk and so the company needs to be very confident in the ability of that one manager to deliver outperformance.
The report also covers the identification of risk factors, such as peer group, financial strength, premium flexibility and liability risk and the benefits of risk budgeting for quantifying and dynamically managing it.
