Insurance Insights Q2 2023: Insurance asset allocation using multi-alternative strategies

Regular review of Strategic Asset Allocations (SAA)

In our past newsletters and in our engagements with insurers, we often stress the importance of constantly reviewing Strategic Asset Allocations (SAA) in view of ever-changing market conditions, capital markets, as well as liability and product profiles. It remains important to assess whether the SAA set some time ago is still valid and whether it is able to deliver on expectations – including from an asset liability management (ALM) perspective – especially relevant as several jurisdictions already have or are introducing updated solvency regimes.

Key inputs into this process are, of course, capital market assumptions. At Invesco, we generate a wide set of such assumptions (CMAs) which are updated on a quarterly basis and incorporate the latest market developments. As alluded to, other than just expected return/yield considerations, other aspects of the portfolio, including capital considerations of asset classes and the overall asset-liability matching profile, need to be considered. We usually illustrate this through the charts below – these have been updated over the prior quarter.¹  Figure 1 assesses the attractiveness of asset classes in terms of current conditions, and Figure 2 re-formats this based on the capital efficiency (expected return-to-standalone capital charge). As before, combining these two elements can help narrow down the initial list of asset types to consider.

Please note that for purposes of this illustration, we have used the Solvency II Solvency Capital Required (SCR) standard formula for relevant risk charges as a proxy for more general risk-based capital (RBC) regimes; this can obviously be tailored to other RBC regimes across the region. While the specific charges may differ based on jurisdictions, we feel the trend or direction of risk charge changes based on allocations would still be meaningful and of relevance. It remains important to continually assess portfolios across several dimensions to ensure that the premise remains valid and achievable.

Updating Strategic Asset Allocations – Incorporating new asset classes

We have shown earlier how the introduction of some representative alternative asset classes (such as private equity, real estate) can help improve the efficiency of insurance portfolios.

To recap, let’s see what happens to a hypothetical portfolio if we were to consider adding private equity and core real estate (as examples of alternative asset classes) - how could we assess the impact?

Using our in-house portfolio management decision support system – called Invesco Vision²– we are able to compare different asset allocations to see which ones may be more efficient than others – and also to look for ways in which we may be able to enhance existing portfolios.  

The charts below (Figure 3 and 4) compare the risk-return profiles of the two portfolios above – to see what impact, if any, the addition of such alternative asset classes has - the aim is to assess how the risk-return profile changes as a result of adding new asset classes.

Figure 3 (left) shows the portfolio characteristics on an economic basis and Figure 4 (right) shows the characteristics on a Solvency II SCR basis. The blue line represents the frontier without private equity/real estate and the green line represents the frontier including private equity/real estate (while the blue and green single points represent the respective portfolio asset allocations).

We can see that by selectively adding a generic private equity/real estate allocations, we can improve the overall risk-return profile of the portfolios – the green frontier is higher (than the blue) and the portfolio with private equity and real estate represented by the green single point shows a move upwards and appears to offer a better profile (obviously, the allocation change is fairly small and so the corresponding portfolio change would be correspondingly small). This is a simple example of how selection of specific asset classes can help enhance portfolios. 

The effect of adding diversified alternatives (multi-alternatives) exposure to a portfolio

Our next step is to assess whether if we diversify our alternatives exposure, we can enhance the efficiency. That is, instead of allocations to single strategy private equity and real estate, what if we were to construct a sub-portfolio of different alternatives strategies – covering different types of private equity, real estate, and some private credit strategies. We believe such a diversified exposure to “multi-alternatives” has the potential to offer enhanced and more resilient portfolios. 

In the revised portfolio below, we have replaced the earlier private equity and real estate exposures with a multi-alternatives growth strategy, and we have also taken the opportunity to slightly reduce global high yield debt exposure and allocated this to a multi-alternatives income strategy.

Again, we have the ability visually or graphically to see what impact such an updated allocation may have on our portfolio from a risk-return perspective.

In this updated portfolio above, we have replaced our single private equity and real estate exposures (and some of the global high yield debt exposure) with allocations to several different strategies - ranging from private equity buyout, growth, venture capital, to opportunistic and value-added real estate exposure, as well as private credit.

The allocations here are meant to be for illustrative purposes only. Bespoke multi-alternatives portfolios can be constructed by taking into consideration desired risk-reward profiles with correspondingly appropriate allocations – these are highly customizable (dependent on certain minimum allocation amounts).

The charts below (Figure 5 and 6) compare the risk-return profiles of the two portfolios above – to see what impact the addition of a diversified multi-alternatives exposure has - the aim is to assess how the risk-return profile changes as a result of adding a diversified range of asset classes.

Figure 5 (left) shows the portfolio characteristics on an economic basis and Figure 6 (right) shows the characteristics on a Solvency II SCR basis. The green line represents the frontier with the single private equity and real estate strategies while the purple line represents the frontier with the diversified multi-alternatives strategies (the green and purple single points represent the respective portfolio asset allocations).

We observe that by incorporating a diversified multi-alternatives exposure within our portfolio, we have been able to further enhance the efficiency of the overall portfolio – by moving our portfolio slightly up and to the left. 

The chart below magnifies the comparison of a single private equity strategy and emerging market debt with the diversified multi-alternatives strategy to illustrate the potential enhanced profile.

Here (Figure 7) we can more clearly see the enhanced profile of the diversified multi-alternatives strategies (Growth and Income) compared to the asset classes they are replacing (on a Solvency II SCR basis). This assessment takes into consideration aspects of expected returns and standard solvency risk charges for the indicated asset classes.

We believe this is an example of the types of analyses that are very appropriate and, indeed, should be part of any standard operating procedure in managing insurance portfolios.

Potential operating model

Operationalizing any such program in an effective manner is almost equally important for insurers - implementing such a program can be challenging and complex.

Our belief is that optimal outcomes of any such program depend on close interaction between investors and asset managers and the approach should be to deliver a portfolio over time that fully meets investors’ requirements – acting as an extension of staff with a focus on knowledge sharing.

Finally, we feel it remains vital to maintain oversight over several activities associated with this asset class and investors can look at an effective combination of external and internal monitoring in order to achieve the optimal process.

The pragmatic process outlined we feel can meet these requirements – this is meant to be a very collaborative approach and can lead to more robust outcomes for insurers’ portfolios.

Key takeaways

We hope the approach and examples above of enhancing insurance portfolios has been helpful. We have built upon our earlier higher-level analysis and supplemented it here by delving more deeply into specific asset classes – the ultimate aim always being to enhance the risk-return profile and make portfolios more efficient. 

We feel alternatives (illiquids/private market assets) are still quite relevant as a satellite component within such portfolio constructs – from both efficiency and diversification perspectives - and lend themselves well to typical life insurers’ portfolios. As we have highlighted earlier, it remains vital to assess the specific types of sub-asset classes, understand the sources of return and risk, including operational, accounting, tax considerations, and, finally, be able to manage and/or have sufficient oversight of such programs.

As always, please do not hesitate to reach out to us – your thoughts on such topics are always much appreciated.