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Research Summary

  • Insurance

Insurers and Less Volatile Stocks:

How to Get Equity Exposure and Lower Risk, Too

July 12, 2012

By necessity, insurance companies must be hyper-vigilant about minimizing volatility and downside risks in their investment portfolios. This sensitivity is reflected in their relatively small allocations to equities. But, with yields on fixed-income assets near all-time lows, many insurers are realizing that shunning equities is also putting them in a financial straitjacket. It not only inhibits their long-term return potential but also risks overexposing them to an eventual sustained rise in interest rates.

This paper explores a more capital-efficient solution. In simulations going back to 1989, we found that replacing the equity portion of a typical insurer’s total allocation of 90% global bonds and 10% global equities with a combination low-volatility/high-quality equity portfolio produced roughly similar returns—but with considerably less volatility and, notably, much better downside-risk protection than the traditional plan. Our work also indicated that insurers could generate higher returns at the same level of risk as the traditional plan by roughly doubling their allocations to less volatile equities.

Further research found that substituting the simulated results of a low-volatility/high-quality equity portfolio for the actual equity returns of a multibillion-dollar US property and casualty insurer would have tamed fluctuations in both its earnings and shareholders’ equity since 2008 (Display).

We think insurers should consider adding a low-volatility equity strategy to their overall investment plans.

Smoother Investment Performance Tempered Earnings and Balance-Sheet Swings in Simulations

Through December 31, 2011
*Substituting simulated US low-volatility/high-quality equity portfolio returns for actual equity returns. Simulated or hypothetical performance results have certain inherent limitations. Unlike the results shown in an actual performance record, these results do not represent actual trading. Results include estimates of trading costs and market impact; however, because these trades have not actually been executed, results may have under- or overcompensated for these costs. Simulated or hypothetical trading programs in general are also subject to the fact that they are designed with the benefit of hindsight. No representation is being made that any account will or is likely to achieve returns or a volatility profile similar to those being shown. Simulation investable universe contains stocks selected using a proprietary low adaptive beta and high quality edge score; returns net of transaction costs; capitalization-weighted S&P 500 index.
Based on reported results of a publicly listed US insurance company
Source: S&P and AllianceBernstein

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