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