With low interest rates heaping pressure on insurers to optimise every inch of their portfolios, we take a look at how bespoke approaches can help them eke out additional returns from their cash allocations while still preserving capital.
Insurers face a perfect storm
Cash management pressures have intensified for insurers in recent years. Increasingly stringent regulations in the wake of the global financial crisis require insurance companies to hold more cash and liquid assets. In today’s “lower for longer” interest rate environment, this can create a drag on returns.
In addition, the COVID-19 pandemic has presented a significant, unanticipated challenge to business liquidity. Operational resilience and solvency in all eventualities have become top-of-mind concerns for insurers worldwide.
General insurers are challenged to manage liquidity needs
These challenges are overlaid on the industry’s complex cash management needs. Life and business insurance units, for example, need to be ready for unexpected withdrawals within a short period or an abrupt increase in claims – triggered, for instance, by a global pandemic. Similarly, general insurers are challenged to manage liquidity needs relating to direct claims, for example those driven by insurable events, including natural catastrophes.
Taken together, these factors have transformed cash into an important investment asset for insurers – cash is now a key part of overall asset allocation. As such, insurance companies stand to benefit from active, sophisticated management of their cash with the objective to not only preserve capital and provide T+0 liquidity, but to also maximise return.
Segmenting cash needs: Viewing cash as a multi-dimensional asset
The first step to cash optimisation is gaining visibility into short-, medium- and long-term liquidity requirements. The goal is to identify and categorize each cash need, then allocate to investment strategies with correspondingly appropriate risk-return characteristics.
The insurer could allocate the pending cash to liquidity-plus style investments
For example, an insurer may find that a proportion of its cash is used to fund private asset mandates, and a timing mismatch often arises as cash becomes available before it should be sent to the intended private asset manager. This proportion of cash is more stable with a slightly longer horizon than cash earmarked to support claims payouts. To achieve better optimization, the insurer could allocate the pending cash to liquidity-plus style investments designed to incrementally increase risk-return boundaries.
Figure 1: Segmenting your cash needs
For illustrative purposes only. Source: Aviva Investors, July 2021
Each insurer will naturally have differing needs for liquidity, determined by their unique mix of business lines, target levels of liquidity buffers, as well as their actual and forecasted cash positions. Once the needs have been analysed and segmented, an investment manager can help match the different cash segments with the most appropriate investments and direct the investment process to manage and meet all cash requirements and return objectives holistically.
Figure 2: Selecting the right investment manager
Due diligence
Given the large diversity of funds and managers running liquidity strategies, due diligence is essential.
Manager expertise
Managers with expertise across short-, medium- and longer-term cash investing can allocate across a continuum of investments, while simultaneously enhancing yield opportunities and delivering required levels of liquidity.
Evaluation
Insurers should evaluate not only fund manager expertise across all investment horizons and risk dimensions, but also the robustness of its investment process, risk management and credit capabilities.
Track record
In general, insurers can benefit from partnering with investment managers with a track record delivering cash solutions to insurance firms. A familiarity with the complex nature of insurance business lines and their associated array of liquidity needs is an essential ingredient for a fruitful partnership.
Source: Aviva Investors, July 2021
Bespoke mandates
More insurers are discovering that bespoke, segregated mandates can be an ideal vehicle for cash optimisation. Cashflow and liquidity needs vary – and those seeking a customisable experience and full control over investment parameters may find significant benefits from a segregated mandate.
Segregated mandates enable insurers to take a proactive approach to liquidity
Segregated mandates enable insurers to take a proactive approach to liquidity, tailored to satisfy the varying cash needs of each business line and readily adaptable to changes in circumstances. These key advantages are made possible by the flexible, bespoke nature of the vehicle: clients have direct ownership of the underlying investments and full control over the investment guidelines, allowing them to create a finely tuned risk-return profile.
Insurance firms, for example, can set limits on concentration risk, particularly with the banks in which the insurer maintains its deposits or geographies where policyholders are clustered. Segregated mandates also offer the flexibility to concurrently adhere to other limitations, including duration or spread risk and rating constraints. Such adherence to multiple, specific parameters is often not achievable with a pooled fund approach.
Additionally, investment managers with experienced, well-resourced ESG teams can help align a bespoke portfolio with a range of goals by actively integrating considerations and metrics into a liquidity management approach. A broad spectrum of ESG considerations can be addressed within a segregated mandate, including climate strategies, such as decarbonisation and net-zero targets, as well as emergent areas of focus, such as biodiversity and supply chain transparency.
Figure 3: Bespoke cash optimisation
