Quelle Surprise! Insurance Industry Succumbs to Wall Street Product Complexity

Get this: insurance companies have long been very big institutional investors. They get cash from premiums and have to pay it out in the future. If they are in the property and casualty or health insurance business, there isn’t that long a time between premium payments and when the losses might show up, but other lines of business (notoriously, life insurance) are long-tailed. And many insurers got into the business of offering annuities, so managing investments to meet future obligations is again important.

So what is happening? Increasingly, daunted by product complexity, they are deciding to give up this traditional role and hand it over to money managers. This looks to be yet another example of the never-ending rise of opacity and complexity enabling the bigger financial players to pull more fees not just out of the real economy, but now also other supposedly sophisticated financial firms (yes, I know some readers will take issue with the “sophistication” of some insurers, but the benchmark is professional v. retail). Deutsche Bank, Blackrock, and Goldman are among the big winners.

The argument is that the cause is the complexity of their portfolios….but how did they get to be so complicated in the first place? These firms somehow talked themselves into dabbling in products and strategies that were over their head.

From the Wall Street Journal:

While many insurers looked after their own investments for decades, lately more have looked for some help, after finding themselves caught off guard by the weakness, or complexity, of their own portfolios. Insurers last year outsourced management of more than $1.1 trillion, according to industry estimates, up from about $980 billion in 2008….

Last year, the company chose BlackRock Inc. to look after $23 billion of bond securities of its nearly $160 billion portfolio. Allstate Corp. got out of the stock-picking business by hiring Goldman Sachs Group Inc. to manage a $5 billion equity portfolio out of its overall $100 billion investment pool….

The move isn’t for everyone. Prudential Financial Inc., which has its own $260 billion investment portfolio, considers asset management to be a core business. The insurance company employs a staff of 3,000 to look after its own investments and about $273 billion of assets from other companies, including insurers.

“The insurers in Europe are feeling that they don’t have the expertise to handle U.S. credit markets, so they hand off responsibility of managing a U.S. credit portfolio,” said Bernard Winograd, Prudential’s chief operating officer who oversees the insurer’s investment-management business. “Smaller insurers are doing the same. We’re proud of the fact we manage a lot of parties.”..

Swiss Re’s Mr. Blumer said that farming out the $23 billion in “credit and securitized assets” to BlackRock while retaining control of the overall strategy has helped turn around the firm’s portfolio. Swiss Re reported a profit for the fourth quarter, after being walloped during the financial crisis by about $6 billion of losses from wrong-way bets on credit-default swaps.

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  1. Gerald Muller

    It seems to me that Warren Buffet is not going to hand management of his “float” as he calls it any time soon to the banksters.

    1. David Merkel

      On the contrary, he offers these services to insurers through his New England Asset Management, as mentioned in the article. He is on the other side of the trade.

  2. Siggy

    I’m uncertain as to whether the insurance industry has succumbed to Wall Street. I do believe, however, that a vast number of institutions and individual investors are confronted with a very real problem.

    The first part is the need to achieve inflation beating yields. The second part is the fact that size matters and that very large size in portfolio management is the enemy of sustainable yields that maintain purchasing power while providing even a modest profit.

    In fact, a portfolio can be of such large size that if you merely maintain purchasing power you have done an outstanding job.

  3. Valissa

    Former Health Insurance Executive comments… saw this comment the other day about how money is made in the health insurance industry and wondered how accurate it was, so thought I would ask here.

    dandelion @ http://www.ianwelsh.net/progressive-enablers/#comment-6093
    I worked as a health insurance executive for 10 years. This bill is a huge boon to the health insurance industry. I’m amazed at the number of people commenting on this bill who don’t understand the health insurance business model. People assume that forcing them to cover pre-existing conditions or limiting them to an 85% loss ration will rein in their profits — that the insurance companies too are having to take some kind of “haircut.”

    But insurance companies DON”T make their money from the spread between premiums in and claims paid. They make their money due to the time value of money — via investment. In most cases, they can count on anywhere from 90 days to 180 days use of cash flow in before they pay out on an incurred claim, and in that time period they are moving vast sums of money in and out of financial vehicles. THAT’s where the profit comes from. THAT’s why boosting their cash flow in by 30 million more paying customers is a huge huge windfall. And I’m 100% certain they need this windfall because they were probably holding a whole lot of paper in CRE and MBS.

    Sure, they’ll cover pre-existing conditions. But they know how to rate for that, and the overall population premium tables will rise to account for that. They didn’t cover pre-existing conditions before because they were afraid of the costs — that had nothing to do with it. Excluding pre-existing conditions was a way to prevent adverse selection and what’s known in the industry as the “death spiral” which comes when people only buy insurance when they know they need it. With the mandate in place, covering pre-existing conditions is a snap and won’t impact their bottom line one iota.

    My problem with this bill is that it further entrenches the insurance industry in our health care system. If you think we have a problem with Too Big To Fail banks — where we can’t rein banks in without “destroying a huge sector of our economy” — well, we’ve just taken one gigantic step toward creating Too Big To Fail insurance companies. Which only makes single payer that much more distant. This is not a step toward any kind of national health plan. This is a gigantic step away from that.

  4. David Merkel

    Yves, this isn’t about complexity. Outsourcing of asset management in insurers has been a growing trend for the last 15 years. It’s a really competitive business, with fees typically below 0.10%/year for top flight fixed income management, and no, not a lot of complexity, because the insurance regulations won’t allow it. At least, it won’t allow any more than an insurance company could do on its own.

    The outsourced investment managers typically customize to the needs of the insurer, at no extra charge.

    The WSJ writer sought a sensational story where there is none. He also did not get all of the facts straight.

  5. Hugh

    This is all a function of the paper economy. Valissa is right. Where do you think these companies were putting all this excess cash during the bubble? In Treasuries? Some of us have speculated that the reason insurers pushed so hard for Obamacare, and don’t be fooled by the stories of their faux opposition to it, was because the wanted to make up for losses they sustained during the bubble and meltdown. That money had to be going somewhere and doing something. But in an era where it has become standard, accepted practice for companies to cook their books, I doubt we will see many smoking guns.

  6. bjc

    I don’t know about the life side, but in casualty outsourcing investment management makes sense for smaller operations. It just means the organization doesn’t want a full-time investment manager on staff who is just as susceptible to screwing up as anyone else.

  7. Meryl Jenista

    That’s a very interesting post that you have. I stumbled on a new one the other day. They look open for business, but very similar to linkedin.com with more of a social business directory look and feel. Nice easy interface though. It’s at SocialTerrain.com

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