Some discover a silver lining

Insurance asset management outsourcing could be a ray of sunshine for investment managers in the current financial storm, according to industry analysts.

General account assets outsourced by insurers grew 11% in 2007, to a record $906 billion, according to Alex McCallum, editor of Insurance Asset Manager, Exeter, N.H.

Financial services consultant Patpatia & Associates, Berkeley, Calif., put the 2007 total of outsourced general account assets at $989 billion, up 9.8% from a year earlier, while money management consultant Eager, Davis & Holmes, Louisville, Ky., put the estimate at $906.46 billion, up 12.4%.

All three firms estimate that combined internally managed and outsourced U.S. insurance company assets total $6.8 trillion.

Mr. McCallum said preliminary numbers for the first half of 2008 show outsourcing of general account assets declined about 8%, likely because of the downturn in the value of the assets.

“That, by the way, is a highly commendable performance, considering what happened to the markets,” Mr. McCallum said. “At this time when markets have been dropping, these guys have managed to avoid a precipitous decline.”

During the first half of the year, the Russell 3000 stock index declined 11% and the Barclays Capital Aggregate bond index rose 1.1%.

The second half of 2008 might prove more difficult, he added.

It also could show a heightened awareness of risk avoidance, which is common in the insurance industry, Mr. McCallum said.

Sunny Patpatia, president of Patpatia & Associates, said by the end of 2007 about 14.4% of insurance assets industrywide, or $989 million, were run by external managers. And despite the credit crunch, he's heard anecdotally that interest in outsourcing has picked up in recent months.

“The credit crisis and the complexities of the markets have gotten business people focused on investments. Now the CEOs are saying, "What's in my portfolio?'” Mr. Patpatia noted.

Mr. McCallum said he believes appetites for new asset classes will diminish temporarily until money managers get a better sense of the post-crisis financial landscape. He said the volatile markets will prompt insurance companies to re-evaluate their investment strategies.

For 2007, Mr. McCallum's industrywide analysis shows a small drop in fixed income managed for insurance companies by external money managers, down 3.7 percentage points from 82.5% in 2006.

Jack Corroon, director and head of client business development at Conning Asset Management, Hartford, Conn., said fixed income historically is the largest allocation of insurance companies, but some began to branch into riskier investments until the credit crunch began around July 2007.

“In this process, risk didn't manifest itself for many years. Risk premiums were way down, causing many investors to chase yield and performance. Lo and behold, that didn't work out as this last year has shown” Mr. Corroon said, noting that Conning runs a “relatively conservative shop.”

Conning followed the industry trend in 2007, reducing its fixed-income investments by three percentage points to 91%, according to the Insurance Asset Manager survey. The firm also was the third largest external manager of insurance company general account assets in 2007 with $69.4 billion, according to the report.

David Holmes, partner at Eager, Davis & Holmes, said insurance companies need managers that excel not only in money management, but also in the regulatory and tax hurdles faced by the insurance industry.

“It's not just the numbers,” he said. “It requires effective communication of the investment process, the investment team and how they are going to respond to that particular company's needs.

“They have to be more flexible. Different insurance companies have different goals. Some are tax sensitive and others aren't.”

A recent study by Eager, Davis & Holmes showed most insurers don't use a structured selection process, manager evaluation database or third-party consultant when selecting a firm. Instead, they often rely on a company's reputation when making a selection.

Mr. Holmes advised a greater level of scrutiny.

“They have to look underneath the numbers and really understand the insurance asset manager's investment process, their investment team and their experience in dealing with the same types of business challenges that their particular insurance company faces,” Mr. Holmes said.

Alton Cogert, president and chief executive officer of Strategic Asset Alliance, a Bellingham, Wash.-based insurance company consultant, said asset managers must learn to effectively communicate and “speak the insurance companies' language.”

“As a manager you have to be able to churn out custom reports as quickly and correctly as possible,” he said, noting that asset managers have told him that insurance company business is more demanding than other kinds of asset management work.

Money managers also might want to brush up on their Portuguese, a language commonly spoken in Bermuda. According to Bermuda's Insurance Advisory Committee, the insurance industry grew to $329.8 billion in 2005, the most recent data available, from $95 billion in 1995.

“Almost the whole Bermuda market is outsourced,” said Eric Kirsch, managing director and head of global insurance asset management for Goldman Sachs Asset Management, New York.

Mr. Kirsch said European markets for insurance outsourcing also are starting to open up. He believes that trend will continue as European insurance companies re-evaluate how their assets are invested in the wake of the financial crisis.

“That's creating a lot more outsourcing opportunities,” Mr. Kirsch said.

Insurance assets worldwide total about $17 trillion, about $1 trillion of which is outsourced, he said.

That could double to $2 trillion in the next three or four years, Mr. Kirsch said.

“The last thing I worry about is when it's going to plateau,” he said. “We're in the third inning of a nine-inning ballgame.”