Insurers eye outsourcing to diversify, boost returns

Updated with correction.

In a low-interest-rate environment, money managers say they are seeing strong interest and hires by insurance companies looking for ways to increase returns in their general accounts through outsourcing, especially alternative investment strategies.

Insurance outsourcing has been around for 30 years, initially used by smaller insurance companies seeking money managers to take over their fixed-income portfolios, which accounted for 70% to 80% of their general accounts, said Daniel Dunay, managing director and head of the Americas financial institutions group at New York-based BlackRock Inc.

"There's been a paradigm shift over the past five to 10 years and especially right now as larger insurers seek to diversify their investment portfolios," Mr. Dunay said. Historically, demand for insurance outsourcing involved assignments of between $2 billion and $4 billion, which were considered a big opportunity, Mr. Dunay said, noting that it's not uncommon now to see outsourcing assignments of between $10 billion and $30 billion going to external managers.

New insurance investment outsourcing mandates totaled 655 globally in 2020, down 6.6% over the prior year but up 62.1% over the five-year period ended Dec. 31, 2020, shows the most recent data available from the Insurance Asset Outsourcing Exchange, which is managed by consultant Eager, Davis & Holmes LLC, Louisville, Ky.

Insurance assets under management by the group of managers totaled $3.3 trillion, up 13.8% from the prior year.

Tough market conditions this year are responsible to a great extent for the significant interest from insurance companies in passing on management of their assets to external managers, BlackRock's Mr. Dunay said.

"The rate environment is depressed and both large and small insurance companies are thirsty for yield, which is very important for their general accounts. To be competitive in a low-rate environment, insurers need access to incremental growth," said Mr. Dunay, adding "the way they are trying to achieve that growth is through investment in alternative investment strategies including direct lending, real estate, bank loans, collateralized loan obligations, emerging market debt, and other private market strategies" managed by third parties.

Almost all insurance companies currently outsource investment management of their general account assets to some degree, Mr. Dunay said.

BlackRock managed a total of $10.01 trillion as of Dec. 31, of which $515 billion was managed globally for insurance companies, an increase of 12.4% over the prior year and up 83.3% over the five-year period.

The pace of insurance investment outsourcing is accelerating, according to survey data collected in October from 86 insurance companies from 20 countries by bfinance International Ltd., London.

The 2021 report — Insurer Investment Survey — released in January, found that 71% of insurance respondents outsource 100% of their alternative investments to external managers and 79% said they intend to increase their allocations to alternative strategies over the next 18 months.

The bfinance survey also found that 61% of respondents expect to add more asset classes to their general account portfolios over the next 18 months; 61% intend to reduce fixed-income allocations over the same time frame; 68% expect to invest in infrastructure equity; and 75% intend to invest in emerging market debt.

At an asset allocation level, data from Pensions & Investments' survey on managing insurance assets found that 36 non-affiliated asset management firms that provided asset-class investment details of their management of general account assets had 79.9% in fixed income, 6.9% in equities, 5.9% in alternative strategies and 7.3% in other strategies.

Worldwide insurance and reinsurance assets of the of 43 money managers that responded to P&I's survey totaled $6.41 trillion as of Dec. 31, 2020.

Insurance companies approach outsourcing in different ways, with smaller companies often electing to invest in outsourced chief investment officer arrangements for their entire general account portfolio, just alternatives or just fixed income, said an investment consultant who specializes in advising insurance companies on their investments. The consultant asked not to be named.

Both small and large insurers also invest directly in alternative strategies with individual managers, said the consultant, adding "our view is that U.S. insurers are underweight private markets, and we are encouraging them to increase their allocations."

Unlike most other asset owners, insurance companies generally do not pass full investment discretion of their assets to external managers regardless of whether they are invested in an OCIO arrangement, a customized strategic partnership or invested in a manager's specific fund, BlackRock's Mr. Dunay said.

"We see insurance companies still maintaining internal investment teams that oversee third-party managers," Mr. Dunay said.

Northern Trust Asset Management, Chicago, has seen less interest in OCIO arrangements and more in strategic, customized relationships with insurance companies, with the internal investment team retaining discretion over the general account's strategic allocation, said John Abunassar, head of the institutional client group.

Northern Trust Asset Management had $1.3 trillion under management as of Dec. 31, of which $57 billion was managed for insurance companies. Insurance assets rose 46.2% from 2020 and 67.6% over the five-year period.

Mercer Investments LLC, New York, is seeing interest in investment outsourcing from its consulting clientele, including smaller insurance companies, said Greg Halagan, a Boston-based partner and co-head of Mercer's insurance investments business.

"A $100 billion insurance company has access to a very different set of resources and a larger opportunity set than a $1 billion insurance company … and are looking for more partnership-based solutions to close that gap," Mr. Halagan said.

Mercer had $684 billion in global insurance retainer assets under advisement as of Dec. 31, 2020, up 83.6% from Dec. 31, 2018, the most recent figures available.

Industry observers noted that one of the drivers behind the rise in insurance company outsourcing is because many firms don't have internal investment staff with the skill sets to manage private market strategies, sources said.

Insurance companies also are experiencing "similar competition for hiring talent and expertise that money managers are in a tight labor market," said the insurance-specialist consultant, noting that "skyrocketing compensation packages for private equity, private credit, real estate and other alternative strategies likely means it would be too expensive to bring on internal managers."

Because insurance companies are intent on diversifying their portfolios with more alternative strategies, most are moving to external management, sources said. "If the investment team doesn't have private market skill sets internally, the insurance company likely will migrate to external managers," Mercer's Mr. Halagan said.

Another reason for outsourcing general account assets is cost savings, sources said.

"Insurers are getting more aggressive about fees, particularly for core fixed-income outsourcing. They can pressure money managers on a traditional strategy, but not for private market strategies, like private equity, real estate and other alternatives," said Christopher Swansey, senior analyst in the institutional practice of Cerulli Associates Inc., Boston.

Money managers also said they've seen a surge in interest from insurers for assistance in integrating ESG principles within their portfolios.

Northern Trust Asset Management has recently "received a lot of questions about ESG as well as inquiries about how to access more yield given the low-rate environment," Mr. Abunassar said.

The bfinance survey data showed strong growth — 71% in 2021 compared with 32% in 2020 — in insurers' move to integrate ESG factors into their portfolios and reported that 59% of firms said they intend to increase the number of ESG specialists in the next 18 months.