Ankabala /
3 April 2018Analysis

Asset allocation for captive insurers: a multi-asset perspective

Insurance companies cover a very broad spectrum of business types, from traditional life insurers, via property/casualty and health insurers, to specialty reinsurers and captive insurers. Generally, the investment strategies insurance companies pursue are very much driven by their liabilities, their business models, and the regulatory environments in which they operate. These drivers, often combined with some degree of home bias, can lead to remarkably similar asset allocation profiles between insurers of the same type in a given geography.

Captive insurers are an exception to this rule, exhibiting a surprisingly wide variety of asset allocation profiles across organisations. Some captives simply invest in loans to their parent company while, at the other end of the spectrum, others can invest as much as a third of their assets into high-conviction equity strategies. Spanning the interval, some captives manage liability-matching and return portfolios, others run their assets in a multi-asset framework, and yet more are just beginning to expand their investments beyond money market funds.

Even within the same regulatory environment, geography, and industry of the corporate parent, captive insurers can display very different investment strategies from one organisation to the next. This is a clear indication that additional variables drive captives’ asset allocation choices, as compared to other categories of insurers, leading to the question of what these variables could be.

Impact of the captive’s purpose

To find the answer, it is helpful to remember the role captives play within corporations. Corporations typically set up a captive insurer in order to centralise insurance risks from across the company, with the aim of reducing costs and improving risk management. In principle, the captive’s investment philosophy should thus be designed to assist the corporate in achieving these objectives.

Yet, because of the nature of captive insurers, a number of other, very specific, variables play a role in the design and implementation of their asset allocations:

  • Industry of the corporate parent company: this has a significant impact on the insurance risks which need to be centralised. A large industrial company with many employees may have a relatively heterogeneous pool of insurance risks which can be hedged in a competitive reinsurance market, allowing for a relatively small captive.

On the other hand, a professional services firm exposed to very large and hard-to-insure professional indemnity exposures could require setting up a captive with a balance sheet of several billion dollars.

  • Regulatory environment: many jurisdictions require the use of fronting insurers, who typically require the counterparty risk on the captive to be hedged through letters of credit issued by banks. These letters of credit are collateralised by assets held in the captive’s portfolio, which may limit the investment strategies and fulfilment vehicles that can be used.
  • Business model and funding profile of the parent: in jurisdictions where this is allowed, captive insurers may invest some of their assets in loans to the parent company. The higher the funding cost of the parent, the more attractive this will be.
  • Risk attitude and philosophy of the parent: many corporate parents view the captive first and foremost as an insurance-risk aggregator, and the returns on the captive’s assets play a secondary role. Meanwhile, other corporates will consider the captive’s assets as another part of the company’s opportunity set, and they will want them to “sweat” just like any other asset on their balance sheet.
  • Lifecycle stage of the captive: unlike most other insurance companies, captives are established with a limited purpose in mind, which can include a limit on its expected lifespan. Different stages in the captive’s lifecycle will call for different types of investment portfolios.

Adapting investment risk to insurance risk

A captive insurer’s investment committee needs to build and maintain the right asset allocation within the constraints imposed by the variables listed above. In addition, it needs to take account of the size and composition of the insurance risks retained by the captive. Many captives are active users of reinsurance, ceding an amount of risk to the reinsurance market which can evolve significantly over time, as pricing and capacity vary.

If a captive insurer decides to retain more insurance risk over a given period because of unattractive pricing in the reinsurance market, the investment committee may deem it appropriate to reduce the investment portfolio’s risk appetite at the same time.

Multi-asset strategies: defining the portfolio’s risk budget

The need to periodically review the risk appetite on the balance sheet assets suggests that developing a multi-asset allocation strategy could benefit captive insurers. In a multi-asset portfolio, an investment manager typically pursues an investment strategy based on asset allocation within a predetermined risk budget, which can be defined in terms of expected volatility, or by other risk measures such as the Value at Risk.

The asset allocation strategies pursued within the risk budget can range from relatively stable strategic asset allocations to highly active tactical allocation strategies; they can even extend to fully algorithmic factor-based strategies.

There are a few important reasons why multi-asset strategies can provide an attractive investment approach for captive insurers:

  • Ability to match the risk appetite on the asset side to the risk retained on the liability side: since multi-asset strategies are risk-budgeted by design, they are very well suited to an investment philosophy in which the amount of risk in the investment portfolio is a function of the amount of insurance risk the captive has retained.
  • Embedded drawdown protection: one of the key properties of the risk budgeting mechanism is that an increase in market volatility will force the strategy to reduce its exposure, helping to preserve capital in volatile markets. For captive insurers, the pursuit of investment returns is often less important than the preservation of capital, and a multi-asset investment framework can help find a good balance between downside protection and return potential.
  • Active risk management combined with strategic oversight: captive insurers’ investment committees often meet only twice a year, and much can happen in six months. While keeping responsibility for overseeing the overall investment strategy and periodically setting the risk appetite for the multi-asset allocation, the investment committee can then delegate management to the asset manager, to pursue the investment objectives within the risk budget, and respond quickly to changes in market sentiment.

Whatever a captive insurer’s specific situation, the wide array of available multi-asset strategies provides ample opportunity to define an appropriate asset allocation strategy to meet their needs. For example, they can structure their multi-asset strategy using building blocks which can also serve as collateral for Letters of Credit at attractive haircuts.

The underlying components of their strategy can also be actively managed where desired, and passively run where needed, to avoid potential conflicts of interest (which can be an issue for captive insurers owned by a professional services company). The implementation of the multi-asset strategy itself can range from highly active to fully algorithmic to align with the corporate parent’s investment philosophy. It is possible to design cost-effective implementations for smaller captives as well.

For a captive insurer looking to implement a multi-asset allocation strategy, finding the most appropriate solution will be made easier by working with an asset manager who understands investing for all types of insurance companies, and who can offer a full range of multi-asset strategies.

This article is for general information and educational purposes only, and should not be considered investment or financial planning advice. HSBC Global Asset Management (Bermuda) Limited (AMBM) of 37 Front Street, Hamilton, Bermuda, is licensed to conduct investment business by the Bermuda Monetary Authority. AMBM is a wholly owned subsidiary of HSBC Bank Bermuda Limited.

Melvin Nusum Sales & Business Development Manager, email address:

Jan-Hendrik Hein Senior Sales & Business Development Manager HSBC Global Asset Management (Bermuda), limited email:

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30 November 2010   Louise Twiss West and Claudio Lede ask the all important question. Segregated accounts or pooled vehicles: which is better for medium-sized captives?

More on this story

30 November 2010   Louise Twiss West and Claudio Lede ask the all important question. Segregated accounts or pooled vehicles: which is better for medium-sized captives?