Investing the balance sheet: re-framing fiduciary responsibility in insurance asset management

Carl Terzer, of CapVisor Associates, looks at why insurance companies need to ensure they’re looking in the right direction when it comes to investment decisions.

Insurance is not solely a risk-transfer business – it is also a balance sheet investment enterprise. Insurers are entrusted with policyholder and claimant capital, which must be invested prudently, strategically and profitably until those liabilities come due. The critical question for boards and investment committees is not whether investments matter, but whether they are focusing on the right investment decisions.

For many small to mid-sized insurers, disproportionate attention is paid to the liability side of the balance sheet – often to the detriment of the investment programme. When investments do receive scrutiny, the focus is frequently misplaced. Selecting an external investment manager is often viewed as the culmination of fiduciary responsibility, when in reality it is only one component of a much broader governance obligation.

This two-part discussion examines why many boards and investment committees, despite their best intentions, might not be fully discharging their fiduciary duties with respect to invested assets – and what best practice actually requires.

Part 1: Asset allocation as  primary driver of long-term results

A common misconception among boards and investment committees is that the most consequential investment decision they make is the selection of an investment manager. Compounding this error, performance is often evaluated almost exclusively against a benchmark index.

Decades of empirical research demonstrate that this emphasis is misplaced. Here is a graphic representation of return contribution attributable to strategic asset allocation (SAA) versus manager selection for insurance companies:

Cross-industry studies – including the seminal Ibbotson and Kaplan research, ‘Does asset allocation policy explain 40%, 90% or 100% of performance?’ – consistently show that strategic asset allocation (SAA) explains the overwhelming majority of portfolio return variability over time.

Investment managers add value through security selection and market implementation. However, they operate within the framework established by asset allocation policy. If that is misaligned with liabilities, capital constraints, liquidity requirements or risk tolerance, even exceptional managers cannot overcome structural inefficiencies.

When we analyse asset allocation’s importance specifically within insurance portfolios, the conclusions are similar:

• Strategic asset allocation typically explains 70-90% of long-term total return
• Manager selection contributes a smaller – but still meaningful – portion
• Short-term performance differentials between managers tend to converge over time

Key takeaway:

If a board or investment committee has not conducted periodic strategic asset allocation reviews and optimisations – explicitly linked to liability characteristics and capital objectives – it is unlikely that fiduciary responsibilities are being fully met.

Part 2: Manager selection is a process, not an event

Typical industry practice involves issuing RFPs to a small group of familiar or recommended managers, reviewing historical performance versus an index, and selecting a ‘winner’. While common, this approach falls short of recognised best-practice standards.

The CFA Institute outlines a rigorous framework for manager selection and evaluation  consisting of three essential components:

1. A proper manager universe

A true manager universe is not a shortlist of known firms – it is a dataset comprising hundreds or thousands of managers within a relevant strategy and asset class. Only within such a universe can relative skill, peer ranking and consistency be meaningfully assessed. Robust third-party performance databases exist precisely for this purpose.

2. Quantitative analysis

Quantitative evaluation must go well beyond nominal returns. Critical elements include:

• Validation of benchmark appropriateness
• Risk-adjusted performance metrics grounded in modern portfolio theory
• Peer-relative analysis within the manager universe

Benchmark selection is particularly important. Managers sometimes employ instruments, leverage or techniques inconsistent with their stated benchmark, undermining the integrity of performance comparisons. Once benchmark alignment is confirmed, statistical measures such as volatility, downside risk and consistency provide far more insight than nominal returns alone.

Importantly, the highest-returning manager is rarely the best manager. Excess returns are often accompanied by uncompensated risk-taking – a reality that only becomes apparent when market conditions reverse.

3. Qualitative assessment

Only after a quantitative ‘consideration set’ is established should qualitative factors be evaluated, including:

• Demonstrated experience managing insurance balance sheets
• Portfolio construction consistent with duration and cash-flow matching
• Alignment between mandate size and organisational commitment
• Depth, stability and experience of the investment team
• Engagement with the insurer’s specific market segment and lines of business

Why manager performance alone is an inadequate governance tool

As demonstrated in Part 1, asset allocation dominates long-term outcomes. One reason is  manager performance dispersion narrows over time.

To illustrate this concept, we use S&P’s 2025 SPIVA reports below. You can see the diminishing role of the ‘active manager’ contribution to investment programme returns over time.

Industry data – including recent S&P SPIVA reports – also shows relatively few active managers consistently outperform peers across market cycles. The data below reflect the percentage of active managers performing in the top quartile of a peer group universe at the start, and those who remain there over various consecutive periods.

This phenomenon, known as performance persistence, presents a governance challenge. A manager that appears exceptional over one period might revert to the mean, while previously average managers might outperform temporarily. Assessing managers on a risk-adjusted basis, rather than on a nominal return basis, will better reveal manager ‘skill’ levels, as defined by strong performance in both up and down-market cycles. Without ongoing peer-relative, risk-adjusted analysis, boards risk complacency.

Relying solely on benchmark-relative performance, as many boards and investment committees do, is insufficient. In some asset classes – such as US investment-grade fixed income – 80 to 90% of active managers outperform the benchmark over rolling multi-year periods. Without universe-based analysis, it is impossible to distinguish true skill from favourable conditions.

Key implications:

Even top-quartile managers find persistency to be a challenge. Continuous, disciplined monitoring of managers within their peer universe is a fiduciary necessity. Benchmarking by index might not disclose managers underperforming their peers. While changing managers is uncomfortable, failure to act in the face of deteriorating relative performance might represent a greater governance risk.

Active vs. passive: A false dichotomy

Given these challenges, some conclude that passive strategies are the solution. In practice, this is overly simplistic.

Passive strategies will, by design, underperform their benchmark over time due to fees and transaction costs. Since actively managed portfolios have built-in efficiencies due to asset liability matching, such risk/return efficiencies are lost in passive strategies. In addition, for asset classes where the benchmark itself is a high percentile performer (US Large Cap Stock), this structural underperformance might or might not be acceptable.

That said, passive strategies have a legitimate role in insurance portfolios – particularly where:

• Allocations are too small to justify active fees
• Portfolio size limits effective diversification by active managers
• Passive exposure is used to complete an asset allocation optimisation efficiently.

The question is not active versus passive, but appropriate implementation within a disciplined governance framework.

Summary: Strengthening investment governance

For insurance boards and investment committees, best practice requires moving beyond manager selection as a one-time decision. Fiduciary excellence demands:

• Periodic, liability-aware asset allocation reviews
• Manager selection grounded in universe-based quantitative analysis
• Ongoing peer-relative monitoring and qualitative oversight
• Clear documentation of decision-making processes

If your organisation has not revisited its strategic asset allocation recently – or if manager oversight relies primarily on benchmark comparisons – it might be time for a deeper review.

We encourage boards and investment committees to reassess whether their current investment governance framework truly reflects executing their fiduciary responsibilities to their fullest extent – and whether it is positioned to support long-term financial strength.

Carl E. Terzer is principal of CapVisor Associates. He can be contacted at: carl.terzer@capvisorassociates.com

Did you get value from this story?  Sign up to our free daily newsletters and get stories like this sent straight to your inbox.