Investment Management

Investment operations are often considered incidental to the business of

insurance, and have traditionally been viewed as secondary to underwriting. In the
past, risk management was the most important part of business, whereas today the
focus has shifted to fund management. Since investment income is a large
component of insurance revenues, skilful and careful management of funds can
extend to the company in question a competitive advantage. The prudent
deployment of the same is, naturally, a matter of concern for the industry as well
as for the government.
Insurance is a business of large numbers and generates huge amounts of
funds over time, making its financial muscle very strong. These funds arise out of
policyholders’ funds in the case of life insurance, and technical and free reserves
in the non – life segment. The time – lag between the procurement of premium and
the payment of claim provides an interval during which the funds can be deployed
to generate income. The power of the sector is evident from the fact that insurance
companies are among the largest institutional investors in the world. Assets
managed by insurance companies are estimated to account for over 40 percent of
the world’s top 100 asset managers. In view of this fact, the investment function
has a crucial role to play.
In fact, returns on investments influence the premium rates and bonuses and
hence investment income will continue to be important component of insurance
company profits. In the life sector benefits of investment profits accrue directly to
policyholder when it is passes on to him in the form of a bonus. In the case of the
non life sector, the benefits are indirect, mostly by the creation of an investment
portfolio.
LIC’s ability to settle policyholders’ claims and maturity benefits (including
bonus and other additions, where they apply) is a function of two elements: one a
‘sovereign guarantee’ which applies only to the sum assured and ‘guaranteed
additions’ components in any policy, and two, LIC’s ability to generate profits
from its business and pay bonus (in ‘with profits’ policies) and loyalty additions
and final additional bonus. In other words, anything that impacts LIC’s
profitability is bound to affect the bonuses and loyalty additions that the
corporation pays (Intelligent Investor, 2001).

Objectives of the investment policy

The objectives of an investment policy in insurance are different from other
industries in certain aspects. Unlike in other sectors, these investments cannot
have the sole object of securing maximum returns. It is to be borne in mind that
the insurers are primarily responsible for catering to the insurance needs and not
providing funds for economic development. That is just one of the obligations and
hence, the performance of the companies cannot be considered simply in terms of
investment income. The major source of income of the companies is from
premium, which is supplement by income on investments. In view of the
worsening profitability experience worldwide, the profitability of the general
insurance businesses is being looked at from a different angle. The actual profits
that would arise from general insurance business are the extent of the yield that is
obtained from the usage of the client’s funds, i.e., the premium. Insurers who are
able to collect funds either from direct business or elsewhere, in a short period and
deploy them profitability alone can survive in the long run. Similarly, the insurer
has to discharge the claims as quickly as possible, without impairing his financial
position and hence must maintain a portfolio with an emphasis on liquidity, safety
and yield.
Therefore, the insurers have an obligation to invest them prudently with the
combined objectives of liquidity, maximization of yield and safety. In this sense,
the investment decisions in the insurance sector are not entirely a matter of choice
only of the investor. Therefore, the governments or the regulators in all countries
insist on a clear and transparent policy for investment and usually prescribe
detailed regulations for the same. Since insurers deal with large public funds
primarily in the nature of premiums of the clients or policyholders, entrusted to
them in good faith, the safety of the same assumes greater importance. The monies
are collected on a long-term contractual basis with the trust that they will be secure
with the insurers.
There is some difference in the approach to investment management by the
life insurance companies and the nonlife insurance companies. The considerations
are different because their requirement of funds and their timing are different.
Thus, generally, the liabilities of life insurance companies are of a longer term.
The contractual liabilities (for example, liabilities under non profit policies) are
fixed and guaranteed. The non contractual liabilities represent with-profit
policyholders’ expectations regarding future bonuses, which are akin to a real
liability linked to inflation.
The nature of investment:-

The investor has to decide between having sufficient funds that are
relatively liquid to settle claims and placing such funds in long-term investments
for higher returns. Quality, security and marketability of investments have to be
kept in mind with a view to achieving the beat rate of return. However, how
effectively the insurance company does this will also depend on the investment
norms mandated by regulators.
It is considered that insurance is the business of generating liabilities that
must be matched by investment in assets. Hence actuarial experts lay emphasis on
anticipation pay out patterns and liabilities. Asset composition is decided after
taking into account a safety factor for unexpected losses. Hence, many companies
hold an asset mix that is highly liquid and fixed income in nature, and not
speculative. They cannot carry therefore; achieve an optimal portfolio mix for
maximizing benefits. Such a policy affects their profitability which it is
theoretically possible to improve with prudent investment and without sacrificing
liquidity. How ever, in view of the nature of this business, an optimal mix with
only returns I view can never be achieved, unless the companies throw caution to
the winds.
Different categories of claims have different tenures viz. short term and
long term. Due to the different periodicities of the claims, asset-liability matching
becomes a highly complex exercise. Areas of investment under the market sector
may be classified into fixed income securities and floating income securities with
details such as long term and short term depending on the tenure of instruments.
Ideally, the securities whose tenure also is the same as these claims would be
preferable. The objective would be to achieve a match between the assets and
liabilities in the form of claims such that the asset liability matching ensures that
there are sufficient assets, which meet the terms of safety, liquidity and maturity.
Obviously the companies must have more assets than estimated liability at any
point of time. This necessitates the creation of a prudent investment portfolio.
Again in life insurance contract, the use of mortality tables helps in making a
fairly good estimate of the claims ratio.
The investment manager has to create a portfolio that satisfies the demands
of both the shareholder and the policyholder. He has to distinguish between the
return on the shareholders’ fund and the policyholders’ fund. Better yields are
possible in the case of shareholders’ funds which can be invested in higher risk
instruments since this a long-term liability. The same level of risk cannot be taken
in the case of policyholder’ funds, which necessarily must be invested with the
objectives of safety, liquidity, and modest return.