OLDWICK, N.J.--(BUSINESS WIRE)--With interest rates remaining persistently low, NAIC Schedule BA assets, which include alternative investment securities, have generally provided insurers with the potential for higher risk-adjusted returns to help mitigate the decline in higher portfolio book yields, according to a new A.M. Best special report.
The Best’s Special Report, titled, “Hedge Fund Performance Has Insurers Reducing Exposure,” states that without a meaningful increase in interest rates, insurers have limited choices for investing new dollars from maturing securities and new business premiums to maintain targeted risk-adjusted returns. Therefore, the current industry trend toward modestly higher allocations to non-traditional asset classes is likely to continue.
Despite some public pullbacks by large life insurers, total insurance industry investments in hedge funds have continued to increase over the last two years. Hedge fund holdings within the life/annuity (L/A) segment have grown from $11.4 billion in 2013 to $14.2 billion in 2015, while the property/casualty (P/C) segment has increased its holdings from $8.9 billion to $10.2 billion. In light of these trends, L/A asset allocations to hedge funds have increased from 7.6% to 8.5% between 2013 and 2015—the largest allocation of the three segments. The P/C segment has increased its allocations from 7.1% to 7.5%, while the health segment has decreased its allocations from 8.4% in 2013 to 7.4% in 2015.
However, in the face of declining returns and potentially misaligned fee structures, investor capital has been decreasing dramatically over the last few quarters for the hedge fund industry. The industry as a whole saw net outflows of $14.3 billion and $19.9 billion in the first and second quarters of 2016, respectively. Outflows have varied by fund strategy, as multi-strategy funds saw net inflows of $11.2 billion for the first half of 2016.
Given the disappointment in both returns and fees, the pessimism and outflows by investors and insurers is not surprising. For example, the top three hedge fund subcategories chosen by insurers, which account for 80.1% of the insurance industry’s hedge fund holdings, have all seen a decline in their returns over the last few years. Additionally, their returns have been consistently outperformed. In light of this, just under half of the top 20 insurers investing in hedge funds, have reduced their hedge fund holdings from 2014 to 2015. It appears some of the outflow has remained in alternatives, whether through increased allocations to private equity or infrastructure exposures.
A.M. Best views modest allocations to hedge funds as it would many other traditional asset classes. Similar to any other asset class, there should not be significant concentrations, whether by a manager or an investment strategy. Most of the alternative asset risk is being borne by the higher-rated insurers that have the capital and expertise to better absorb the risk. A.M. Best remains committed to closely monitoring the rising trend in alternative investments and regularly reviews capital charges to ensure appropriate treatment of this asset class. A.M. Best recognizes that there is a place in the investment portfolio for hedge funds, but insurers in this asset class need to understand the volatility this investment may bring to quarterly performance.
To access a copy of this special report, please visit http://www3.ambest.com/bestweek/purchase.asp?record_code=255634.
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