This piece is by Joseph Cordahi, Product Strategy Director, Front-to-Back Portfolio Management Systems, NeoXam. As insurance and insurtech start-ups rethink their funding strategy now that the era of cheap money seems over, it’s worth considering how insurers invest in assets, spread the risk and make
Over the last few years, there has been a limited, but increasingly growing tendency, for European insurance firms to dip their toes into more alternative asset classes. Indeed, many private-equity firms are invested by institutional investors. Large asset managers view these insurance whales as huge catches – and are using these new investment vehicles as the bait.
Historically, private equity in particular has carried with it a very high capital charge under Solvency II regulations, which govern the amount of capital insurers need to have on hand at any given time. This has served to put insurers off of investing in the asset class during periods where the overall returns in private equity are not sufficiently superior to those being secured across more vanilla asset classes. So, what is the appeal in shifting towards private equity now? Well, for a start, proposed amendments to the Solvency II regulations, both in the UK and in the EU, are geared towards encouraging more investment in alternative asset classes – especially in the UK.
Insurers will undoubtedly be mindful that the overall risk levels are going to be higher for private market funds in the years to come, due to the global economic downturn and continuing market instability.
The danger for insurers when pulling the trigger on private funds is that they can’t simply pull out of these positions with a snap of their fingers – these funds are normally gated for a set period of time. Insurers must always be focused primarily on risk management – this can’t and wouldn’t be compromised in a search for larger returns.
The key to this is for insurers to have a clear understanding of their current holdings, which requires absolute transparency into the underlying assets contained within these private funds. Their requirements from an operational standpoint could be very different from where they stood, say, a decade ago, based on the different asset classes and financial instruments that they are using. The amount of data that insurers consume in 2023 is vast, and when you throw in the very different makeup of private market assets, legacy technology or Excel spreadsheets simply won’t cut it anymore.
The doorway to absolute clarity into the live makeup of a portfolio hinges on availability and visibility of information. The ability to harmonise this information is vital, as the data being consumed is very different to what you’d get in vanilla asset classes. Having access to clean, integrated data is essential to help insurers avoid any unexpected liquidity or NAV (Net Asset Value) issues, which are more common across private funds as the valuations are significantly sparser than in public funds.
Simply put, insurers must be able to evaluate all their assets, private market ones included, in a centralised place in order to aggregate both risk and performance. Only then can they ensure that private funds can be incorporated safely into their investing strategies.