Owning the Risk: Investing in Assets that Shift Liability
What Are Risk Assets in Insurance?
A risk asset refers to an investment that has potential for significant price swings and losses. In insurance, companies invest premium funds from policyholders into various assets. Some of these assets carry more risk than others. Risk assets tend to provide higher returns over long periods to compensate for the extra risk.
Common risk assets in insurance investment portfolios include:
- Stocks
- High-yield bonds
- Real estate
- Derivatives such as options and futures
- Mortgage-backed securities
Why Insurers Invest in Risk Assets
Insurance companies collect premiums upfront and pay claims later. This allows them to invest the premiums to generate investment income. Insurers aim for a balanced investment mix with an appropriate risk-return profile. Risk assets offer higher long-term returns so insurers allocate a reasonable portion of their portfolio into them. However, these assets can experience short-term price volatility. Insurers account for this by holding enough secure assets to satisfy near-term obligations.
Managing Risk Asset Exposures
Insurers use asset diversification and rebalancing to manage risk asset risks. By investing in a variety of assets, the impact of underperformance in any single asset is reduced. Also, insurers rebalance portfolios periodically by buying assets that have dropped and trimming outperformers. Monitoring economic trends is also key for risk assets.
For example, during periods of expected rising interest rates, insurers may shift from longer-duration to shorter-duration bonds to mitigate rate impacts.
Regulations on Risk Asset Investing
Insurance regulators impose capital and asset allocation rules on companies to protect policyholders. For instance, insurers must hold enough capital buffers to cover potential investment losses. Also, companies cannot allocate more than specified amounts into stocks, real estate, and other riskier asset classes. These guardrails help ensure insurers maintain adequate assets to pay out future claims even during times of financial market distress. Policyholders can take comfort knowing insurers invest premiums prudently within defined regulatory guidelines.
In summary, risk assets like stocks and real estate allow insurers to pursue returns while balancing risks using diversification, rebalancing, economic analysis, and following prudent regulations.
This sophisticated approach to investing premiums is integral to insurers providing financial safety nets to consumers and businesses relying on their insurance coverage.