Insurance companies receive premiums from policyholders and invest the funds to generate returns for paying out future claims. The investment strategies of insurance companies are shaped by their business models and risk profiles. This article will examine some core investment strategies commonly adopted by insurance companies using real-world examples. Key factors that influence insurance companies’ investment decisions include investment horizons, liquidity needs, and risk tolerance levels. Understanding the investment principles of insurance companies can provide insights into their asset allocation and risk management practices.
Investment objectives reflect business models and liabilities
Life insurance companies often have long-term liabilities and investment horizons, allowing them to invest in riskier and less liquid assets like stocks, real estate, and alternative investments to pursue higher returns. For example, TIAA, a leading retirement and life insurance provider, invests heavily in real estate, private equity, and other alternative investments to match its long-duration liabilities. In contrast, property and casualty insurers like Progressive and Geico have shorter-term claims payment obligations, so they favor liquid and lower-risk fixed income securities to ensure they can readily access funds.
Diversification across assets reduces portfolio risk
Insurance companies construct diversified multi-asset portfolios to reduce risk. For instance, USAA, which offers insurance and investment products to military families, invests in a mix of stocks (45%), bonds (40%), real estate (5%), and alternatives (10%). The diversified allocation limits concentration risk and volatility compared to investing solely in equities. Research shows diversification benefits are particularly valuable during market downturns as correlations between assets converge.
Immunization strategies match asset and liability durations
Many insurers adopt immunization strategies by matching the durations of assets and liabilities to minimize interest rate risk. For example, Northwestern Mutual constructs bond portfolios with durations approximating its long-term liability contracts. If interest rates rise, the decline in bond prices will be offset by lower liability valuations. This immunization approach helps Northwestern Mutual meet its return assumptions regardless of rate movements.
Laddering bonds provides steady liquidity and reinvestment
Insurers generate dependable cash flows to pay claims by laddering portfolios of bonds with staggered maturities. Principal Financial, for instance, ladders corporate and government bonds so securities are continuously maturing. This provides recurring liquidity for claims while allowing reinvestment at new market rates. Bond laddering smooths returns and limits reinvestment risk from interest rate changes.
Mortgage-backed securities offer attractive yields
Many insurers allocate a portion of their fixed income portfolio to mortgage-backed securities (MBS) for their relatively high yields. For example, New York Life, a leading mutual life insurance company, invests significantly in agency and private-label MBS alongside corporate bonds and municipals. The prepayment risk of MBS is modest in their diversified portfolio context while adding yield over government bonds.
Insurance companies utilize core investment strategies like diversification, immunization, bond laddering, and mortgage-backed securities to meet their business objectives and risk preferences. Their long-term investment horizons and liabilities shape overall asset allocation policies. Understanding these investment principles provides insights into insurers’ risk management and return generation practices.