Investing in Private Markets: A Road Map for Insurance Companies

May 15, 2018

Updated October 25, 2021. 

In the late 1960s, it became clear, especially to American endowments, that investing in low-risk portfolios that were tilted toward fixed-income securities was a suboptimal strategy. Though this approach made it easy to set a fixed spending rate, real returns were so low that some endowments saw their corpora shrink. Since then, many endowments have perfected more sophisticated strategies that often rely upon private markets to outpace inflation and preserve capital.

The issues that confronted US endowments were not as problematic for insurers at the time; yield compression over the past 40 years allowed insurance companies to invest conservatively and still remain competitive. As many other investors have discovered, today’s market dynamics are forcing insurance companies to consider incorporating private markets to boost returns. While it may not be sensible for insurers to invest in alternative asset classes as heavily as endowments or sovereign wealth development funds, many portfolio managers are looking outside of traditional asset classes to find sufficient returns.

In addition to preferring the straightforward, low-cost nature of fixed-income investing, insurance companies historically avoided private markets, which they perceived to be inefficient. With few, if any, visible transactions, the difficulty of accessing data that were robust and trustworthy made it hard to judge and model—let alone implement—alternative investments and to capture the risk premia they offer. Today, however, there is a broader array of data available to model these asset classes.

These data are allowing more portfolio and risk managers to model investment duration, implement asset-liability management (ALM) techniques, and develop risk management tools. Beyond the challenges of modeling duration and risk characteristics, regulatory hurdles have affected how insurers view private markets. The incongruous patchwork of international rules, and the difficulties that some regulators have had promulgating new guidelines in a timely manner, have led some insurers to avoid  alternative asset classes altogether.

Our experience working with insurers leads us to conclude that with the right framework they can benefit from an increased allocation toward alternative investments. Although this paper serves only as a primer, we attempt to quantify these benefits. As a baseline, we reference a traditional insurance portfolio for a client we recently worked with (the “Client Portfolio“). The expected returns of that portfolio when shifting 10% of its existing assets into specific alternative investment strategies (the “Enhanced  Portfolio”) are higher than those for the Client Portfolio by 60 basis points (20%), with expected volatility lower by 20 basis points (nearly 5%).

Historical Allocations

Insurance companies have allocated significantly less toward alternative investments than have other institutional investors. Although investment preferences vary from country to country and across the insurance business lines, in general, private markets represent less than 10% of most companies’ portfolios. A considerable part of this allocation is often in direct real estate.