Investment Strategy of Captive Insurers – Are Risk Managers Becoming Investment Managers?

Abstract

Captive insurers have been largely perceived as risk financing vehicles, that among other things, generate a superior investment performance. That perception was advanced by promoters injecting tax advantages and a free investment atmosphere as key factors. Previous research has shown that captives, by and large, are rather conservative in terms of their underwriting exposure and insurance leverage posture. These findings invited a supposition that such conservatism would afford more risk taking in investments. While risk managers have been involved in operating captives for the last two decades, unanswered is the question of their involvement, if any, in investment decisions or investment management. Very little has been written on this subject and practically nothing on an empirical basis. A questionnaire approach was used to gather the data with which to answer the question of what is the risk manager's role in captive investment strategy and other related issues. A model of captive's investment strategy is presented in which the outputs - instruments, maturities and currencies – were a function of investment policy issues such as who sets the policy, the investment policy criteria; and investment management issues such as who manages the portfolio, who selects the manager, and manager's selection criteria. All inputs boiled down to four main components; “risk” versus “return” for investment criteria and “insiders” versus “outsiders” for the personnel who select or manage the investment portfolio. The key finding of the study was a general reaffirmation of captives' conservatism which apparently spilled over into their investments operations. Captives have pursued a generally short term investment strategy using primarily short term instruments mostly for short maturities. Equities and mutual funds were almost inexistant. Captives investment strategy is largely dominated by minimizing “risk” concerns rather than by maximizing issues of “return”. It also becomes evident that the most influential individuals in setting guidelines and/or managing portfolio are inside personnel. Risk managers appear to be quite influential in setting policy or selecting the investment manager but, the least likely candidates for actual management of the portfolio. Investment performance of captives, in the year of the survey, was compatible with the overall investment performance of the U.S. property and casualty industry. However it was largely below investment performance yardsticks applied to investment return in other industries.