Hired help: insurers are expected to embrace third-party asset management more fully. (Industry Strategies: Asset Management).

The current investment environment, arguably the most perilous in recent memory, poses serious challenges to insurers and their asset managers.

High quality fixed-income investments such as U.S. Treasury securities pay modest yields. The corporate bond market has grown dangerous, with record defaults and many fallen angels. Equity markets, clown sharply, remain uncertain. Stock return volatility is near record levels. The property/casualty insurance sector is suffering from global capacity constraints. Large losses in 2001 and three years of equity-market declines have moved the market from a position of excess capacity to one of severe capacity shortage. The life sector also is under stress, especially in Europe, where portfolio allocations to equities are typically much higher than in the United States. In many countries, guarantees that once seemed easy to fulfill now seem out of reach due to the low-yield environment.

In the face of this capital-market turbulence, many insurers are rethinking their investment strategies and turning to outside experts such as third-party asset managers for guidance.

Size of Asset Holdings

Fundamental to understanding the asset management market for insurers is knowledge of their investments. At year-end 2001, insurers worldwide held assets totaling approximately $11.5 trillion. Of these assets, life insurers held $9.4 trillion, or 82%. Nonlife companies held the remaining $2.1 trillion. U.S. insurers, who accounted for 38% of global insurance premiums in 2001, held a similar share (34%) of global insurance assets. Insurance asset holdings are concentrated geographically. The five largest markets-the United States, Japan, the United Kingdom, Germany and France--account for three--quarters of global assets.

In recent years, insurance assets have grown faster in Europe than in the United States and, because of the popularity of separate account products, faster in the life sector than in property/casualty. (See "Insurance Asset Growth Rates.") In addition to premium growth, a need for increased asset leverage--the ratio of assets to premiums--has contributed to asset growth among property/casualty companies. The growing importance of liability lines of business, an ongoing trend toward more litigation and high inflation for insured goods and services such as medical care all have created a need to build technical reserves and capital funds. Since 1985, asset leverage for nonlife insurers has increased in each of the four largest European markets at an average rate of 1.8% a year. In the United States, this growth has been even more rapid: 3.2% a year.

The Move to Outsourcing

Three-quarters of U.S. insurers out-sourced at least some of their assets in 2001, up from about half in 1988. Among the largest insurers, many of the third-party asset-management mandates are only a small percentage of the firm's overall assets. Thus, third-party managers currently oversee some $300 billion of general account investments for U.S. insurers, or about 10.8% of these assets. (See "U.S. Insurance Assets Outsourced.") The European third-party management market is less established, with about $140 billion of insurance assets. (See "European Insurance Assets Outsourced.")

Today's challenging investment environment, which has prompted insurers to review their approach to asset management, has supported further growth in the third-party asset-management market. During the difficult year of 2001, 22 of the 31 insurance third-party managers participating in an annual survey conducted by Insurance Finance & Investment reported increases in insurance assets. Several of these firms boosted insurance third-party assets under management by more than 40%.

In the current market, chief investment officers face competitive pressures to deliver solid returns, to maintain adequate diversification and to manage risk effectively. Juggling these concerns in the face of increased scrutiny of investment strategies by rating agencies and equity analysts, more varieties of securities and regulatory revisions, investment managers find it harder to keep up without outside help.

Because their market is competitive, insurance asset managers typically charge fees that are lower than those charged to other institutional investors. For fixed-income mandates of $100 million or more, reported fees averaged 20 basis points in 2001, less than the average pension-management fee of 26 basis points. Similarly, management fees for $100 million active equity mandates are around 30-35 basis points for insurers as opposed to 42 basis points for pension funds.

U.S., European Markets

The U.S. insurance third-party asset-management market is highly fragmented. Ten competitors each manage at least $10 billion of third-party insurance assets and another 11 each manage $5 billion to $10 billion of assets. The five largest competitors account for approximately 40% of the market. Deutsche Asset Management, which includes the acquired Zurich Scudder Investments unit, heads the list with $34.3 billion under management at year-end 2001, followed by BlackRock ($30.6 billion) and Conning Asset Management ($27.6 billion), (See "Leading Insurance Third-Party Asset Managers.")

Of the 21 leading insurance third-party asset-management firms, banks own seven, four are independent and insurers own only five. Thus, the third-party market, which serves insurers, has only five insurers--Allianz, Axa, General Reinsurance, Old Mutual and Swiss Re--among the largest 21 players. Investment banks, by contrast, are especially active in the business. Six of the largest (Goldman Sachs, Merrill Lynch, Morgan Stanley, Citigroup, Credit Suisse and Deutsche Bank) are among the largest third-party asset-management players.

In Europe, insurance asset managers must maintain a local presence. In some cases, this reflects legal requirements. Sometimes insurance clients demand it. The need for a local presence raises the cost of market entry, reducing competition. New entrants tend to focus exclusively on their home markets or to limit themselves to the largest markets, the scale of which justifies bearing the costs of entry. This in turn strengthens the competitive position of the major global European financial institutions that already have a foothold in many of the local markets.

Alternative Investments

Opacity high fees and regulations have historically limited insurers' allocations to alternative investments. Nonetheless, insurers in search of diversification and higher returns are increasingly looking to these asset classes. Since 1992, worldwide hedge fund assets have increased at a 21% compound annual growth rate to $537 billion at year-end 2001. Insurers constitute approximately one-tenth of institutional hedge-fund ownership, with their holdings totaling about $10 billion to $15 billion. A key advantage of hedge funds is their flexibility to pursue strategies that produce returns with low correlation to the overall stock market. Hedge fund returns averaged 4% over the past three years. By contrast, the S&P 500 and the Morgan Stanley Capital International World index each have registered double-digit negative returns.

Swiss Re estimates that European and American insurers also held private equity investments totaling $25 billion to $35 billion at the end of 2001.The private equity market now faces severe challenges, however, with 2001 returns a dismal -18.5% in the United States and -2.3% in Europe.

U.S. and European insurers now outsource some $440 billion of general account investments to third-party managers. The current challenging investment environment will pressure insurers to place new emphasis on their asset-management operations, leading to more manager turnover. Investment risk management, an area in which some insurance third-party managers excel, will become a higher priority for upper management. Insurers are predicted to increase their use of third-party asset managers by 10% a year in coming years. In this environment, superior asset managers will have the opportunity--and the need--to distinguish themselves and prove their worth to clients.

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Insurance Asset Growth Rates

Asset growth has been strongest in Europe and in the life sector.
Figures represent invested assets.

($ Billions)

                                             Nominal Growth
                                                 Rates,
                                             1992-2000, per
                                                  year
                   Total     Life    Nonlife
                  Assets   Assets     Assets
                    2001     2001       2001   Life Assets

North America
 United States    $3,947   $3,165       $782            8%
 Canada             $200     $174        $26            6%

Europe
 United Kingdom   $1,428    $1324       $104           14%
 Germany            $838     $505       $333            9%
 France             $783     S686        $96           16%
 Italy              $248     $197        $51           20%
 Netherlands        $231     $206        $25           10%
 Switzerland        $205     $154        $50            9%

Asia
 Japan            S1,635   $1,384       $251            2%

                   Nominal
                   Growth
                   Rates,
                 1992-2000,
                  per year

                  Nonlife
                   Assets

North America
 United States         4%
 Canada                5%

Europe
 United Kingdom        4%
 Germany              11%
 France                7%
 Italy                 7%
 Netherlands          10%
 Switzerland           8%

Asia
 Japan                 2%

Notes: The assets of health insurers are included in life assets in
North America, but in nonlife assets elsewhere. Growth rates are local
currency rates. Assets include those held in separate accounts. Japanese
data are as of fiscal year-end 2001 (March 31, 2002)

Source: Swiss Re Economic Research & Consulting.

European Insurance Assets Outsourced

The European third-party asset-management market is less established
than the U.S. market, with about $140 billion of insurance assets.

($ Billions)

                      Total           Estimated
                  Insurance         Third-Party
                Investments         Investments

France                 $784             $20-$40
Germany                $839             $25-$50
United Kingdom       $1,430             $20-$40

Total Europe         $4,502  approximately $140

Note: Total Insurance investment figures are preliminary estimates

Source: Comite Europeen des Assurances (CEA), Swiss Re estimates

David Laster is senior economist and Richard Sbaschnig is associate economist with Swiss Re Economic Research and Consulting. Swiss Re Sigma No.5/2002, "Third Party Asset Management for Insurers," on which this article is based, is available at www.swissre.com.