Outsourcing Asset Management is Hurting the Insurance Industry

In general, I think insurance companies with more than $100 million in assets should have their own investment departments, and not outsource the management of assets. (Note: to any insurance CEOs reading this — would you like a chief investment officer with experience in all major fixed income classes, equity, and derivatives, and a knowledge of the actuarial side of investing as well? E-mail me, and we can talk.)

I only know one insurance asset outsourcing larger than this, but Safeco (SAFC) has outsourced their asset management to BlackRock (BLK). I think that it is a mistake for the following reasons:

Insurance companies excel at creating tailored liabilities, taking individual risks away, and pooling them. The same should be done with assets. Anyone can hire BlackRock (a very good firm), but an intelligent management will take the time and effort to develop in-house expertise, which is usually cheaper than most third-party solutions. It gives up what should be a profit center for the enterprise as a whole.

Third-party arrangements miss what I call, “The Bottom Left Hand Drawer” issues. I worked in insurance for 17 years, and I grew to love the competent, but uncelebrated people in the company that did excellent work, but who management thought were expendable. Third-party relationships lack the freedom for customization that in-house management allows for. Often because accounting systems don’t get it quite right, human intervention is needed. Someone makes an adjustment off of a schedule that they keep in their bottom left hand drawer once a year, and that keeps the system running right. In a third party solution, those issues can get lost; I have personally seen it fail.

Penny wise, pound foolish. The explicit expense savings are easy to see, but the implicit losses from not having someone managing the investments that is totally on your side is hard to measure. Though I can’t prove it, the soft costs are large.

If I served an insurance company again as an asset manager, I would want to serve that company only, and not run a third-party asset management shop. The work of an insurance company is important enough that it deserves the undivided attention of professionals on staff.

Comments

[Mrityunjay ...:]

Considering today's challenges for the insurance companies, I think it would be pretty archaic to not outsource their IM operations. It would have been and was natural to do it inhouse but with increasing life expectancy and increase in natural catastrophes, insurance companies have no choice but to logically outsource operations and investments to those who excel at it and focus on increasing the size of their business.

2007 Dec 04 11:55 AM

[Mr Smith:]

David is right on the money. I currently work for Safeco, and it is a company in the grips of outsourcing mania. The asset management department is just one example, albeit one of the more obviously bad choices. People with specialized "Bottom Left Drawer" knowledge are grossly undervalued here, and implicit costs are gleefully ignored by the current management team.

2008 Mar 31 09:08 PM