The financial crisis laid bare the challenges insurers face managing their investment portfolios during periods of market instability. Chief investment officers now want to know risk exposure immediately-not just in time for the next quarterly financial report. Insurance Networking News asked Courtland Gates, CEO of Boise, Idaho-based Clearwater Analytics, to describe how insurers can employ new tools to better manage financial risk.
INN: How important is financial risk management for insurers?
CG: Recently, we've watched enterprise risk management emerge as a primary concern. Insurers may view risk first from an underwriting perspective, but the need to monitor and account for risk at the enterprise level is gaining traction. Investment portfolios account for a significant percentage of the asset side of insurer balance sheets and are significant contributors to both performance and risk. Generating income and meeting liabilities as they come due are matters of survival for any business. Put simply, insurers cannot pursue an ERM strategy without addressing financial risk management.
We see significant interest among Chief Investment Officers in tools that help them monitor compliance, measure performance and understand the risks of their portfolios. Where there are multiple portfolios-let alone multiple asset classes, investment managers, and state deposits-aggregating the holdings, ensuring their accuracy, and extracting actionable information from them represents a significant effort operationally.
INN: How has the financial crisis altered portfolio management?
CG: The financial crisis has increased the importance of the portfolio management function within insurance companies. Before the sub-prime meltdown, the failure of Lehman, and the ensuing crisis, many insurers treated portfolio management as more of an operational function than an actual investment activity focused on opportunity and risk. Depending on the nature of their liabilities, insurance company portfolios cover a broad spectrum of asset classes. For example, insurers with heavy concentrations in long duration, mortgaged-backed securities were affected very differently than those with short duration portfolios. Independent of the type of exposure-duration, credit, sector, issuer, etc.-the need to quantify and explain it quickly has become critical.
The financial crisis, above all, has elevated the demand for greater investment portfolio transparency. Top of mind in the wake of the crisis are exposures to asset classes and issuers. Portfolio managers need to be able answer questions and make decisions based on accurate, current information. Ignorance is not bliss; particularly when investment results need to be reported up within the organization. The drivers of premium income and portfolio performance are complex and interrelated. Rising unemployment rates affect premiums collected and subsequent revenue. Declining interest rates affect returns on invested income. The anticipation of rising interest rates affects investment strategy. From an enterprise perspective, beyond premium revenue and portfolio exposure, risk assessment becomes even more complicated and can involve other interrelations. For example, a catastrophic event can affect both claims and portfolio risk. There is significant debate on the best way to address these correlations on an enterprise level, but there is consensus that transparency into the components is step number one.
INN: Can insurers solely leverage technology to improve risk management or is a new mindset necessary?
CG:I think a new mindset is needed and it involves a willingness to apply technology and outsourcing in order to optimize the use of internal resources. Historically, the industry as a whole may have been resistant to adopting new technologies, and our clients and prospects frequently cite the limitations of legacy systems as being among the key drivers towards adopting new solutions.
Insurers frequently use a combination of installed point solutions and spreadsheets that are not "integrated-by-design," requiring layers of middleware, custom coding, and manual intervention that add cost and complexity for the insurer and expose them to unnecessary risk. For the investment management function, we strongly advocate daily, integrated accounting, compliance, performance and risk reporting and analytics constructed on a foundation of aggregated and reconciled tax lots to monitor the investment portfolios, make informed decisions, and report to senior management.
Adopting new technologies, particularly software-as-a-service, places minimal operational strain on IT departments, which do not have to upgrade hardware or install regular software updates. Outsourcing portfolio reporting and analytics places the burden on a third-party vendor and allows insurers to deploy internal resources in a manner that plays to their core strengths.
