Investment officers in insurance companies have been urged to increase exposure to equities to deliver better returns for shareholders.

Russell Investments Director Risk Advisory Tom Gillespie says insurers currently have about 3% of their portfolios in equities and the rest in cash and fixed income investments.

“In a simple world, insurers could aggregate their risk to include about 20% of the portfolio in equities,” he told insuranceNEWS.com.au.

“One of the reasons why insurers’ equity holdings are so low is the strategy of using cash has been right for the past few years.”

Dr Gillespie says fixed interest returns have been running at about 6% compared to the negative return of equities in recent times.

But the cycle of good returns for cash is changing, with a fall in the running yield on short-dated fixed interest as the Reserve Bank eases monetary policy. 

There is also a rise in the market value of the bond book, but Dr Gillespie believes markets will move into positive territory.

“We are seeing the extreme downside tail of equities, and insurers should look at their locations,” he said. “They need to ignore the past four years’ returns and focus on the future four years’ returns for making allocation decisions.”

He says insurers have to be careful not to build volatility into the investment portfolio by using long equity positions.

“These positions in the investment portfolio can exacerbate this adverse exposure to volatility,” the report says.

“This is because sharemarket crises are often associated with downward spikes in prices, simultaneous with upward spikes in volatility.”

The report says implementing a strategy to deal with volatility can be challenging, and suggests investment officers look at managed futures that would involve global tactical asset allocation across a broad range of markets and regions using futures trading embodying a momentum bias.

“Importantly, this momentum bias leaves managed futures funds long on volatility, but with a return premium rather than a return discount,” the report said.

“It is more important than ever to identify the conduits via which global market volatility is impacting the insurance business; and more important than ever to ‘squeeze the lemon’ in search of enhanced profitability.”