Asset management costs are increasingly important—and a source of growing disagreement between insurers and asset managers. Historically, when portfolio yields exceeded 6%, those costs had negligible commercial impact. That is no longer the case. Under Solvency II, and with new-money yields dipping below 3% in the UK and below 2% in Germany and Switzerland, many insurers are still saddled with sales and administrative costs exceeding 100 basis points. Meanwhile, capital charges can easily add another 100 basis points, as new money is invested in ever-riskier assets. Suddenly, a cost differential of 20 to 40 basis points is no longer academic. This is especially pertinent for asset managers that have built a significant third-party business and now face increasing scrutiny from regulators and nonexecutive directors alike.
Simply arguing over fee levels, however, adds little shareholder value and is unlikely to lead to a resolution or to change the underlying economics. Instead, insurers and their in-house asset managers should cooperate closely to identify the solutions that will allow them to prosper jointly. They should consider, for example, the following questions:
- Where can the asset manager add value that would exceed any provided by a third-party manager or by employing a passive strategy? This overarching question must be addressed rigorously, so that the insurer and the manager can reach an explicit, shared view.
- How can the asset manager help differentiate the life insurer’s products? As insurers focus on the next generation of products, internal asset managers can help build a differentiated customer proposition—for example, by supporting “segment of one” products, transparency on fees, robo-advice, or client access to differentiated investment strategies.
- How should insurers prioritize their asset classes? In which asset classes does the insurer already have a clear edge or have the ability to develop one? In which is the manager certain to be able to perform at least at market level in terms of costs and returns over the next ten years?
- Should operations be in-house or outsourced? Which parts of the insurer’s asset management value chain should be kept in-house, and which (such as commodity operations) should be outsourced? Which activities could be discontinued as a result of digitization? It is worth noting that the highest-margin asset management businesses are often the most selective about which functions they retain in-house.
- How can insurers optimize and align asset managers’ incentives? What are the right performance incentives for an asset manager? Do those incentives align with the respective insurer’s strategy and business model? For example, is the manager truly motivated to control costs if it is compensated on a cost-plus basis? Asset managers’ costs are a key underlying value driver for policyholders and shareholders alike. Insurers and managers should therefore approach the topic strategically and jointly.
Captive asset management can be rewarding for all parties. Benefits for the insurer include the ability to define and execute long-term strategies, to create business transparency at the base fund level, and to build its retail business on in-house capabilities. Benefits for the asset manager include access to attractive funds—such as those of endowments, pension funds, and smaller insurers—and investment opportunities, all under the brand of the life insurer. Captive management also allows the insurer to commit funds to long-term investments (such as in private equity, senior debt, and private placements) and to bring scale to product innovation.