Making cash work - optimising investment performance

For insurance organisations investment return is an important component of overall profitability. However few of these organisations would claim that their investment performance is well-managed and optimised to achieve maximum value. Why should this be the case? I share some of my experiences in this article.

Obscure metrics and performance

To simplify reporting, some insurance management teams present investment performance as a percentage of investment returns over total invested assets, often at their Boards’ request. (In one more extreme example I have seen this metric containing assets supporting unit-linked liabilities!) This approach may work well for simple organisations operating in the same or similar geographies with similar products but becomes problematic in more complex set ups, with multiple geographies, regulators and products. (A couple of months ago I wrote about performance indicators, you can read the article here https://www.dhirubhai.net/pulse/driving-performance-alvinos-micromatis-lk80e/?trackingId=VwExAK3hQpuX9s%2BzxFQuFw%3D%3D)

In such insurance organisations the investment objectives differ depending on the product or entity being supported. For example, the investment strategy supporting a life/savings product with guaranteed returns will be different to the investment strategy supporting the solvency margin of a subsidiary. The product’s or entity’s currency denomination will also affect the currency strategy for the investments as will other factors such as regulatory requirements. It is therefore important to segment investments appropriately, adopting different strategies and metrics to each segment.

Not part of core strategy

In my career I encountered management teams with deep industry expertise, focussed on what they do best, be it underwriting, broking, business development and others, their expertise developed over several years in the industry. But what happens in executive committees and Boards full of such experts when looking to manage a business and its balance sheet holistically? With the exception of life insurance businesses, for many other insurance organisations investment return is not part of the core customer proposition and hence not part of the core business model. As a result, the Boards and management teams are not always focussed on optimising and maximising investment returns and the required corporate investment expertise is not always present in the Boardroom. Here is where a good CFO can build awareness and bring the holistic capital and balance sheet management disciplines which allow not only for the efficiency of working capital and investments, but also for the effective and optimal capital deployment and distribution.

Risk comes from not knowing what you are doing

Investments is an area where many (Board and management team members) may present themselves as being experts. You may think that this is a small/medium organisation issue. However I have encountered this also in large organisations. When it came to investments, very often risk appetite and ‘beliefs’ were unclear and less appropriate comparisons were being drawn between individuals’ personal investment portfolios and those of the organisation. The absence of clarity often led to over-monitoring of investments and cumbersome approval processes which made investment execution more difficult than necessary. As a result opportunities were lost, cash was not quickly invested and investment performance was less than optimal.

Under-resourced/skilled investment function

With everyone trying to be an expert, the need to invest in the investment function is not always obvious. As a result, investment management teams are often under-resourced and under-skilled which results in lost opportunities.

I came across such an issue a few times and in the beginning this was not immediately obvious to me. Later in my career and having engaged with several investment professionals over the years I realised the importance of making sure the department is appropriately skilled and resourced. On every occasion that I invested in such a team the result was a huge success for the business.

Is cash really king? Liquidity (in)sensitivity

The insurance industry is known for the relatively high level of trade receivables balances (and endless reconciliations of transactions). Sometimes this is due to the business model/product, but often this is due to business practices, where generous credit terms are issued to clients and distribution partners. The prolonged low-interest rate environment which prevailed for so many years prior to the relatively steep increases in interest rates may have contributed to this behaviour. Many insurance organisations have introduced increased disciplines over the collection of debt and the credit terms issued, however this remains an area of opportunity for many more.

Increasing collections increases the assets available for investment and, if quick action is taken to invest these assets appropriately, results in additional investment revenue. This benefit is in addition to the direct benefits of collection of old debt which may result in reduced provisions for bad/doubtful debt.

Too much cash held locally

Whilst it is obvious that no organisation wants to run out of cash, keeping too much cash is almost equally bad as not having enough, as investment returns are not maximised. What I have encountered is organisations applying the same risk appetite at a local subsidiary level as at the group/holding company level when it comes to the risk of illiquidity. (This was often the result of the absence of a clear policy on liquidity.) This approach has meant that, whilst at the top of the group liquidity was well-managed, for the group as a whole too much cash was being held.

Taking action

So how does the Board or CEO/CFO begin to make a difference and use investment return as a means to increase value?

Here’s 5 starters:

• Assess and invest in the investment management team. More often than not, the investment will pay for itself (often multiple times). The cost/revenue analysis makes the business case obvious.
• Review and consider changes to the credit policies. The more cash collected, the more can be invested. The difference this has made has been remarkable, with occasions of reduction in receivables balances of around 30% over 1-2 years.
• Assess and/or put in place a liquidity policy for working capital in subsidiaries/local businesses. To achieve consensus this will require a robust process which also allows for a local subsidiary/business to receive liquidity at short notice in case of need.
• Revisit the investment performance indicators. Review the investment portfolio objectives and apply different performance indicators for its component parts. Consider governance and approval processes in the context of the different investment strategies.
• Confirm and clarify risk appetite and beliefs. Individual risk appetite and beliefs vary therefore it is important to agree and document these across the different portfolios in sufficient detail and clarity. This will empower the investment function of the organisation to seek the best possible opportunities without the ‘red tape’.

Finally, it is important that cash is invested as early in the financial year as possible for the organisation to maximise the benefit from such investment. Taking action now will secure, to a certain extent, a certain amount of revenue for the year which will no doubt assist in meeting whatever targets are set for the organisation.

If you are on a Board or in senior management or in investment management, I hope some of the above resonates with you and that you have found this helpful. I would love to hear your comments and discuss how this applies to your organisation.