Hedge funds remain an option for some insurers, says new report

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The life/annuity and property/casualty insurance segments increased their exposures to hedge funds in 2020, leading to an overall 6 per cent increase in insurance industry investments, according to the latest AM Best report.

The new Best’s Special Report, “Hedge Funds Remain an Option for Some Insurers,” notes that during 2020 the hedge fund market did not fall as far as the public markets and recovered more quickly and efficiently. Several qualities made hedge funds attractive to investors during the pandemic, including risk diversification and a low correlation to other asset classes. The hedge fund industry still lost approximately USD44.5 billion in asset flows in 2020, according to the report, but that is nearly half the amount pulled out in 2019. Asset flows were positive under multi-strategy, with an addition of USD9.5 billion, and a USD2.9 billion increase in equity strategy allocations—the two strategies most popular among insurers. Although the number of insurers’ hedge fund holdings continued to decline in 2020, the book-adjusted/carrying value (BACV) increased for the first time since 2015, to USD12.3 billion in 2020 from USD11.6 billion in 2019.

The life/annuity segment raised its dollar exposure in hedge funds 5.8 per cent, to USD5.4 billion, and the property/casualty segment, 5.5 per cent, to USD6.6 billion. However, the health segment continued to pull back on its modest concentration in these investments, leaving with approximately USD320 million in holdings, compared with USD490 million in 2019.

Twenty rating units accounted for 87.7 per cent of the industry’s hedge fund exposure in terms of BACV.

A majority of those rating units have expanded their holdings since 2019, while seven have continued to pull back. Nevertheless, investments in hedge funds are not that prevalent in the insurance industry as a whole—fewer than 80 US rating units have hedge fund investments.

Just over 95 per cent of the rating units that invest in hedge funds have either an A-level Best’s financial strength rating with the superior (60.6 per cent) or excellent (34.5 per cent) rating descriptor. The remainder fall in the lower-rated categories. Higher-rated companies are better equipped to manage the elevated risk inherent in hedge fund investments and have substantial capital and expertise to manage the risk. Moreover, the hedge fund holdings are significantly concentrated in large organisations, with 86.5 per cent of these rating units having over USD2 billion in capital and surplus.

The lingering effects of the pandemic and ongoing market uncertainty in 2021 will determine if the hedge fund market will continue to see renewed interest and greater exposures or revert to being viewed more unfavourably relative to other asset classes.