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Insurance Asset Managers Attack the Target-Operating-Model Opportunity

July 16, 2014 By Gary Shub , Simon Bartletta , Brent Beardsley , Hélène Donnadieu , Renaud Fages , Craig Hapelt , Benoît Macé , Andy Maguire , and Tjun Tang

Insurance company asset managers oversee the world’s second-largest asset pool, as they steer their parent companies’ general accounts. Despite this financial heft, few of them can boast leading operating models. They have, consequently, left on the table substantial benefits related to business upside, risk, and efficiency.

Intense and persistent cost-cutting pressure is among the chief obstacles inherited from their corporate parents. Needed resources are perpetually shoved to the back burner. Capability development is undermined. In operations and IT, managers face a cost squeeze that makes it difficult to address critical concerns.

Now a few leading insurers are stepping back to revamp their asset-management units and redesign their operating models. They are doing this, in part, to provide support for the core front-office business, including the flexibility to manage new products and tools to help investment professionals perform. Furthermore, they aim to achieve better management of both operational and investment risk. Also, these efforts promote greater cost-effectiveness.

Insurance company assets compose nearly 20 percent of the global total. Insurers’ total AuM reached $13 trillion in 2013. Yet their AuM growth of 7 percent in 2013 was far lower than the overall average 13 percent increase in AuM.

There are several reasons for insurers’ slower asset growth. First, most insurers have been affected by slower-growing inflows from the liability-producing insurance side, driving net outflows of 0.5 percent, relative to total market net inflows of 1.6 percent. Second, because insurance companies typically hold a large proportion of fixed-income assets in their portfolios, they did not benefit as much from the global surge in equity markets. Last, their exposure to high-growth specialties was similarly limited. Insurers must decide which of the following hurdles they need to overcome.

Insurers have lagged behind their asset-management peers in operations and IT capabilities. In the past two years, insurers  have reduced operations and IT spending by 4 percent per unit of AuM. In contrast, the broader asset-management industry has increased that spending by 3 percent—despite beginning at a higher overall cost position. Furthermore, many insurers have applied simple across-the-board cost reductions rather than pursuing a well-conceived target operating model.

Organizational impediments have created or sustained asset management inefficiencies. These include regional fragmentation—an artifact of historical organization ties to the insurance company’s sources of cash and liability. The asset managers of most insurers operate in regional silos as well as asset class silos, exacerbating fragmentation and complexity.

Structural and role impediments abound. Low transfer pricing, for example, caused by the historically strong political pull of the insurance units, has skewed asset management economics and allowed lower investment levels in managers’ capabilities. This bias can lead to a penny-wise-and-pound-foolish approach to investing in front-office resources and capabilities and to supporting talent, operations, and IT. For instance, independent asset managers typically spend more to research an investment than does the insurance company that bears the direct benefit or burden of the investment’s outcome.

Insurers struggle to manage new complexity created in expanding their third-party offerings. While insurers’ asset managers have not historically focused on profitability and growth, they are tempted by the high returns on equity of third-party management. Some managers have built this business to more than a third of their activity and, in doing so, have invested and grown stronger commercially. As a result, they have achieved higher revenue margins and profits—averaging 25 basis points of revenues and 39 percent profitability, compared with 12 basis points and 26 percent, respectively, for mostly captive managers that focus predominantly on the insurer’s general account.

But achieving third-party growth generates new challenges, including greater operational complexity, for insurers’ asset managers. So far, they lag behind independent asset managers in operational efficiency. For instance, they have a significantly lower proportion of straight-through processes for both fixed-income and equity products.

Leading managers are actively working to create target operating models that address these challenges. They have moved beyond mechanical cost cutting to focus on creating differentiators, which range from organizational, process, and technology changes to commercialization in order to build scale.

The good news for these forward thinkers is that there is much to gain in efficiency and effectiveness, including higher investment returns and enhanced revenue streams, from the growth of third-party asset management.

Insurance Asset Managers Attack the Target-Operating-Model Opportunity
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