Performance Measurement and Insurance Liabilities

Abstract

In this article, we develop an attribution framework for the evaluation of investment performance of institutional investors, such as insurance companies. The model is very useful in identifying the investment skills of insurance companies. This is accomplished by developing a dual benchmark for the investor. The dual benchmark is focused towards the two objectives of the investor, namely the maximization of shareholder value and the protection of the value of the policyholders. For each objective, we develop a different benchmark. As a result, our model finds a balance between these two objectives, and reduces agency costs.

The benchmark implies a distinction between "surplus-driven" assets and "liability-driven" assets. Based on this distinction, there are four different sources of investment performance. We applied our model for the evaluation of the performance of a funeral insurance company. The outcomes for this funeral insurance company yields some interesting results. Although the liability-driven benchmark implies a conservative portfolio with cash matched assets, the present value of the liabilities based on market interest rates requires only a modest allocation to bonds and as a result, a potentially large allocation of the portfolio to stocks. Investing according to this benchmark would have improved the shareholder return considerably, without endangering the future payout to the policyholders.

JEL Classification: G22, G11, G14