Why a Safe Bond Portfolio Can Leave an Insurer Unable to Insure the Future
The investment chief links higher returns to how much new risk an insurer can take on.
Invest Like the Best with Patrick O'Shaughnessy · Investing a $120 Billion Balance Sheet with No Outside InvestorsThe chief investment officer of Liberty Mutual Investments, which oversees the roughly $120 billion balance sheet of Liberty Mutual Group, was asked why not put the whole portfolio in bonds and go away. His answer was that a bond-only balance sheet could not adopt new technologies or adapt as risks evolve.
He said a balance sheet must be, in his words, "able to adapt to the evolution of the economy." The risks insurers covered a generation ago look very different from today, and they will be different again tomorrow.
He builds that strength from two main sources of profit. One is underwriting, the business of pricing and selecting insurance policies, which he describes as operating on thin margins. On the asset side, the choice is between settling for a 4 percent or 5 percent investment grade bond versus trying to earn 7, 8, 9, or 10 percent on the total portfolio. An investment grade bond is a loan to a highly creditworthy borrower. That choice is, in his words, "all the difference in the world."
He points to data centers as, in his words, "a totally different scale of the asset and values" than what existed before. He says insurance balance sheets "aren't large enough to just absorb that," which is why outside capital is coming in through other forms of third-party funding.
That is why he talks about building what he calls a "fortress balance sheet" that is able to do things others will not. The amount of capital an insurer has, he says, dictates the opportunities available to it, both in the policies it can write and the investments it can make. Higher investment returns, he argues, help build that capital, which in turn shapes the opportunities available.
Questions people ask
What is an investment grade bond?
An investment grade bond is a loan to a company or government deemed highly likely to repay. It pays modest, steady interest, currently around 4 to 5 percent, and is considered one of the safest investments, but it offers little growth beyond that coupon.
Why are data centers too big for insurers to handle alone?
A single modern data center campus can cost several billion dollars to build and equip, and insurers must be able to pay if it burns, fails, or is interrupted. Because the potential loss is so concentrated in one place, even a $120 billion insurer cannot comfortably hold all of that risk and shares it with other investors.
What does underwriting mean, and why is it thin margin?
Underwriting is the business of deciding which risks to insure, at what price, and on what terms. After paying claims and expenses, insurers often keep only a few cents on each dollar of premium, which is why investing those premiums well matters so much.