Insurance: Insurers can now invest in Fund of Funds

By Nirjhar Majumdar

The Insurance Regulatory and Development Authority of India (Irdai) has allowed insurers to invest a portion of their investable funds in “Fund of Funds” (FoF). FoF is a pooled Fund which makes investments in other funds falling under Alternative Investment Funds (AIF) into which the insurers are already authorised to invest some specified portion of their investable fund. By investing in FoF, the insurers can diversify their investments to the extent it is safe and profitable.

Investments made by life insurers and pension funds can help in the growth of our real economy. Insurers are considered to be in a better position to invest in AIFs like FoFs. It is beneficial also for insurers and pension funds to achieve desirable asset liability matching by investing funds in areas which need long-term financing.

Investments in AIFs
Mature markets of the world have proved that direct long-term investments in AIFs have been able to diversify risks and increase total returns. For this reason, long-term savings oriented life insurance products and annuities are most favoured products in those countries. In Taiwan, the country with highest insurance penetration, about 80% of insurance products sold are whole life products, because people get handsome returns from these products. The focus everywhere is shifting from de-risking of investments to re-risking, since risk-free investments is fetching lower and lower returns as interest rates continue to plummet.

Recently, domestic private retirement funds were allowed to invest up to 5% of their investable funds in AIFs. The recognised provident funds have also been allowed to invest in domestic venture capital, SME funds and infrastructure focused AIFs. Annual premium income of the insurers pooled together exceeds the total capital available in the entire AIF space of the country. So, even a small portion of this fund can transform the AIFs.

Portfolio construction
Claims under life insurance policies can be estimated with a significant level of accuracy. This enables the insurers to invest in less liquid assets (like FoF) quite confidently, fetching better returns and getting cash inflow that can match fairly well with cash outflows. This policy can immunise an insurer’s value against possible interest rate changes. Insurers everywhere are making fundamental changes in their portfolio construction, to achieve a better risk adjusted return. Irdai’s recent policy can enable insurers to compete better in the financial market and contribute more for further economic growth.

Insurers and annuity fund managers need to make investments in areas which are less correlated to the traditional approved investments. Since FoF invests money in a wide spectrum of industries, they are likely to earn higher than average returns. Large insurance companies and pension funds can invest in FoF to invigorate the startup ecosystem. This will not be a bad investment as startups had been growing at 12-15% annually even up to 2019. The Covid pandemic has dampened the spirit of the startups to some extent but they can be back on their feet again if long-term financial support is available.

Insurers investing in riskier instruments should follow sound underwriting principles to reduce total risks. Persistency of insurers has to improve significantly so that more money can remain invested for a longer term. Insurers need to have a fair amount of knowledge of the projects where their money is being invested. They need high quality data to ascertain the long term viability of these projects.

Product innovations may be required to ensure that surrendering of certain types of policies in the near or short term is not allowed or allowed with heavier penalties. Further, tax reliefs can be granted to those investing money in very long-term policies (25 years and more). If such measures are taken, there is no reason why the latest initiatives of the government and Irdai to allow insurers and annuity fund managers to invest money in FoF cannot be a game-changer for the industry.

The writer is assistant secretary, Kolkata Audit Centre, LIC of India. Views expressed are personal