The word "unaffiliated investments" refers to financial assets that are not linked or associated with a specific company, institution, or entity in finance and investing. These investments are sometimes regarded as independent of the investor's direct ownership or control, and they are typically made through various financial instruments and vehicles that do not involve ownership holdings in individual companies. Unaffiliated investments provide various options, each with its own set of advantages and disadvantages for investors.

History of Unaffiliated Investments

Initially, insurance companies usually invested in traditional assets such as government bonds, which are known for their stable earnings. Due to low-interest rates following the financial crisis, this changed. To maximize earnings, insurers have expanded their investment horizons.

This shift prompted them to explore other investments, such as private equity and structured finance, and assets like residential mortgage-backed securities (RMBS).

Because these newer investments tend to be more complicated, many insurers increasingly seek advice from specialized investment management firms. This strategy is popular among smaller insurers with limited resources for portfolio management.

Unaffiliated Investments Explained

Insurance companies manage the money they make from their underwriting activities in various ways.

They set aside certain funds as a backup to cover any policyholder claims. They also pay brokers who bring in new customers and cover expenses such as payroll and other costs. They may even invest money into bonds and equities to make more money.

Insurance companies must have money on hand promptly to pay their debts. So, people usually invest their money in things that may be transformed into cash quickly, such as short-term investments. They also invest in things that may take longer to convert to cash but may yield a higher payoff.

How long an insurance company needs to be prepared for claims is determined by the type of policies they sell. Some last only a short time, while others last much longer. The money they keep for short-term requirements is similar to their current money, which is easy to spend, especially for short-term policies.

Types of Unaffiliated Investments

• Stocks and Bonds: Stocks are ownership shares in a company, whereas bonds are debt securities issued by governments, municipalities, and corporations. Unaffiliated stock and bond investments involve purchasing securities on the open market without gaining a major ownership share or developing an affiliation with the issuing companies. Investors can trade these securities on exchanges to benefit from price movements and revenue from dividends and interest payments.
• Mutual Funds: Mutual funds collect money from multiple investors to invest in a diversified portfolio of stocks, bonds, and other securities. Unaffiliated mutual fund investments allow investors to gain exposure to a wide range of assets without having direct ownership in any one company. The fund manager handles investment decisions, diversification, and professional management.
• Exchange-Traded Funds (ETFs): Like mutual funds, ETFs trade on stock exchanges like individual stocks. Unaffiliated investors can invest in ETFs to access many markets, sectors, or asset classes without directly owning the underlying assets.
• Real Estate Investment Trusts (REITs): REITs allow unaffiliated investors to invest in real estate without purchasing physical assets. These trusts pool funds to invest in income-generating real estate projects, offering dividends and capital appreciation.
• Commodities: Another type of unaffiliated investment is investing in commodities such as gold, silver, oil, and agricultural products. These assets are traded on commodity exchanges, allowing investors to speculate on price fluctuations without getting involved in the production or distribution of the products.
• Derivatives: Derivative products, such as options and futures, allow investors to put money on the price fluctuations of underlying assets such as stocks, bonds, or commodities in the future. These investments are unaffiliated because investors do not own the underlying assets but speculate on their price movements.

Important Factors to Consider

Insurance companies are required to report financial information to state insurance regulators regularly. These regulators look at liquidity ratios to see how quickly an insurer can meet its obligations to policyholders. They also assess if the insurer's investment plans and holdings could jeopardize its financial stability.

Unaffiliated investments are included in calculating the overall liquidity ratio, whereas affiliated investments are not. These investments, however, are not considered when determining the insurer's combined ratio. The combined ratio considers cash outflows such as losses, expenses, and dividends to estimate the cost of running their operations.

Benefits of Unaffiliated Investments

• Diversification: Unaffiliated investments help to diversify a portfolio by spreading exposure across different asset classes and markets, lowering risk.
• Liquidity: Many unaffiliated investment options, including stocks, bonds, and ETFs, are traded on active markets, allowing investors to purchase and sell their holdings quickly.
• Professional Management: Financial experts manage vehicles such as mutual funds and ETFs, saving investors time and effort in selecting and monitoring individual assets.
• Access to various markets: Unaffiliated investments provide investors access to markets and industries that would otherwise be difficult to enter directly.

The Bottom Line

Unaffiliated investments are vital in the insurance industry for diversifying portfolios and increasing returns. Insurance companies manage these investments carefully to ensure liquidity for covering liabilities. While regulatory scrutiny is present, these investments provide insurers with opportunities to improve financial stability and meet policyholder commitments.