Insurance companies take in huge amounts of money from policyholders. Part of the purpose of an insurance company is to invest the massive amount of policyholder funds.
Much of the money is invested in bonds or fixed income, some can be invested in stocks or equities, and portions can be invested in real estate, hedge funds, venture capital, etc.
The point is that through investing an insurance company is exposed to the ups and downs of the capital markets, and as we have seen over the past several years, these ups and downs can be extreme.
A volatile investment portfolio can be problematic for an insurance company because it may impact solvency requirements imposed by regulators. Volatility may also be an issue because the insurance company has commitments (claims or payouts) that need to be met within very specific time-frames.
Most insurance companies will develop hedging programs that help insure that they are able to maintain a somewhat orderly portfolio and meet their commitments in a timely manner.
Hedging, however, is expensive because it requires the development and purchase of derivative programs. In a sense, hedging involves the insurance company buying insurance.
Not all hedging programs are created equal. This was clearly evident during the recent financial crisis. While it is clearly unreasonable to assume that any consumer should have a grasp of the hedging strategies used by various insurances companies, it is certainly a reasonable data point and a question that can be presented to a financial advisor.
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