Portfolio Insurance: First Impressions

Abstract

Insurance in general serves as a means of pooling and transferring risk among the economic agents within a society. The more participants there are available, the greater becomes the possibilities of dissipating individual risk. By virtue of both individual and aggregate wealth, the insurance industry especially in developed countries like the United States and United Kingdom, is extremely large. The concept of portfolio insurance has only become more well known in the last decade (Luskin, [1988]). Despite its name, portfolio insurance is not the creation of the insurance industry so commonly known to us. The parallels between the two are limited. Portfolios in need of portfolio insurance are highly correlated to be insured through risk pooling like automobile and life insurance. Also, until recently, there existed no financial instruments with adequate liquidity and volume necessary for successful implementation of portfolio insurance. Chapter two will give us a better understanding of what portfolio insurance is. The portfolio insurance strategy has been a very fast growing investment strategy in recent years. After the decline of the stock market in 1973-74 due to a world recession, many pension funds retreated from the stock market. Stock market activity at that point was down. Portfolio Insurance would definitely appeal to these fund managers and lure them back into the stock market, increasing market activity. Portfolio insurance should not only appeal to pension or endowment funds which must at all cost maintain a minimum value but thereafter can afford to accept reasonable risks. Institutional investors whose funds they control are expected to return above average returns (through superior stock selection) but at the same time want to keep risk within a manageable level, should be interested in portfolio insurance too.