Of no fixed abode - PART II:The hunt for yield

This previously uncharted economic background is a toxic dynamic for insurers. This previously uncharted economic background is a toxic dynamic for insurers. The need to match assets and liabilities, coupled with the advantages bestowed by the vagaries of regulatory capital, have made the industry firm adherents to the cult of fixed income during the past few decades. But today, what was once a comforting contractual bulwark against uncertainty has become a crushing burden. Low yields exacerbate and arguably exaggerate liabilities. They also make it harder for assets to generate the cashflows needed to meet liabilities as well as generate shareholder returns. A survey at the March event found that four out of five insurers saw increasing yields, finding new fixed income. The last Insurance Investment Exchange event on 03 March 2015 tackled a key dilemma for insurance companies: in today’s environment of challenged yields and regulatory change, where does the fixed income portfolio evolve to next? This opinion piece echoes the ensuing debate at the event, mixed in with our own analysis of macro and industry dynamics. The Insurance Investment Exchange is the leading global forum for insurers to debate macro and investment issues, with more than 500 members. Of No Fixed Abode Bob Swarup and David Worsfold 3 substitutes and minimising regulatory drag as their key challenges in fixed income. Value and quality have demerged in today’s world. The result is a continual pressure to find higher yields and new sources of cashflow, as the old staples prove inadequate to the challenge. However, as money has poured into new areas, the spreads have often tightened, thanks to the limited capacity of these nascent areas, increasing risks. At the same time, new risks are also being taken on that are less understood and less easily quantified. Yet, a perverse dichotomy has emerged, as risk aversion has not shrunk but grown in recent years. As humans, we are all prey to the asymmetry of losses and gains. In other words, a loss of say £100 wounds us far more deeply than the pleasure derived from winning the same amount. The painful memories of 2008 are still fresh in many minds, and there is strong cultural opposition – not always misplaced – within insurance companies to newer asset classes. Regulation has further complicated the picture. The prescriptive nature of incoming rules, such as Solvency II, create a strict environment of demands, with implications for regulatory capital requirements across the industry. It is hard for a person to serve two masters, and insurers are waking up to this as they seek to tap new sources of returns while also maintaining returns on capital and profitability. Limits on asset eligibility (eg as in the matching adjustment) look through to underlying exposures, the importance of data quality, the focus on quantification and the rise of risk management up the totem pole – these are all challenges for insurers looking to stray off the welltrodden paths of public fixed income and their like. There is a widening gap today between the complexity and increasing demands of the outside world, and the ability of insurers to keep apace, which will only worsen in the absence of change. The growing need is for a holistic rethink of insurance approaches to asset allocation, asset-liability management and regulatory capital. There is a need, in short, for that most bastardised of words – innovation.