September 2016 seminar report
David Worsfold
The challenges facing insurers as they continue to adapt to sustained low returns and absorb the full impact of the new regulatory environment were dissected at the recent Insurance Investment Exchange (IIE) half-day seminar on 20th September 2016 entitled “Assets, liabilities and making money? Managing risks, returns and capital today”.
The tone for the seminar was set by veteran commentator and analyst Con Keating, currently head of research at Brighton Rock, whose presentation ‘Breaking the rules’ [Link to Con’s presentation] offered some trenchant insights into the liabilities insurers – general and life – are required to match under Solvency II and the limited options they often have.
In particular, he focused on the misunderstandings around pension scheme deficits which he said were now being blown up into a “post-Brexit deficit crisis”, adding “most of this pensions crisis is an invention”. In his view most corporations can fund the deficits on an annual cash flow basis but too much of the comment around deficits ignored this, creating a false sense of looming disaster.
Alongside this is the misunderstanding of the generational issues. Keating cautioned against allowing it to become conventional wisdom that the current generation of pensioners were benefiting at the expense of future generations: “Inter-generational fairness is much mis-understood. All future liabilities are a claim on future production and always have been”.
The real threat to pension schemes lay in the longevity risk and the inflexibility of the current ALM regime: “It is now possible that retirement could last up to sixty years, far longer than any annuity was ever designed for. If an annuity is to do the job it was intended to do in the later years of retirement, then uplifts need to be linked to care workers’ salaries which are rising at a faster rate than average earnings”. Currently, there is no hedging instrument available that can do this. If one was developed it “would have to be equity-based as that is the only asset with a potential lifespan to match the liability. Infrastructure would be potentially attractive too”.
Keating also had a warning for motor insurers whose liability profile was being fundamentally altered by periodic payments for catastrophic personal injury cases: “They effectively turn the balance sheet of a motor insurer into a life assurance book. In some cases, this now represents up to 50% of the balance sheet”.
The first panel session took some of these challenges into the broader investment environment, addressing the question “Lower for longer or negative for ever?” with Bob Swarup, co-founder of the Insurance Investment Exchange and principal at Camdor Global Advisors, sketching out today’s ostensibly bleak picture: “Every time we think we have reached the bottom, another trapdoor opens. The latest is that we now have the first corporate bonds issued at negative rates”.
David Astor from Hiscox was scathing in his dismissal of these: “Buying negative yielding bonds seems madness to me. However I think we have to accept that lower for longer means settle for less”.
This acceptance adds to the challenges for companies like Hiscox. “Before the crisis, 50% of income came from investments. However, Hiscox has always been an underwriting driven business and that focus is even more important in today’s market”.
Dan Loughney from AB said the UK market was now priced to remain low for at least three years and that the longer term future depended on how central banks reshaped their objectives: “Central banks talk about stability but over the last few years, they have focused on elevating asset prices to match broader liabilities. This is now running out of steam and it seems that their objective is now to promote inflation. However, they are running out of options for doing that.”
The second panel session turned its attention to the future, posing the question Quo vadis? (Where are you going?).
It opened with a warning from Leigh Skene of Lombard Street Research: “The credit bubble is still a major threat. We have no way of knowing how it is going to end but we do know that it will end”. He said the ending could be caused by hyper-inflation – unlikely as it would be happening already after eight years of quantitative easing – or deflation provoked by rising defaults including sovereign bonds.
Independent actuary Norman Peard took up the theme of central banks running out of options, saying he worried they are potentially losing control of the financial system: “Could we be heading for QE-infinity, for example? When a bond the central bank owns reaches maturity, a new bond is issued to replace it and the central bank immediately buys it back?”.
For insurers the overriding concern in the future would around “around having enough cash to pay policyholders when claims become payable”, said Peard, adding that the current model for annuities in particular was not sustainable in such a low interest rate environment. Alex Wharton from Natixis Global Asset Management said life companies faced complex challenges in generating yield from matching adjustment efficient assets given the limited investable universe: “The restrictions of the matching adjustment mean that lot of firms are chasing the same assets leading to the need for innovative new structures from the asset management industry”.
This could cause liquidity issues, warned Russ Bowdrey from Aviva’s Group ALM and Capital team: “Everyone is chasing after the same assets which could lead to real issues. If we accept that a crisis is coming, then will the return on those assets be adequate for the risk taken? We need diversification, especially outside our core domestic markets. Reinsurance and hedging have important roles to play in helping balance our risk profiles.”
Bowdrey felt the trend towards responsible investing, in particular around climate change, was a part of that diversification.
The seminar also featured two breakout sessions. AB hosted one on ‘Private capital opportunities in the US commercial real estate space’ [Link to AB’s presentation], which examined some of the opportunities opening up in that market as banks are forced by regulators to limit their activity in this area. As an asset, it offers attractive yields and aids diversification.
The other breakout looked at ‘Sweating duration: finding opportunities across the yield curve’ [Link to Natixis’ presentation] and was presented by Esty Dwek from Natixis. It took people through some of the opportunities for diversifying duration using short-term emerging market debt, loans and other private debt assets.
Participants at Insurance Investment Exchange seminars LAO always have an opportunity to have their say, either by questioning the panelists and speakers directly or by taking part in the anonymous electronic voting. This gives a fresh insight into the thinking among insurers and also shows how that thinking might be changing over time. You can read more about what people thought at this seminar in ‘Lower for Longer?’
The next Insurance Investment Exchange seminar rakes place on 6 December with the theme of ‘The ghosts of Christmases past, present and future – 2016 gone and a look ahead to 2017’.