David Worsfold
As insurers try to escape from the “slow grind downwards in terms of yield”, they have sought out a more diverse range of assets, including those with limited liquidity that would previously not have found their way into portfolios, Bob Swarup, co-founder of the Insurance Investment Exchange, told the audience at the recent Insurance Investment Exchange seminar in London.
“What we called core fixed income ten years ago looks very different today”, a trend encouraged by Solvency II, said Swarup, noting that amidst the opportunity, risks and gaps also remained.
This theme was taken up by the two panel sessions that framed a series of workshops on specialist topics presented by Loomis Sayles & Company, an affiliate of Natixis Global Asset Management, Allianz Global Investors, Mesirow Financial and Insight Investment.
In the first panel session, Alex Thompson, a product specialist at Loomis Sayles, said illiquid assets were proving attractive: “I’ve witnessed a huge interest in all things illiquid. For insurers, that makes a lot of sense but I would say ‘not at any price’.
“Asset price valuations are forcing insurers to take risks. But who is to say they are taking the right risks?”, said Thompson.
Don Schrupp, principal at Camdor Global advisers, agreed that there are risks in illiquid assets: “The real challenge is how to avoid the pitfalls we have seen in the past, such as the real estate bubble. Insurers need to work with people who understand these and can fill in their gaps.”
The lack of understanding of these assets classes also worried Erik Vynckier, board member at Foresters Friendly Society: “We have to rework and restructure investment teams because they don’t have the knowledge and skills to manage these new asset classes”.
Insurers could be missing opportunities because of their reluctance to invest more in non-correlated assets such as hedge funds, noted Dermot Keegan, senior managing director at Mesirow Financial: “A lot of institutional money has moved out of hedge funds. With Basel III and with solvency regulation, banks and insurers have moved out of these asset classes. We are at the most liquid we have ever been”.
He said that as markets now found themselves at the end of a very extended credit cycle, there would be opportunities and it was important for insurers to be in a position to take advantage of them.
This concern was shared by some in the audience who questioned to what extent insurers could lock themselves into illiquid positions.
In response, Vynckler said people were right to be concerned: “I don’t think many insurers have thought through how far they can put themselves into illiquid assets and maintain sufficient liquidity for meeting lapses or meeting catastrophes if they are on the P&C side”.
Thompson agreed there was a pressing need to balance and control risks:
“It is the combination of risks that is the problem and that can catch you out. It is one thing to go down the risk spectrum, or become less liquid or longer duration, but it is when you start combining the whole lot together that the crisis comes – and it can get quite nasty very quickly”.
The second panel, which followed a presentation by David Rule, executive director of insurance supervision at the Bank of England given under Chatham House rules, inevitably focused on the impact of regulation.
Promises by the Prudential Regulation Authority to review the way Solvency II was being implemented were welcomed by insurers, said Steven Findlay, an assistant director at the Association of British Insurers:
“There is scope to introduce a bit more proportionality to bring down the overall cost and reduce complexity. Could processes be streamlined, the internal models changed and made a lot more dynamic or some of the reporting burden be cut down? All of that would have a positive impact on insurers’ asset allocation strategies”.
Brexit also cast its shadow across the regulatory scene, said Findlay: “If we don’t end up in the single market, there will be a need for the UK to have its own prudential regime”.
The potential for different regulatory regimes to dictate behavior concerned Adrian Jones, senior portfolio manager at Allianz Global Investors: “There are some awkward differences between banking and insurance regulation which create problems, as you get arbitrage when regulation doesn’t work”.
In closing, the role of internal ratings was a hot topic for the audience and the panel had differing responses to this.
Jones said Allianz Global Investors didn’t use them: “We are not a huge fan, especially because we feel that internal ratings are another form of arbitrage”.
Fellow panel member Heneg Parthenay, head of insurance at Insight Investment, took a more positive view of them: “We use then and share them with clients. It gives them another view of the credit risk. They can use it or they can choose to ignore it”.
Regardless, insurers’ long, weary quest to find yield shows no signs of abating, according to the audience voting results, though internal factors are also forcing their way up in today’s environment with many questioning their own organisational culture and business models.
The next Insurance Investment Exchange event takes place on Tuesday 19 September and is entitled “New assets, old liabilities: enhancing returns on capital”. You can register your interest here: http://www.insuranceinvestmentexchange.com/event/new-assets-old-liabilities-enhancing-returns-capital/