David Worsfold
Leading insurers, industry experts and investment managers from across the insurance industry found themselves grappling with the consequences of volatility in a low interest rate world at the Insurance Investment Exchange’s latest seminar in London on 3 March.
Entitled Stability and instability: navigating today’s complex landscape, the seminar explored the challenge set out by the chairman, Paul Abberley, CEO of Charles Stanley, as he welcomed the 70 participants: “We see greater volatility across a range of asset classes and we have to understand how that has a greater impact in the low return world that we now know has no immediate end in prospect.
“We also need to understand how insurance investment strategies feedback to the real economy. That connection is becoming increasingly important to regulators.”
This was the topic of the keynote presentation by Andrea French, senior manager at the Bank of England: “Insurance and financial stability: How insurer distress could disrupt critical services to the real economy”.
Having heard from a policymaker, the first panel session waded into some of the issues raised by regulation with Bob Swarup, principal at Camdor Global, saying: “One of the major concerns is around the impact of policymakers on investor behavior. So many investors are trying to double guess what regulators will do that it actually increases correlation risk”.
This was reflected in the audience voting during the seminar when one-third placed pro-cyclicality forced on them by Solvency II as the key risk they face. Among the other issues that were causing major concern among the audience was the prospect of facing low interest rates for longer, something that another panelist Rob Drijkoningen of Neuberger Berman warned there was little prospect of escape from except by looking at emerging economies: “The emerging markets are not subject to the same downward pressure on rates that the ECB and the Fed exerts. But they are having to offer risk premiums of up to 10% without differentiating between well-managed and poorly managed economies, given high correlations on the back of risk aversion”.
Talk of the next crisis is never far around the corner and it emerged during the panel session. “The 2007/08 crisis was a confluence of events that came together”, said Peter Allen, Chairman of Euro IRP. “Many of the issues that were there in 07/08 haven’t been addressed. In particular, according to figures produced by McKinsey, we have almost 50% more debt in the world now than at the beginning of the Great Financial Crisis”.
Swarup added that any signs of a new crisis set alarm bells ringing: “We are now nine years since the last crisis began, and we have a generation of analysts, investors and policymakers who have grown up only in a world of low rates and yields. They are spooked by volatility, as it is largely unfamiliar to them, but much of this is a resurgence of the normal and not necessarily an aberration.”
There were breakout sessions on “The outlook for emerging market debt” run by Rob Drijkonigen, on “Navigating the credit spectrum: a macro approach to the credit cycle” led by John Taylor from AB and “Keeping it simple: enhancing returns in today’s markets” run by Dick Rae from BMO Global Asset Management.
The second panel session returned to the topic of volatility and tackled the question of what could be done about it. There was a general consensus that the environment going forward would remain volatile and that this needs to be factored in. “Insurers need to understand that volatility is here to stay,” said Robert Talbut, Chairman of EFG Asset Management and a non-executive director on the Independent Governance Committee at Aviva. “Rather than fighting it, they should accept and plan around it. In a zero interest world, returns are bound to suffer.”
Confidence has clearly suffered in recent years and investors would do well to do their own fundamental credit research, according to John Taylor: “Rating agencies currently sit at the heart of the regulatory framework, but they are focused on historical data.
“This can make them behind the curve, when investors need to be forward-looking to capture opportunities.”
A strong focus on portfolio construction and a move towards absolute return as well as low volatility strategies were key strategies highlighted by over half the audience to tackling the impact of volatility on insurance balance sheets. But the pressures of the environment are also clear. Near 2 in 5 expected to increase allocations to illiquid credit as they sought to enhance yields, while nearly half identified regulatory capital constraints and uncertainty as their key barrier to investing in new investment opportunities.
“Greater transparency has also meant that insurers have to manage their balance sheets and respond to current volatility constantly, despite being longer-term investors,” said Dick Rae. “The only way to resolve this is to rethink the current approach to constructing insurance portfolios.”
Look out for further detailed analysis on the themes explored and the audience voting on the Insurance Investment Exchange website.