Amid geopolitical fragmentation and inflationary pressures, Mercer has suggested that insurers prioritise 10 areas for their investment assets in 2017.
According to global consulting firm Mercer, the ten areas include:
- Optimise the operating model: Investment operating models are the framework covering all aspects of the investment approach, from governance to strategic asset allocation to implementation. Insurers are increasingly looking to review and optimise their operating models to deliver superior net returns.
- Protect the downside: The uncertain macroeconomic and political environment continues to give the potential for sudden significant volatility across financial markets. For bond yields and currencies, Mercer says it is important to consider risk holistically across assets and liabilities, and the overall asset-liability management approach should be reviewed to confirm that this approach appropriately manages these risks.
- Capture emerging risks and opportunities. According to Mercer, the US Federal Reserve Bank appears increasingly poised to raise interest rates more quickly than was anticipated at the start of 2016, with this being further encouraged by Donald Trump’s stated views on fiscal policy expansion as well as the potential for a more protectionist policy.
These factors may further exacerbate volatility in emerging market assets and currencies which presents both risks and opportunities for investments in emerging markets and hence the allocation both to and within emerging markets should be reviewed.
- Investigate alternative return generators: The global policy focusing on monetary stimulus has created an abundance of capital seeking higher investment returns.
This has led to a reduction in the yields available on the assets traditionally used by insurers. To improve the quality of returns achievable from growth portfolios, Mercer says non-traditional sources of return, including wider use of assets that provide for an illiquidity premium and that rely on manager outperformance (also known as “alpha”), should be considered by insurance companies.
- Investigate real assets: Insurers are typically long-term investors. As such, Mercer says they should review the significant potential benefits offered by investing in real assets such as real estate and infrastructure, particularly given that these assets can also provide some protection against a higher inflation environment, which now looks more likely.
- Understand and utilise liquidity: Insurers typically ensure adequate asset liquidity to support the insurance and operational needs of the business.
However, Mercer argues that holding excess liquidity can present a significant opportunity cost in the form of lower returns.
Instead, the consulting firm says insurers should regularly review their liquidity risk and requirements to not only ensure that business needs are met, but also to ensure that investment opportunities are not missed.
- Integrate environmental, social and governance (ESG) considerations: ESG factors are gaining increasing prominence when setting an insurer’s long-term investment approach.
One recent stimulus is the ongoing global initiative to introduce voluntary climate-related financial disclosures at a company level, which will potentially have a far-reaching impact on insurers. Proactively considering the impact the initiative may have on reporting and disclosure from an investment perspective is a task recommended to insurers, says Mercer.
- Adopt smarter implementation: While investment strategy is generally the key determinant of realised returns, efficient implementation can provide a notable added value. Insurers are encouraged to undertake such actions as ensuring asset management fees are competitive, leveraging the scale of assets across the balance sheet and considering the outsourcing of mandates for non-traditional assets that previously would have been accessible only to larger investors.
- Consider alternative risk quantification measures: Value-at-risk measures continue as the market standard for risk measurement, and are a main measure that insurers focus on when setting their investment strategy.
While such measures are a key tool for measuring risk, Mercer says there are several limitations in their use. These traditional risk measures should be complemented with alternative measures (eg scenario analysis) both when setting the overall market risk appetite and when determining the underlying strategic asset allocation.
- Align management information with need for dynamism: Mercer says the quality and quantity of management information provided to insurance boards and committees has improved in recent years, driven by factors such as increased regulation and stakeholder demand. However, the consulting firm argues this is still a work in progress for many insurers.
In addition to ensuring the appropriate quality of management information, Mercer says insurers should look to move one step further in setting and monitoring specific triggers for action (e.g., around asset-liability mismatches) in case experience diverges materially from expectations.
Ravi Rastogi, insurance group leader, Europe, at Mercer, said: “Global financial markets have generally held up well over 2016, especially given the unexpected geopolitical events that have occurred.”
Rastogi added: “Recent equity market rallies further signal that investor sentiment is moving in a more “bullish” direction. That said, there are significant downside risks persisting due to concerns around the sustainability of the economic recovery, increasing inflationary pressures, ongoing geopolitical uncertainty, and practical limits around the efficacy of central bank and governmental policy actions.”