European insurers can no longer generate sufficient returns to meet guaranteed rates to policyholders, according to a survey undertaken by Standard Life Investments.
In response, the survey says many European insurers are undertaking significant strategic asset allocation (SAA) and tactical asset allocation (TAA) changes, expanding traditional investment horizons to maximise returns.
Standard Life Investments commissioned the research to assess the longer-term impact of the low-return environment and Solvency II regulations might have on European insurers’ business and investment strategies.
A total of 56 interviews were carried out with senior insurance investment executives representing over 2.4trn, or around 30%, of pan-European insurance assets under management.
Over 60% of the executive interviews were undertaken with chief investment officers across the 56 different European insurers.In addition to insurers’ asset allocation changes, other key themes identified by the survey include:
1. Insurers’ investment freedom is constrained by Solvency II. This affects asset allocation as insurers balance greater risk appetite with optimising capital charges and the diversification benefits of the new regulations
2. Outsourcing asset management activity is increasingly attractive, but there are concerns about industry capacity and the number of asset managers able to meet complex insurer requirements
3. Insurer business strategies and profitability are under pressure from a structural shift away from guaranteed savings to unit-linked structures.
In response to European insurers no longer able to generate sufficient returns to meet guaranteed rates to policyholders, most insurers express an aspiration to boost risk appetite and risk-asset exposure, says the Standard Life Investments survey.
At a high level, SAA to sovereign and investment-grade fixed income are expected to fall, with allocations to alternatives and equities expected to increase.
Overall, the survey said:
– 50% of European insurers are expecting to decrease sovereign fixed income exposure
– 43% expect to increase their investment risk appetite
– Over 60% of insurers expect to increase allocations to real estate and/or alternatives.
One medium-sized UK life insurer is quoted as saying in the survey: "We’ll be looking to improve returns to help meet guarantees through diversifying credit exposure and adding infrastructure."
In the UK and Ireland, there was a strong focus on exploiting illiquidity premia rather than credit risk.
Infrastructure and real estate debt, or diversified fixed income, were cited as attractive sub asset classes for optimising return and capital efficiency.
Respondents explained that, while taking on more credit risk (buying high-yield fixed income) improved yields, these investments attract higher capital charges and offer no diversification benefit.
According to Standard Life Investments, German respondents expressed the same preference for exploiting illiquidity premia over credit risk as UK & Ireland insurers.
Furthermore, in addition to changes in SAA, it says TAA strategies are becoming
more important to German insurers.
They increasingly see TAA as a driver of return as market volatility is the new norm – a situation viewed as both an opportunity and a threat by investment divisions.
In Southern Europe, respondents expressed fewer concerns about SAA and more confidence in existing investment strategies.
Standard Life Investments says Southern European portfolios remain more weighted to sovereign fixed income and investment grade debt, where domestic yields are higher than in other parts of Europe.
It added there was more interest in building out equity exposure than alternatives in southern Europe.
Finally, Northern Europe expressed similar asset allocation preferences to the UK & Ireland, albeit with a still-high but less pronounced preference for alternatives, said Standard Life Investments.
The provider says of all four sub-regions, northern Europe displayed a greater interest in high-yield fixed income as an alternative asset class option.
Equity was also identified as a destination, but to a lesser extent than other continental regions
Commenting on the survey’s results, Stephen Acheson, executive director at Standard Life Investments says: "European insurers’ business strategies and traditional business models are being fundamentally challenged due to the combination of the long-term low return environment, Solvency II and the ongoing need to deliver on promised guarantees."
He adds: "It is important to remember that Solvency II was conceived and developed in a very different economic environment. Since our survey was completed, fundamental questions about the design and performance of the Solvency II balance sheet in the current low interest rate environment have begun to be raised.
"For example, in the UK the PRA has recently pointed out that, as a consequence of low interest rates, the risk margin is leading to higher capital requirements and volatility. So the Solvency II development and implementation issues that the European industry has been working on over recent years will certainly not end on 1 January 2016."
The challenging investment landscape for insurers portrayed by the Standard Life Investments survey is not unique.
In April 2015, Life Insurance International published a news article highlighting that Goldman Sachs Asset Management’s (GSAM) annual insurance survey found the most pessimism among insurers in four years as they struggle to identify attractive investment opportunities.
Michael Siegel, GSAM’s global head of insurance asset management, said "Insurers are concentrating on finding new investment opportunities which are sparse because yields still remain at low levels, and insurers are not anticipating a meaningful increase in rates this year."
He added: "Nonetheless, one-third of insurers globally intend to increase overall portfolio risk. Insurers believe equity asset classes will outperform credit assets and they are looking to increase allocations to less liquid, private asset classes."
An insight report published by Timetric, which is available at the Insurance Intelligence Center (IIC) Insurance Markets after the Global Financial Crisis explains that insurance industries in developed markets increased their focus on investment income to offset underwriting losses and maintain overall profitability, following heavy underwriting losses during 2008-2009 as a result of the global financial crisis.
This is evidenced by the 10.4% increase in total investments, from US$14.7trn in 2009 to US$16.2bn in 2011.
Given the low interest rate environment, the IIC report notes that the proportion of investment in government securities fell from 26.3% in 2011 to 23.8% 2014, while the proportion of investments in corporate bonds and investment funds rose from 35.9% and 24.8% in 2011 to 36.4% and 28% in 2014 respectively.