The life sector must adapt to survive under Solvency II with low investment yields, says the former chief investment officer of Alliance Bernstein, Erik Vynckier. He talks to David Walker
The generous past promises on life policies hang like millstones around the necks of some underwriters, but it will be the inability to offer attractive guarantees on future business that will ultimately break some, according to Erik Vynckier.
The former CIO of Alliance Bernstein and non-executive director at Foresters Friendly Society, the 212-year old provider of life insurance and investment products, says "with quantitative easing there is little that life insurers can do to produce attractive returns for policyholders. The yield curve is simply too low at the moment."
Vynckier voiced his views on the industry in a purely personal capacity, to Insurance Asset Risk. He says dismal yields on life insurers' core holdings, and the reticence of many to invest more adventurously for better, will dispatch some players.
"With quantitative easing there is little that life insurers can do to produce attractive returns for policy holders. The yield curve is simply too low at the moment."
Most industry practitioners at InsuranceERM's Insurance Risk & Capital 2016 conference in October (60%) cited prolonged low interest rates, and unfavourable monetary policy as the greatest risk to their industry. The view is repeated in myriad other industry surveys.
Vynckier applauds those underwriters that are educating themselves about unfamiliar asset classes, which yield enough to support more alluring guarantees.
But this will come too late for some, he says. "We are not living in favourable times for life insurers, and it is difficult to get customers to come to the life insurance industry if you cannot give them clarity about what they are investing for."
Vynckier is decidedly more sanguine about prospects for general insurers. Notwithstanding normal competitive pressures, he says "there is nothing in their structure that tells me they will be no good at what they do, nor anything in the economy that suggests fundamental issues about their business model".
His less rosy prognosis for the life portion of Europe's €9.9trn ($12.1trn) underwriting industry accords with other trends in the industry, including insurers realigning their businesses with pension providers', and coming to compete with banking services.
A Darwinian struggle
Vynckier says Solvency II distracted the sector, understandably but for too long, from focusing on winning new business. He says: "In the run-up to Solvency II insurers lost track of consumers' interests in new business. Customers are not interested in Solvency II. Rather, they ask what can you do for me?"
Now that Solvency II is live, Vynckier predicts a Darwinian struggle between mid-sized and smaller life underwriters, to re-assert their relevance to consumers.
Some will merge to build scale. Foresters joined the M&A trend by acquiring the Post Office Insurance Society in late 2014. Last April, Paul Osborn, Foresters' chief executive, said he wanted more: "Our message is simple - we are actively seeking other like-minded organisations who wish to uphold the fundamental principles of mutuality and be part of a stronger organisation. We will...open a dialogue with a number of interested parties during 2016 with a view to further expansion."
New competition
Vynckier says some life firms will turn to reselling, not manufacturing, insurance products to survive. Underwriting will become tangential at best. "They will become the eyes and ears of clients, and offer a critical selection of competitive financial products in a trusted environment."
Expect more rivals' products on smaller life insurers' shelves, he says, complemented by retirement savings and pure investment offerings.
The transformation will pit insurers directly against pure asset managers, in a battle tilted in favour of investment houses, "which do not have the extra regulatory burden associated with Solvency II".
To compete, Vynckier recommends life insurers exploit their "superior brand, products fine-tuned to the customer life-cycle, and trust of their customers, which together have to outweigh the simplicity and cost-effectiveness of asset managers' products. Life insurers' brands are still strong and trusted, so people still bring savings they can put away for a while, based on our brand."
Unfamiliar territory
Those smaller and mid-sized insurers that wish to keep underwriting will need to display openness in regards to making unfamiliar investments.
Foresters has delved into asset classes less commonly used by insurers. During 2015, it switched equity investments from index trackers by Legal & General, to direct, active investing managed by Quilter Cheviot, which was also its fixed interest manager.
"Our industry has the scale and expertise to invest in assets that are not accessible to less sophisticated investors, such as assets that do not fit into unit trusts."
Vynckier reasons: "Our industry gets remunerated for pooling risk and for stepping into investments where potentially other investors are constrained. We have the scale and expertise to invest in assets that are not accessible to less sophisticated investors, such as assets that do not fit into unit trusts."
For him, smart beta strategies are "an interesting add-on" for general account portfolios. Still considered a fringe investment by many insurers, Vynckier says they display low correlations with insurers' "bread and butter investments of bonds and equities, so you can pick up returns while generating diversification in your portfolio, and cut capital requirements for standard model computations."
He also advocates mortgage lending, which Europe's banks have retreated from since 2008.
Treated under Solvency II's counterparty default risk module, Vynckier says "regulation will not stop you from investing" in mortgage lending. Happily for insurers still considering it, he says "it is an opportunity that will not go away overnight as there is an economic need for it".
Infrastructure debt is another yield investment life insurers are finding worthwhile. Vynckier says the loans are interesting in that holders typically have first charge on the underlying tangible assets, so "defaults have been lower and recovery rates higher than in other sectors". But he adds the volumes available "are not big enough to absorb meaningful amounts of insurers' balance sheets. There is just not enough paper there."
Calling all asset managers
Vynckier is dismayed not more asset managers can think like an insurer, and serve the industry adequately as a result. In his view, of 1,378 managers in Europe, at most 15 – affiliated to insurers or not – can do so.
Analysis by Spence Johnson, the data analytics and market intelligence consultancy, broadly supports Vynckier's contention, by finding that only 20 to 30 managers in Europe are running significant volumes of general account assets.
Robert Holford, retirement lead and head of strategic consulting at Spence Johnson, says: "Asset managers will try to win more insurer business because it is an opportunity that cannot be ignored, but I do not think you can enter the market quickly. Many will underestimate the size of the challenge, and it can be hard to admit that to yourself."
Vynckier admits that servicing insurers requires a long-term commitment. "As an asset manager you have to really dedicate yourself to it. That is the nature of insurance business, but some managers think they can just quickly put their foot in the pond. That is not enough for an insurer looking for partnership and service."
For some mid-sized and smaller underwriters it is preferable to team up with one another, rather than with asset managers, particularly when buying 'big ticket' hard assets, such as infrastructure and property.
Vynckier acknowledges the concept "has legs" for smaller insurers that "have to find ways to scale up by merging or collaborating on outsourcing to common partners". But he emphasises the governance surrounding such 'club deals' needs to be clear and effective.
It seems likely that whatever challenges lie ahead, and whatever opportunities present themselves, a prowess in investment will serve life insurers well.