29 December 2014
The events of 2014 confirmed that low interest rates and regulatory change remain the top concerns for insurers, says Christopher Cundy
Looking back over our biggest stories of 2014, it's clear that we are still dealing with a hangover from the financial crisis. New regulations to better manage the risk in financial insitutions and the economy-boosting decision to keep interest rates low are causing all sorts of headaches for insurers.
No corner of the sector seems immune from a government-led initiative. The biggest shock of the year was felt by UK life insurers, where a shake-up of the rules on retirement savings is having profound effects on business models. In March, one sentence in a speech by the UK's finance minister George Osborne sent share prices tumbling - and the reverberations are still being felt.
Osborne's decision to remove the effective obligation to buy an annuity led to a sharp decline in sales of individual annuities, with a consequent effect on investment decisions. On the other hand, insurers are expected to do more bulk annuity deals with pension funds, so the overall investment mix may not change that drastically. The downside of bulk deals is that they come in big chunks and are less predictable, so there will be more volatility in insurers' financial figures.
Still hunting for yield
The mix of assets in insurers' portfolios broadened further in 2014 as the hunt for yield continued. The common themes were investment in real estate and infrastructure, with some insurers venturing back into peripheral European debt and emerging markets debt.
Investors are keeping an eye on whether firms are taking on excessive risk in their assets - a position that is unlikely to change in 2015 as the pressure to make a decent returns shows no sign of easing.
Solvency II capital charges
The capital intensity of investments is increasingly a consideration for European insurers as there is now just one year until Solvency II comes into effect. After much discussion in 2014, the capital charges for assets are virtually settled, though still complicated. Compared to earlier versions of the Solvency II text, insurers' lobbying paid off in regards the treatment of private equity and securitisations.
However, there is still an argument raging over the capital charges for infrastructure investments. Insurers say they are penal, while the European Commission says they are not that bad once you take into account the credit you get for diversification. Insurers may yet win this battle. Commission chief Jean-Claude Juncker's bold plan to mobilise billions of euros for infrastructure investment in the EU needs the participation of insurers and MEPs have formally requested that the calibrations are looked at again.
Government efforts to encourage investment in infrastructure need to go far beyond Solvency II's risk charges, to supporting standardisation of the asset class and the creation of prokect bonds. That the CEO of Swiss Re stood up and described his company's allocation to infrastructure as "ridiculously low" should ring bells across the continent.
Matching adjustment and reporting
UK life insurers are keenly awaiting clarity on the use of the matching adjustment. The country's Prudential Regulation Authority has invited firms to make a pre-application to use the MA, the results of which should be revealed early in 2015. At issue is the assets that can be put into the ring-fenced MA portfolio, specifically mortgages and property.
Data reporting for Solvency II will remain a big challenge this year and next. The first pan-European data submission trial will be conducted in 2015 and is likely to reveal some significant deficiencies.
What to come in 2015?
The pain caused by low interest rates may begin to ease, with governments widely expected to begin raising rates within the next year or two. The rate of increase is crucial to insurers, who will make mark-to-market losses in the short term, before reaping the benefit. Of course, there is the possibility that rates may not rise or even go negative, especially if economic recovery stalls.
In 2015, insurers may have to deal with more volatility in asset prices as governments scale down their monetary easing programmes. Firms will also have to watch their exposure to government bonds, which were revealed as being a flaw in insurers' resilience to the stress scenarios recently tested in Europe.
Will there will be further "drastic shifts" in investment portfolios because of Solvency II? The consensus seems to be that there will be lots of activity at the margin, but the overall picture will not change massively.
The other major story that should be resolved over 2015 is the merger of Friends Life and Aviva. There is evidently a threat to who manages Friends Life's money in the future, but there is a bigger picture around other mergers and acquisitions in an industry awash with capital and facing softening prices in many non-life markets. Take XL Group's planned acquisition of Catlin, for example.
At Insurance Asset Risk, we will endeavour to keep you up to date with all the issues affecting asset management in the insurance sector during the next 12 months. In the meantime, we wish all our readers a happy new year.