As the credit cycle comes to an end, a commonly held market belief is that a recession is coming, which will force insurers to do some thinking around their asset allocation and risk appetite.
Where we are in the credit cycle, is the big debate in fixed income and wider markets, according to Eugene Dimitriou, head of insurance solutions at Columbia Threadneedle Investments.
“It's been a long cycle, largely because extraordinarily loose monetary policy has fuelled the expansion of the cycle, and in the US recent fiscal stimulus has pushed the cycle further still,” he says.
“Of course, it's hard to predict exactly when that will end. We think the next big move in the cycle is the contraction phase, which is typically not a very good time for risk assets – now is not the time for insurers to be aggressive with credit risk in their portfolios.”
Carl Moxley, chief risk officer at Legal and General Retirement, says the coming recession and the resulting widening of the credit yields could mean credit would become more attractive than illiquid assets resulting in a greater prevalence of credit in insurers’ portfolios.
“However, I don't personally think that would be the case,” he noted. “From a purist asset liability matching perspective, it does make sense to ensure that within your portfolio there are long dated illiquid assets that match your long-dated liabilities.”
In particular, looking at annuity types of liabilities which can span over 50 years, having appropriate assets that back that duration is integral to an effective portfolio management, he continues. “And mostly it is illiquid assets that tend to have the longer duration and therefore the current trends towards investing in those illiquid assets will continue.”
Capturing the illiquidity premium is key for annuity businesses, and in that sense Moxley said Solvency II has hugely influenced asset allocation.
“From an insurer's perspective and especially one that writes significant volumes of annuity business, the need and want to look for assets that are matching adjustment eligible is really important so that we can capture the illiquidity premium and that does influence assets and structuring to be able to do that,” he said.
For Dimitriou, Solvency II has not led to massive first-order changes. “We have seen many of the more obvious activities such as increased investment in government paper and decrease in investment in asset-backed securities - the former having zero capital charges in most geographies and the latter having very high capital charges,” he said.
To some extent, more investment in shorter-dated credit and less so in longer-dated credit have taken place, he continued. “My perception is that there has not been a massive move in or out of risk assets but anecdotally we understand that some de-risking has taken place.”
Dimitriou and Moxley will speak at the Insurance Risk & Capital EMEA two-day conference in London on 3-4 December. Click here for more information and to confirm your attendance.