Investment Outlook 2021 - meeting the post-Covid challenges

In the wake of Covid-19, many insurers were initially reluctant to make strategic changes to their investment policies (particularly in 'risking up' asset portfolios) until there was more confidence around the recovery, and with announcements around possible regulatory changes also delayed until late in 2020 and 2021.

With vaccination programmes now being rolled out and a path back to some form of normality now emerging, many are now embracing the (relatively) increased certainty to conduct a fundamental review of their investment policy and implementation approach.

The particular challenges will vary across types of insurer and geographies. However, for all it will be necessary to consider the 'even lower for longer' environment, with very low / negative government bond rates going far out along yield curves, and with reduced credit and equity risk premia following extensive quantitative easing.

To illustrate the scale of this challenge, to generate the same level of yield now as was available on treasury bonds just three years ago needs a degree of credit risk between A and BBB, depending on geography. For many insurers, however, simply increasing credit risk in this fashion is unlikely to be consistent with risk appetite and capital / risk constraints so alternative approaches are needed.

Challenges beyond low yields

Adding to this difficult economic position are the increasing requirements for insurers to recognise and manage climate-change related risks in their businesses; for example with the UK government mandating that most UK insurance companies will have to provide enhanced climate change disclosures over the next few years. EIOPA and the UK PRA are also expected to formalise the recognition of ESG risks within regulatory frameworks in 2021 across risk, capital and investments.

The implications of these economic and regulatory developments will differ between sectors of the insurance market:

• For non-life companies, the much lower return environment could prompt a review of investment and underwriting risks within the overall enterprise-wide risk appetite. The direction of travel has generally been to take more investment risk, driven by lower yields, but also by benefiting from diversification between market and underwriting risks to make this capital efficient. With even lower yields and a possible hardening of the insurance market in several sectors, this could reverse. CIOs may need to justify to their boards and risk committees that they are able to exploit the risk budget allocated to investments relative to other business areas.
• For life companies, the impact of anticipated regulatory changes is likely to be more pronounced. For European insurers, it is expected that the Solvency II Volatility Adjustment will change to reflect better the actual investment strategy adopted, and the liquidity of this and the liabilities being backed, to avoid 'overshooting' an appropriate level. For UK life insurers, the UK government will consider changes to the Matching Adjustment and Risk Margin to reflect the importance of these mechanisms to this sub-sector and to ensure they remain fit for purpose.

Informed investment thinking

In this paper, we suggest how to adapt portfolios and the overall asset management approach to withstand this new environment. We consider these issues across five main themes:

1. Integrating climate risk management: understanding the upcoming requirements, setting realistic goals and aligning investment portfolios with these goals.
2. Increasing robustness and dynamism in asset allocations: achieving true diversification in portfolios, being more dynamic around the investment risk level and successfully exploiting Tactical Asset Allocation.
3. Enhancing equity outcomes: recognising the key themes that will impact equity investing in 2021 and delivering an equity implementation solution that will maximise outcomes.
4. Effective integration of ESG into credit investing: ensuring that investment returns are not compromised whist still delivering the environmental outcomes.
5. High yield: unlocking increased returns in a post-Covid world: looking forward to the credit environment for 2021 and beyond and considering how high yield bonds can deliver higher returns in a risk and capital efficient manner.

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The views expressed are the author's own and do not constitute investment advice. Past performance is not a reliable indicator of future results. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested.