The insurer investment management insights - October 2019

Interest rates have fallen to historic lows. Volatility within equity markets has risen. And geopolitical risk continues to be the catalyst for global market sentiment. So, how should insurers adapt their investment strategies to overcome these challenges, particularly in the face of tougher regulation?

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Sustainability and climate risks are also on the agenda of the Solvency II review, and further challenges could be on their way as the European Commission evaluates the transparency of costs for retail products. These are uncertain times indeed for traditional insurance portfolio investors, eager to protect their earning and solvency.

So, what are the key factors that are going to impact insurers’ investment plans?

Macro-economic trends

While the joint risks of tariff wars and central bank tightening seem to have subsided for the time being, they still represent some of the most significant risks to the economy and markets in 2019.

1.     Monetary, geopolitical and technological disruption

Along with a more dovish stance for 2019, the Fed indicated that it expects to end balance sheet normalisation later this year. This abrupt change in policy raises the risk that the Fed will not have enough ‘dry powder’ available for the next crisis. 

Significant geopolitical disruption in recent months has led to structural fragmentation, but the biggest risk is the potential for full-blown trade wars. 

We also expect innovation and the Fourth Industrial Revolution to continue affecting the distribution of global growth and the balance of power in the world. Highly innovative firms will continue to use technology to disrupt established business models, even if tech stocks come under further pressure as markets normalise and social media platforms come under greater scrutiny. And we should all be keeping one eye on US-China trade tensions, which have wider implications for investment and global economic and political influence. 

2.      Debt overhang

The world is becoming increasingly indebted, likely to increase as monetary policy normalisation continues and accelerates in coming years. There is a long-term effect too; more money spent on servicing debt means less money for investing, and that will impact longer-term economic growth.

3.      What this means for insurers

We believe exposure to risk assets is important for meeting long-term goals, especially with the upward bias for stocks. Mitigating against downside risk will be critical, and that includes being well-diversified within equities and fixed income.

Perhaps most importantly of all, we believe that market neutral portfolios and other lower-correlating asset classes, especially those with income-producing potential such as real estate, can help with diversification and risk mitigation.

Regulatory news

Insurance sector policymakers are looking beyond the risk posed by stricter regulations to consider how the financial system can better serve the economy and citizens.

Systemic risk is back on the agenda

The International Association of Insurance Supervisors (IAIS) has finally agreed to replace the “G-SII” framework for designating global systemically importance insurers with a new activities-based approach.

It will focus on the key drivers of systemic risk: liquidity risks, interconnectedness through common macro-economic exposures or counterparty exposure, lack of substitutability of critical functions, as well as other risks such as cyber risk.

In addition, the insurance industry is likely to face extra scrutiny of its liquidity risk management systems, and recent proposals relating to liquidity and leverage in the fund industry may give an idea of what we can expect down the line.

Sustainable and climate risk

The Paris Climate Accord in 2015 put climate change – as well as broader environmental, social and governance (ESG) issues – on the map. The insurance industry is on the frontline of these issues, and the International Association of Insurance Supervisors (IAIS) has been exploring how insurance companies and supervisors should respond to these challenges. That includes assessing the portfolio exposure to carbon asset risk and undertaking scenario analysis and stress testing for climate change factors.

It’s clear that insurance undertakings will need to have an enhanced focus on sustainability issues in the future. This will include greater analytical capabilities to allow stress testing and scenario analysis in relation to their exposure to sustainability risks, and considering how to optimise their strategic investment allocation to sustainable investments and the integration of ESG considerations across their investment portfolio.

The Solvency II review

Along with systemic risk and climate change, the Solvency II review will look at issues such as improving proportionality of the rules, as well as lowering disincentives to insurers financing the real economy as part of the Capital Markets Union project.

This includes a review of the Delegated Acts that aims to fine-tune the technical details under Solvency II, to be followed by a full review of the Solvency 2 Directive in 2020.

Changes announced in March 2019 to the Solvency II Delegated Acts detailed new measures to harmonise the treatment of deferred taxes to absorb present losses, and fine-tune the calibration and risk sensitivity in certain areas, amongst others.

Transparency and costs of retail products

In December 2018, EIOPA published its first report on costs and part performance of retail insurance products, concluding that there are significant data quality and comparability issues in the insurance retail market.

A full review of the Packaged Retail Investment and Insurance Products Regulation (PRIIPs) will take place in 2019. The review will address the many issues financial market providers have encountered with the PRIIPs Key Investor Document (KID). The European Parliament and Member States have also agreed to postpone the inclusion of UCITS in the PRIIPs regime until 2022.

Finally, in February the European Parliament and Member States reached an agreement on a proposal for the creation of a new Pan-European Pension Product (PEPP). The new product label would apply to a private pension vehicle that can be ported across the EU. The product will include a default option, the basic PEPP, which can consist of either a guarantee or a life-cycling option.

To see all our insights, including our insurance asset allocation benchmarks market updates, download the full article.



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