Divergent monetary policy is creating a unique set of challenges for global insurers. While they have seen the positive effects of quantitative easing (QE) on asset prices and economic growth in the short term, they also fear the market imbalances and unsustainable investment environment it may create. Combine this with continued low interest rates in some regions and concerns of an interest rate hike in others, as well as a lack of liquidity in the fixed income market, and insurers face a quandary.
These complex concerns are driving changes in insurance investment strategies, according to BlackRock’s fourth annual survey of global insurance companies, conducted in July 2015. QE’s impact on asset prices is leading insurers to seek more risk, although fears of an asset price correction and a lack of quality opportunities in some asset classes suggest that insurers are taking a balanced approach to deploying cash—keeping their powder dry for when the opportunities arise. At the same time, more than two-thirds of insurers are planning to make greater use of derivatives and exchange-traded funds; one reason for this is the lack of liquidity in investment grade fixed income.
The key findings of the research suggest:
Insurers see positive short-term effects of QE and looser monetary policy-Almost half of insurers surveyed have made significant changes to investment strategy in light of QE and monetary policy, with asset prices and economic growth expected to be positively impacted in the short term. A similar number are making or are planning to make changes in the coming 12-24 months—a trend most pronounced among North American insurers.
Divergent monetary policy and the potential negative long-term effects of QEworry insurers -Just under half of the insurers surveyed cite the low interest rate environment as a major market risk, especially in North America and EMEA, although the risk of sharp rate rises also troubles many, especially in Asia-Pacific. A majority of insurers worry that QE and monetary policy create imbalances in markets that negatively impact the economy as well as an unsustainable environment for the insurance industry. Mike McGavick, chief executive officer of XL Group and chair of the Geneva Association, speaks for many insurers when he says that “a continued distortion of the market is what we worry about long term.” Against this backdrop, it is not surprising that our survey suggests most insurers want to see the pace and size of QE reduced and monetary policy tightened.
Insurers are planning to raise their risk exposure in search of higher yield-More than half of insurers are looking to increase risk exposure over the next12-24 months, compared to just one-third in last year’s survey. “Like many(re)insurers, our goal in increasing risk appetite on the investment side is toincrease yield,” explains John Tan, group chief executive of ACR Capital Holdings.
Insurers are changing the composition of their risk assets-Equities willbe given a smaller allocation as insurers reposition their risk exposures togenerate income. More than four in ten insurers are planning to reduce theirexposure to equities—especially in North America, where more than halfintend to do so. This may be driven by concerns around quantitative easing:the possibility of asset price corrections is seen as a major risk by one-thirdof insurers. The survey suggests insurers are turning to a broader range ofrisk assets, particularly income-generating alternative credit investments;four in ten insurers are increasing their allocations to commercial real estatedebt and direct lending to SMEs. Ian Coulman, chief investment officer at PoolReinsurance, explains that his company began diversifying risk exposure threeyears ago by reducing equities and adopting “a multi-asset credit strategy”,focusing on a “well-diversified risk portfolio.”
Insurers are struggling to find a good home for their increased cash holdings-Almost half of respondents expect to increase cash holdings over the next12-24 months specifically because of QE and monetary policy, and morethan one-third plan to increase cash holdings more generally. Importantly,this includes nearly half of those looking to increase their risk exposure.Shaun Tarbuck, chief executive of the International Cooperative and MutualInsurance Federation, says: “Finding homes for the money that are not going topenalize insurers from a regulatory viewpoint but give them a decent amountof return is an issue.” Mr McGavick confirms this view: “We’re holding cash aswe want the flexibility to be opportunistic.”
Challenged liquidity is making it difficult to access the fixed income markets-Approximately half of respondents wish to increase their holdings of qualityfixed income assets, with investment grade corporate bonds and governmentbonds the most popular choice. However, they are struggling to find what theyneed—over two-thirds of insurers say lack of liquidity is making it difficultto access fixed income investments and roughly three quarters believe thatliquidity is challenged relative to pre-financial crisis levels. According to oneinsurer: “Spreads on high-quality, investment grade fixed income are illogicallytight, so the supply is picked over, and what is available is less attractive.”Against this backdrop, lack of liquidity is encouraging the use of derivatives (seven in ten insurers agree); four in ten insurers are planning to increase theiruse of derivatives over the next 12-24 months.*
*Source: “Rethinking Risk in a More Uncertain World.” The Economist & BlackRock. October 2015.
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