Insurance companies are adapting their investment approach via diversification and hedging techniques, yet much of the industry has a long way to go in responding to the challenges of low interest rates, regulation and risk management.
A new study released today from The Boston Consulting Group (BCG) and AXA Investment Managers (AXA IM) entitled 'Adapting asset management strategies to the current market environment' highlights the key challenges facing European insurers and how they are adjusting their investment approaches in response. BCG and AXA IM interviewed Chief Investment Officers (CIOs) from nearly 30 insurance companies across Europe, representing over €3 trillion in assets under management.
Nearly two thirds (68 per cent) identified low interest rates as their key challenge, followed by new regulations (58 per cent) and risk management complexity (47 per cent). Macro-economic uncertainty and related financial-market volatility were less troubling (26 per cent and 16 per cent respectively), which suggests that insurers may be growing accustomed to operating in the New Normal. What does concern insurers, however, is the prospect of continued political intervention in economics: almost one-third (30 per cent) of insurers cited political intervention as a major challenge, adding that it hinders their ability to make predictions and investment decisions.
The study found that whilst there is increasing appetite amongst CIOs to counter the impact of the low-yield environment by allocating to alternative sources of return, there has been very limited actual movement towards real diversification of investment portfolios. The majority of insurers pledge to allocate up to 10 per cent of their portfolios to alternative asset classes, however, most currently sit at only 2 to 3 per cent.
Laurent Seyer, Global Head of Multi-Asset Client Solutions at AXA IM:
"There is a clear first-mover advantage for those firms who take the steps to genuinely diversify their investment portfolios and access the most attractive asset classes in the market. As this survey highlights, insurance companies are talking about diversification, however, we are seeing little movement towards implementation. In fact, the financial crisis and new regulations have pushed insurers to hold their allocation to fixed income investments."
"Diversification can help an insurance company improve its risk / return profile. Moving into satellite assets can also help insurers find assets with less volatile cash-flow patterns than with publicly traded assets. This is important, as under IFRS regulation, it translates into lower balance-sheet volatility.”
The survey reveals that while European insurers recognise the need to better manage the volatility of their balance sheets by using hedging strategies, nearly half (45 per cent) currently employ no hedging mechanisms and cite the lack of internal know-how, resources and infrastructure as the main blocks. This raises questions around how they will manage volatility on their balance sheets with the onset of IFRS 4 and Solvency II in the coming years.
Deciding the optimal balance between managing assets in-house and outsourcing remains an issue for insurers. At present, fewer than 5 per cent of European insurance assets are outsourced to non-affiliated third-party asset managers, compared with 20 per cent of American insurance assets. Critically, during the interview process, no European CIO mentioned a structural reason for this failure to embrace outsourcing. Interviewees did cite ‘losing control of investment portfolios’, and ‘less transparency and risk control’ as barriers. On the flip side, having access to a partner with the required expertise, whom they can exchange ideas on a variety of topics is seen as a benefit.
The Asset and Liability Management (ALM) function is playing an increasingly important role in insurance companies’ corporate governance given the pressure to deliver on investment objectives. Seventy-five per cent of large insurers surveyed have been or are currently in the process of moving their ALM functions from a business level to a group level in order to create strong central units that can manage all asset and liability positions across all of their businesses.
Davide Corradi, Partner and Managing Director at The Boston Consulting Group:
"In our experience, the best practice insurers have invested heavily in centralising and optimising their asset and liability management processes and positions. As we are moving towards an economic balance-sheet world, having a tight grip on the ALM position is becoming an important source of competitive advantage. Insurers who are strong at this will have more flexibility to offer better value-creating products to their clients.
“However, centralised ALM, or even an understanding of the ALM position, is still far from standard practice throughout the industry. Many insurers still don’t have an ALM process in place. Our research has also highlighted a clear distinction between large and small-to-medium insurers, with the latter still relatively early on in this journey.
“Centralising the ALM process is not an insignificant business transformation. We have seen clients face numerous implementation difficulties in terms of pushback from internal stakeholders, the need to change performance attribution and measurement for executives, significant HR redeployment, and the courage to realign their investment portfolio to their target ALM position. To achieve a centralised ALM position requires senior management buy-in right from the top and a dedicated project team with a mandate to make real change."
The study demonstrates that current ‘best practice’ insurers have invested heavily in centralising and optimising their ALM process and are evaluating their investments and hedging needs in order to actively manage interest-rate and mismatch risks. It will be interesting to see if achieving outperformance in investment management moves from a ‘nice to have’ to a recognised source of competitive advantage for insurance companies.
The study can be downloaded here
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