Low rates and new regulations are beginning to drive European insurers to diversify their asset allocation by investing in new, more illiquid, asset classes, notably private loans, says Moody's Investors Service in a new Special Comment published today. The report, "European Insurance: Low Rates and New Regulations Will Drive Increase in Illiquid Investments" is available now.
Moody's believes that the trend towards greater diversification will accelerate in the coming years for three main reasons. First, insurers are keen to reduce concentration risk to sovereign and banking debts that are no longer perceived as risk-free. Second, interest rates are at historically low levels, and insurers, both P&C and life, will increasingly chase yields. Third, the introduction of Basel III and the resulting deleveraging from banks creates new investment opportunities for insurers, and there is an increasing willingness from public authorities to incentivise insurers to, at least partly, replace bank financing.
"We expect insurers to progressively reduce their exposure to banking bonds, including covered bonds, and replace part of this exposure with investments in corporate loans or other types of loans. Sovereign bonds will remain an important asset class for insurers because they offer long durations, which enable insurers to match the duration of their liabilities, a key area of focus for Solvency II", says Benjamin Serra, senior analyst at Moody's.
Moody's says that insurers will increase their investments in direct property and also indirectly through mortgage loans. Insurers could diversify their non-fixed-income portfolio with, for example, some trade-off between listed equities and alternative investments. Investments providing regular cash flows, such as infrastructure, will nonetheless be favoured. As such, a substantial increase in equity weighting from current levels is unlikely.
Moody's report indicates that there will be only minor changes to investment portfolios in the next 12-18 months. However, if the low interest rate environment continues and investment opportunities arise, more material shifts in insurers' portfolios will occur. In the long-term, the rating agency expects that insurers will increase their exposure to real estate and loans at the expense of public corporate bonds and covered bonds.
Moody's anticipates that these changes will have negative credit implications for insurance companies for two main reasons. First, the weight of illiquid investments is likely to increase substantially, which, even though insurers remain generally very liquid, is credit negative. Second, some insurers have limited expertise in some of the illiquid asset classes, and some of these classes still lack a consistent legal and contractual framework, hence carrying particular risks for investors.
Moody's subscribers can access this report via the link below.
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