• Insurers weigh short-term impact of QE with unknown long-term imbalances
• Alternative income sources in favour
• Solvency II and liquidity concerns create complexity
Against a backdrop of loose central bank policy, depressed bond yields, and stuttering economic growth, BlackRock’s research, conducted by the Economist Intelligence Unit, found that quantitative easing’s (QE) impact on asset prices has caused insurers’ risk appetite to nearly double, with 57% planning to increase risk exposure over the next 12-24 months, compared to 33% a year ago.
Patrick M. Liedtke, head of BlackRock’s insurance asset management business in Europe, said, “Insurance companies operate in an extremely challenging investment environment. QE has driven insurers to take on significantly more risk than in previous years, and central bank policy divergence is a looming challenge to their businesses.”
Monetary policy challenges
Insurers are weighing the short-term benefits QE and monetary policy have had on asset prices and economic growth, with the long-term market imbalances these policies could potentially create. 49% have made significant changes to their investment strategy in response to QE and monetary policy, while a further 43% intend to make changes over the next 12-24 months. 83% of global insurers expect QE and ongoing monetary policy to support price levels in the next two years.
However, many also worry that QE and monetary policy have the potential to create imbalances in markets that negatively impact the economy, as well as create an unsustainable environment for the insurance industry. The persistently low interest rate environment is viewed as the main market risk (44%), followed by a sharp rise in interest rates (36%) and asset price correction (33%).
As a result, and in order to create more room for tactical manoeuvres in the future, nearly half (47%) of respondents expect to increase cash holdings over the next 12-24 months. More than one-third (36%) plan to increase cash holdings more generally. Importantly, this includes nearly half (45%) of those looking to increase their risk exposure.
Liedtke added: “The macroprudential picture is causing a lot of people to have one foot on the accelerator and one foot on the brakes at the same time, which unsurprisingly makes driving the balance sheet difficult.”
Alternative is the new standard
82% plan to increase holdings in one or more income-generating alternative credit asset classes like commercial real estate debt, direct lending to SMEs, and direct commercial mortgage lending – domains traditionally dominated by banks.
This is significant as insurers have traditionally been heavily invested in investment grade government and corporate debt securities. As traditional bank lenders have pulled back from the lending market in recent years, BlackRock’s survey suggests insurers have - at least partly - picked up this slack, lending to commercial real estate development and to small and medium enterprises (SMEs).
“Insurers are turning to a broader range of assets, particularly income-generating alternative credit investments such as direct lending, in order to diversify returns and boost income. But it isn’t easy as these markets often aren’t their natural habitat, and there are barriers to being successful here,” added Liedtke.
Solvency II-style regulations force insurers’ hand
Regulatory change is highlighted as the most critical driver of industry change in the insurance industry in the next 12-24 months, with 49% citing this.
Stricter capital requirements under Solvency II which take effect on January 1st 2016 are pushing European and global insurers – particularly those with lower solvency ratios - to increase holdings of investment grade fixed income and diversify under tighter risk budgets. Surprisingly, and contrasting with the trend towards alternatives, the number of respondents looking to increase their holdings of investment grade fixed income assets has nearly doubled to 45%, from 24% a year ago.
Liedtke stated, “If you don’t get Solvency II right, you won’t attract capital to your business. Those with higher solvency ratios can branch out further and invest in higher returning strategies which carry higher capital charges with them. But for those with lower solvency ratios, this is becoming more difficult as monetary policy, strong demand for quality paper, and financial regulatory reform have contributed to reduced dealer inventories and lower bond turnover, pressuring fixed income liquidity.”
Liquidity concerns push insurers towards derivatives and ETFs
More than two-thirds (68%) of insurers say a lack of liquidity is making it difficult to access fixed income investments and roughly three quarters (73%) believe that liquidity is lower than pre-financial crisis levels. As a result, the majority of insurers are planning to increase use of derivatives (69%) and exchange-traded funds (67%), citing a lack of liquidity in investment grade fixed income as a key driver of this.
Liedtke said, “The mix of divergent central bank policy, bond market liquidity risk, and a heightened regulatory regime, presents the industry with a dilemma. Opportunities exist to protect balance sheet health and maintain challenged business lines, but investors need to quickly get familiar with diversifying portfolios into higher-risk, higher-yield assets, and also closely manage the risks inherent in these new areas.”
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