By Matthew Smith, Head of Client Solutions, Aberdeen Asset Management
Since the global financial crisis, Europe has been mired in an artificial world of low or negative interest rates. Life insurance has been among the industries most hard hit from the prolonged low rate environment. Many European insurers wrote policies prior to the crisis when market interest rates were much higher than today. Those obligations are becoming increasingly burdensome in the current low-yield environment.
As if that wasn’t enough, meaty demands from regulations like Solvency II, in particular its requirements for insurers to hold higher levels of capital for growth assets, is putting additional pressure on the profitability of insurance companies.
Together, these factors are forming something of a perfect storm for European insurers.
Asset managers can and do help. Insurers have long sought out services to provide solutions to the challenges that long-term liabilities inevitably throw up. The partnership is vast in scale and, given the factors mentioned above, one that is unsurprisingly growing. Asset managers manage approximately EUR 3.6 trillion for European insurance companies, which is estimated to grow to EUR 4.5 trillion by 2019.
Prometeia, an Italian consultancy recently conducted a survey of 60 asset managers in the insurance sector, including Aberdeen Asset Management (http://www.prometeia.it/en/AM-insurance-market-survey). In aggregate, those surveyed oversee around EUR 22 trillion for insurance clients. The survey’s findings highlight the various ways that asset managers are providing value-added services to insurance companies.
It shows that insurers are seeking asset managers who can help optimise their portfolios within the principals of Solvency II. One of the unintended consequences of the regulation introduced at the start of 2016 was insurers trying to minimise the Solvency Capital Requirement (SCR) and, as a result, reducing exposure to assets that have the potential to deliver greater returns, but which are more costly in terms of capital. That focus has now shifted to squeezing out extra basis points of risk-adjusted return within the constraints of the new capital requirements.
One of the key findings was that insurers are re-evaluating their strategic asset allocation as they search for yield. In particular, more esoteric areas of fixed income are being considered. Insurers’ long-term liability profiles mean many are able to sacrifice some liquidity to capture additional returns.
Approximately 20% of survey respondents recommend insurance clients invest in corporate and high-yield bonds, and a further 29% in alternative fixed income strategies including bank loans, infrastructure and real estate debt. Liquid alternatives (9%) and multi-asset fixed income strategies (10%) are also drawing interest from investors looking for additional yield and diversification.
These assets were previously the domain of only the most sophisticated insurance companies’ investment strategies. Yet given the current environment, smaller insurers are also seeking them. This poses fresh challenges. While being able to meet the regulatory reporting standards of Solvency II Pillar 3 is a pre-requisite, illiquid and alternative investments mean that insurers must have even stronger risk management and valuation capabilities to satisfy the requirements of Pillar 2. Perhaps as an illustration of how tough the investment landscape is out there, Solvency II’s implementation has not halted interest in these more illiquid fixed income investments, and alternative assets in general.
Alongside changes in asset selection and allocation, Prometeia’s survey highlights that insurers want their asset management partners to bring Solvency II into the heart of the investment management process.
Asset managers are evolving as a result – many, including us, now offer ‘Solvency II-optimised’ strategies. Fully 60% of surveyed managers offer at least one ‘Solvency II-friendly’ strategy, while a further 15% are working on one.
The survey suggests that some insurers’ in-house, or captive, asset managers lack the resource and/or capability to successfully deal with these challenges. Insurers are therefore outsourcing management of some assets/funds to external ‘non-captive’ managers who have the necessary expertise.
In summary, insurance companies face challenges but are finding ways to deal with them. As a seemingly large part of those solutions, asset managers need to be competent in tailoring solutions to clients in full knowledge of the regulations affecting insurers.
This is all the more important for non-affiliated, independent asset managers who will need to demonstrate a detailed understanding of how insurance companies approach their investment portfolio if they seek to win and retain insurance assets under management.
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