The search for yield and higher returns has been a dominant concern among insurance company chief investment officers since they were thrust into the “lower for longer” world of constrained returns in the wake of the global financial crisis.
Asset managers have been increasingly creative as they have looked at ways of delivering solutions that will meet insurers’ needs in that search for better returns than they could squeeze out of their government bond-dominated portfolios. Corporate bonds, a new generation of asset backed securities and infrastructure bonds, all formed part of the growing menu of alternative assets being offered to insurers. Many of these promised strong returns and were carefully constructed to meet the demands of asset liability matching and the Solvency II regime. For non-life insurers presented with these new opportunities almost without fail their first thoughts would be about liquidity.
Asset managers sometimes seemed to weary at the constant questions about liquidity but CIOs at non-life insurers know that they must always be ready to provide cash to meet major claims. They cannot afford to have money tied up in assets that cannot be sold quickly, either because no market exists at the vital moment or because values are vulnerable to sudden erosion. They do not have the relative luxury of their long-term cousins to patiently ride out storms.
The Covid-19 pandemic has reminded us why that relentless focus on liquidity is so important. Insurers, especially those exposed to business interruption, event cancellation and travel insurance claims, need cash to pay those claims, estimated globally at over US$200bn.
Ratings agencies have been scrutinising insurers’ balance sheets for signs of weakness. They have largely concluded that the decade of regulatory reforms have put the industry in a good position to meet these claims. Capitalisation is strong, as the UK industry was about to demonstrate to the Prudential Regulation Authority in the now postponed climate change stress-testing exercise. In particular, the agencies see the lack of exposure of the non-life sector to the volatility of equity markets has been seen as a positive factor. Alongside this has been insurers ability to raise money in the markets seems undiminished as both Hiscox and Beazley have demonstrated to the tune of £375m and £247m respectively.
There are warning cones being raised over some assets likely to be sitting in insurer portfolios, however.
Central bank action, especially from the Federal Reserve, has ensured the wobbles in the corporate bond market did not lurch into instability. Indeed, bond issuance is buoyant but there are warnings that this represents a deferral of problems as it is extending refinancing and increasing leverage. Down the line there will be a reckoning for some firms and insurers will not want to be holding the wrong bonds when that day comes.
There are also nervous eyes being cast across the commercial property market, another core asset for many insurers. Construction projects have been delayed by the pandemic. As they re-start, investors will worry about what the new normal – widely expected to see a significant shift to home-working – means for the occupancy rates of those new offices. Rents will be squeezed and are likely to remain depressed for several years. Although the boom in building major retail developments is largely over, those holding large exposures to them must be worried about their ability to produce the returns once expected of them.
There are many questions to be asked about how insurers are facing up to these challenges. Is there any consensus? What assets will be winners and which will non-life insurers shun in the future?
Liquidity will be everything in the short to medium term as insurers strive to de-risk portfolios but just how they will go about achieving that is now a question many are seeking to answer. $200bn of claims to pay already and no-one knows what the course of this pandemic will be, especially as summer fades into autumn and winter. And what was that about a climate change driven catastrophe? Keep the cash handy.
We aim to tackle these questions and many more when, together with our sister company Research in Insurance, we launch the UK Insurance Investment Study later this month.
If you are an Investment Director/Manager at a non-life insurer who would like to anonymously take part, or an asset management firm who would be interested in the compelling insights the study will provide, please get in touch with Phil Davison or Richard Ley.