Swiss Re’s latest sigma study, #5/2010, – “Insurance investment in a challenging global environment” – warns that a “low yield environment coupled with tighter regulatory standards could hamper insurers’ investment returns, leading to lower profits for the industry and higher rates for policyholders.”
The study points out that the ongoing financial crisis has created a “new, challenging environment for insurance investment managers. In its aftermath, government bond yields have reached historically low levels that may persist until the global economy truly recovers. Changes in regulatory standards such as mark-to-market accounting and heightened risk charges on certain asset classes could lead insurers to invest more heavily in low-risk, low-return assets.”
The changes are of special importance to the insurance industry, as it is one of the largest investors in financial assets. Swiss Re pointed out that at the end of 2009, “insurers worldwide held nearly $23 trillion of assets. “Together with mutual funds and pensions funds, they are by far the world’s biggest investors. Life companies held $19 trillion in investments, while non-life insurers held the remaining $4 trillion. The four largest national markets – US, Japan, UK and
France – held more than $14 trillion, or 60 percent of world insurance assets.
Insurers tend to invest conservatively. David Laster, one of the authors of the new sigma study, stated: “Both life and non-life insurers hold most of their assets in government and highly-rated corporate bonds. Nonlife companies hold proportionally more cash and equities, while life companies hold more loans and fixed income instruments and less cash.”
The financial crisis has spurred on the trend towards tighter regulation of where insurers invest their capital. Swiss Re noted that the current plans call for “stricter accounting and regulatory standards as well as higher capital charges on some investments may encourage insurers to allocate more of their assets to government securities at a time when yields are extremely low and sovereign bonds are no longer fail-safe investments.”
Raymond Yeung, the study’s co-author, stated: “Bond yields in safe haven countries like Germany and the US are at record lows, and are even lower in Japan. Escalating national debt has heightened the financial vulnerability of sovereigns.
“By making some allocations to additional asset classes, such as emerging market equities and real estate, insurers can build portfolios that earn higher expected returns at no additional risk. Any unnecessary restrictions on their ability to do so can compromise their investment performance and their ability to achieve the risk-return profile that best serves the needs of policyholders and shareholders.”
Swiss Re also pointed out that a requirement for US insurers to “allocate half of assets to Treasury bills and half to Treasury bonds would have reduced returns by 1.5 percent a year from 1991-2008.” Laster explained that “if this requirement were applied to the industry’s global insurance assets of $23 trillion, it would cost insurers over $1 trillion within three years.”
A consequence of requiring insurers to invest heavily in government securities would be a reduction in investment returns, which would in turn put pressure on “life and non-life insurers to raise premium rates in order to maintain profitability.”
Yeung noted: “Higher insurance prices would adversely impact policyholders, as some consumers and businesses would scale back coverage, or forego it entirely.” Laster added: “Annuitants and pensioners would receive lower payments and more clients would opt for other, riskier, investments, thereby losing the benefit of insurers’ investment expertise.”
The report also concludes that the financial crisis has “modified the behavior of many insurance asset managers. First, insurers are much more commonly managing their investments with an awareness that crises occur on a regular basis. Second, for some insurers with low or negligible equity allocations, increasing their allocation to equities improves their overall risk profiles. Third, because of the robust relative outlook for emerging markets, allocations to these countries are increasing. Fourth, insurers concerned about inflation risk are partially mitigating it by investing more in commodities, real estate and inflation-indexed bonds. Finally, a growing number of insurers are turning to third party asset managers for managing at least part of their portfolios.
Source: Swiss Re