The shift from public to private investments among insurers is continuing and the coronavirus crisis has not changed that so far. The crisis has, however, emphasised the added value of managing risk budgets rather than maintaining strict limits on allocations to different asset classes.
This flexibility makes it possible, for example, to benefit from short-term market dislocations, says Etienne Comon (photo), head of insurance asset management EMEA, Goldman Sachs Asset Management (GSAM). We spoke to him on the occasion of the publication of the annual GSAM Insurance Report.
‘During the crisis, decisions had to be made quickly. In the turbulent markets of recent months, insurers have started to look differently at many things, such as maintaining separate euro and dollar portfolios,’ he says. ‘Both internal and external asset managers have been given more room for manoeuvre by focusing on risk budgets instead of limits to currency holdings.’
Does this mean insurers have increased risk overall? ‘It’s not about the level of risk, but more about the agility in the use of the risk budget,’ says Comon.
Annual survey
For the ninth edition of its annual survey, GSAM interviewed 273 CIOs and CFOs of insurers worth $13,000 billion in total, which is roughly equal to half of the global insurance market. Traditionally, the survey is conducted in the month of February. But the outbreak of the coronavirus crisis suddenly rendered the results outdated.
‘We therefore conducted additional interviews in June and carried out various analyses on our own available data on the insurance market,’ says Comon.
GSAM manages $300 billion on behalf of insurers worldwide and therefore believes it has a representative insight into the changes that have recently been made by insurers in terms of risk budgets and rotations in investment portfolios.
The pre-corona survey shows that CIOs had made only negligible changes to their long-term investment strategies over the past year. An observation that, according to Comon, has also persisted during the crisis.
Risk reduction
‘Insurers had been anticipating the nearing end of the credit cycle and had therefore already reduced risk. This has not changed since,’ he says. Moreover, their conservative allocations protected insurers to some extent during the crisis, according to Comon. ‘In addition, European insurers, and Dutch insurers in particular, have increased their interest rate hedging in recent years, partly under the influence of Solvency II. This also offered protection.’
However, the success of this moderate risk policy in the short term may lead to insufficient returns in the long term. After all, the lower for longer scenario means that the costs of hedging interest rate risk are relatively high and insurers will ultimately have to look for alternative, more risky asset classes.
‘De-risking the portfolio will be necessary at some stage because insurers also have to make a certain return.’
Comon therefore does not expect risk aversion to continue for an extremely long time. ‘At the end of March, we saw that credit spreads and illiquidity premiums were skyrocketing and insurers were already taking on more credit risk in some cases.’
Risk of downgrades
But what about a possible fear of company downgrades as a result of the crisis? This is certainly a risk that needs to be monitored as it could cause a double whammy to insurers, Comon warns. ‘Under Solvency II, the capital requirement of credits is based on ratings and maturity. In case of a credit rating downgrade, not only will the value of the bond be reduced, but the capital requirement will also be higher’. In response, European insurers already tried to mitigate that rating risk in April and March by buying debt securities with shorter maturities.
Partly as a result of this, private assets continue to be in demand. ‘But bear in mind that risk levels of private investments vary widely. Where, for example, insurers have used private credit to mitigate volatility risk and the risk of downgrades, it is embedded in a barbell approach. This means a relatively large proportion in government- and government-related paper and a small proportion in lower-quality paper that, provides higher yields.’
Here, the risk of a credit downgrade is lower and there is a trade-off between default risk and downgrade risk, as it were, Comon explains. ‘In some cases, insurers take the higher capital requirement for granted. Sometimes it is better to have a higher but stable capital requirement than to have a lower initial capital requirement with high volatility.’