Market complexity and shift to alternatives turns global insurers to outsourced portfolio management

From

Louise Watson

Global insurers are turning to alternatives to fill the void left by meager bond returns over the past decade of ultra-low interest rates, reveals Natixis Investment Managers’ global survey of 200 CIOs and investment team members at life, property and casualty and reinsurance firms.

A decade on from the financial crisis, investors still face significant difficulties presented by the low yield environment, resulting in increasing liabilities and the widening of the duration mismatch. As a consequence, insurers are willing to take on more liquidity risk in pursuit of higher yields, with three quarters (75%) stating allocation to alternative asset classes is essential, and over half (53%) saying they’re increasingly using alternatives as a fixed income replacement.

“Insurers have been squeezed by the low-yield environment over the last decade. The likes of private debt, private equity and other alternative investments provide a potential fix to underwhelming returns in the bond market, where insurers have traditionally turned to in the hope of finding stable returns to match their liabilities.” said Louise Watson, Managing Director for Australia, Natixis Investment Managers.  for Natixis Investment Managers in Australia. “We find that increasingly the industry is willing to take on liquidity risk in pursuit of higher yields to balance alpha generation with the cost of capital, while protecting assets against drawdown.

Regulatory barriers remain

The survey found that, despite the growth in appetite for alternatives amongst insurers, nearly all (89%) of insurance investment teams say regulations keep them from investing in these asset classes as regulatory capital requirements, for example, mean a natural portfolio orientation towards low-yielding fixed income.

This represents a significant increase compared to the same survey in 2015, when Solvency II had not come into force. In the 2015 survey only around half of insurers said regulation and capital requirements were frustrating attempts to invest in new and alternative asset classes.

In complying with regulations, insurance investors say the following are the top challenges facing their organization:

 

 

Despite this, nearly all insurers (93%) say they are well prepared for the changing regulatory environment – a major improvement from the 2015 survey, when two-thirds of European and US insurers admitted they were not ready for regulatory change.

CIOs turn to external expertise to navigate complex environment

The survey found that insurance executives say the main reasons they don’t use more alternatives in their portfolio are:

  • Complexity (51%)
  • Their organisation’s investment restrictions (42%)
  • Fees (42%)
  • Regulatory constraints (41%)
  • Liquidity issues (37%)

As insurers grapple with the regulatory and executional complexity that comes with the search for higher yield and moving into alternatives, investment teams are increasingly drawing on external expertise to access innovative and specialised capabilities. Seven in ten (72%) of survey respondents outsource some of their portfolios, with 10% of insurers delegating their entire portfolio to an outside firm. On average, insurance investors outsource nearly half (48%) of their portfolio.

 

 

“Investors are facing new challenges as the regulatory environment takes a firm hold of the industry, and it is unsurprising to see a majority turning to external specialists to help them navigate the many complexities of today’s market,” Louise Watson continued. “CIOs may struggle to add more resources in already stretched investment teams and there is greater need for good quality specialist advice and execution.”

Key points:

  • Global survey of 200 CIOs and investment team members reveals three quarters (74%) of insurers are struggling to balance generating alpha with the cost of capital in a low-yield environment
  • As bond returns fail to match liabilities, two thirds (66%) of respondents say it’s essential to invest in alternatives like private debt and real assets in order to diversify portfolio risk
  • However, barriers for entry remain and 97% say regulations are de facto stopping them from investing in higher risk, illiquid assets
  • Higher level of complexity associated with this diversification has resulted in two in three insurers seeking outsourced portfolio management to access innovative and specialized capabilities 

Read the full report.

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