Pandemic era sees major shift in asset allocation, investment risk exposures and ESG practices
Neil Holmes
A new study from bfinance, the independent investment consultancy, reveals major shift in insurers’ investment portfolios, driven by a combination of long-term pressures and the effects of the COVID-19 pandemic.
The 2022 bfinance Insurer Investment Survey highlights substantial changes in asset class exposures, risk profiles, resourcing/headcount and ESG approaches, drawing on data from nearly 90 insurers in 20 countries (including Australia), whose combined investment portfolios exceed US$5 trillion.
Insurance firms in Australia and across the globe have found it increasingly challenging to deliver appropriate investment outcomes to support the needs of their businesses – a task which, before the era of rock-bottom interest rates, could often be achieved through relatively low-risk core holdings. This pressure has driven widespread innovation, which is now reinforced by the ongoing macroeconomic fallout of the pandemic
Some well-established shifts of the ‘pre-pandemic’ period such as diversification away from fixed income and towards ‘alternative’ investment strategies and illiquid investments, are observed continuing or accelerating through the ‘pandemic’ era and beyond — both for P&C insurers and their longer-term Life counterparts. Yet there have been notable changes in direction, with investors who had been leaning harder on the credit risk lever turning towards the equity risk lever. The data for the ‘pandemic’ period shows a significant slowdown in new entrants to corporate private debt (by far the most popular pre-pandemic portfolio addition), and an acceleration of new entrants for infrastructure. There has been particularly rapid acceleration in ESG-related activity through the COVID-19 period.
Key findings from the survey include changes that are expected over the next 18 months: 61% of respondents expect to enter unfamiliar asset classes in this period — with popular options including Emerging Market Debt, Private Debt, Private Equity, Infrastructure Debt and Infrastructure Equity — while 61% plan to cut fixed income allocations and 74% expect an increase in portfolio illiquidity. Insurers also expect further growth in the size of investment teams, which increased during the pandemic period, with 59% planning to increase ESG headcount.
Investment and risk
In the hunt to improve returns, insurers are dialling up on risk exposures and 73% say there is still scope to add more risk to the investment side of the balance sheet. The ‘average’ insurer now has 10% in equities, 7% in real estate and 8% in other alternatives. Respondents are also holding relatively high proportions of assets in dry powder, with allocations to cash or money market funds averaging 7% – and (typically more short-term oriented) P&C respondents averaging 11%.
The size of insurer is a major determinant of asset allocation. For instance, smaller insurers (<US$5 billion) have the largest average allocations to equities (13%) but the smallest average allocations to alternatives aside from real estate (5%). Meanwhile, life insurers are investing higher proportions in ‘alternative’ investments than their P&C counterparts (11% versus 7%).
Notable key shifts asset allocation include: 68% of insurers increasing allocations to alternative investments (other than real estate) in the last 18 months, rising to 79% in the next 18 months; 55% of insurers decreased fixed income exposure during the pandemic period, rising to 62% in the next 18 months. The COVID-19 period also brought a clearer shift in favour of adding equities exposure. Of the major ‘risk’ levers – credit risk, equity risk, duration risk, illiquidity risk – the strongest trends in the past five years have been towards credit risk and illiquidity. Today, bfinance sees a decline in the proportion of insurers adding credit risk but the movement to increase illiquidity appears stronger than ever, with three quarters expecting to do so over the next 18 months.
Recent years have also seen a large push among insurers towards the introduction of new asset classes in portfolios, and this looks set to continue with 61% expecting an increase in the number of new asset classes in the next 18 months. For example, 52% of insurers now invest in Infrastructure Equity, up from just 36% in March 2020, and the figure is expected to rise to 68%. 62% now invest in Emerging Market Debt, up from 49% in March 2020, and the figure is expected to rise to 75%.
Resourcing and governance
The growth in complexity of insurers’ investment portfolios has significant implications for resourcing. Changes have been supported by an increase in internal headcount and/or greater use of external asset managers. Nearly half of insurers (46%) have increased their investment personnel headcount during the pandemic period (March 2020 – September 2021), and more than a third are expecting to do so in the next 18 months. This continues a long-term trend. Looking ahead, three in five insurers (59%) will add dedicated ESG staff during the next 18 months, representing a substantial acceleration of the pre-existing trend.
Recent innovation has also created challenges around alignment and governance. Just 56% of insurer respondents indicated that their board and senior management team are “strongly aligned” with the delivery of “successful” investment outcomes over the medium term (three-to-five years), while only 28% said their risk team is “strongly aligned” on this point.
Expanding investment capabilities and more ambitious outcomes are being underpinned by an increase in investment outsourcing. Survey results reveal a trend towards external management in all asset classes other than core fixed income. 28% of insurers investing in real estate intend to increase the proportion of the real estate portfolio that is externally managed over the next 18 months, versus 2% who anticipate insourcing, while the results for other alternatives are 21% and 4% respectively.
ESG overhaul
Within the insurer community, there has been a massive increase in focus on ESG considerations. 71% integrate ESG factors into the investment process, up from 32% in March 2020, and 76% do negative screening/exclusions, up from 45% in March 2020. Moreover, for nearly one third of insurers, the goal is to be “ahead of the curve on sustainable investing”, including half of the larger (>US$25 billion) insurers and 38% of Europeans. Only 7% of insurers said that ESG is a “low priority issue for us”.
There is a dramatic and ongoing increase in the use of various ESG-related investment practices, including ESG integration, active engagement, exclusions, impact investment and more. The proportion of insurers involved in active engagement (via external managers) has almost doubled in 18 months, while the proportion who have adopted ESG integration has more than doubled in 18 months. More than half of insurers now consider Diversity and Inclusion issues as part of their investment activities, and around one in ten say that D&I is an “important consideration”.
Newer practices that are rapidly rising in popularity include carbon reporting (40%) and impact investment (43%). Although smaller insurers and North American insurers may appear to be somewhat behind the curve, these gaps are closing: North American insurers, for example, are showing the greatest level of interest in entering impact investing (65% planning to do so).
The results suggest that one third of insurers have made “Net Zero” commitments at company level and 37% are planning to do so. For investment portfolios, the data indicates a smaller proportion of Net Zero commitments, with only 24% putting these in place so far and 40% planning to do so. There is a large gulf between North America (0%) and the rest of the world, but we see a significant catch-up in store (40% planning).
In terms of challenges, two thirds of respondents say that “obtaining robust ESG-related data” is a “major obstacle” to implementing their ESG strategy, with nearly half indicating that resources/staffing presents a “major obstacle” – supporting the significant trend already noted for rising ESG headcount. Only 22%, however, pointed to challenges around “validating the investment case” (i.e., obtaining conviction that returns will not be compromised). Importantly, just 6% said that senior management commitment/understanding is a “major obstacle” in this space.
Neil Holmes, Director of Insurance Client Consulting at bfinance, said: “Through recent years, bfinance’s Asset Owner Surveys have aimed to help our clients and other investors understand key trends from a practitioner’s perspective. This is our first dedicated survey focused specifically on insurers, in recognition of the major changes taking place within this sector and our own work for more than 75 insurer clients globally. The inaugural Inaugural Insurer Investment Survey illustrates key trends before the onset of the pandemic, the key shifts since that time and insurers’ plans for the future. The findings showcase insurers’ increasingly diverse investment portfolios and very significant evolution in ESG investment approaches.”
Frithjof van Zyp, Senior Director, Client Consulting at bfinance (Australia), said: “Insurers in Australia and across the globe have been innovating to improve investment outcomes against a challenging macroeconomic backdrop. The findings of the bfinance’s global insurer survey are based on data from nearly 90 insurers across 20 countries, with aggregate investment portfolios valued in excess of US$5 trillion. Respondents include insurers in Australia and the results confirm a continued focus on ESG, movement away from fixed income towards “alternative” investment strategies, and the increased use of external managers. These trends are very much in line with our experience supporting Australian based Insurers.”
