Managers Must Help Insurers Achieve Portfolio Harmony

Managers Must Help Insurers Achieve Portfolio Harmony
As rate hikes loom, selectivity, duration, and timing are crucial when adding investments

August 2018, London. European insurers are considering how to position their portfolios in anticipation of interest rate rises, though 2017’s high catastrophe losses mean non-life firms remain under pressure to extract risk-adjusted returns from their growth portfolios, according to The Cerulli Edge―Europe Edition.

Rising US interest rates have seen insurers in the country shorten their portfolio durations and capitalize on improved treasury bond returns. In Europe, however, where rates are expected to remain at very low levels for the next 12 to 24 months, there has been only a slight repositioning, says Cerulli Associates, a global research and consulting firm.

Justina Deveikyte, associate director, European institutional research at Cerulli, believes the current strategic moves by insurers in the US foreshadow similar trends in Europe within the next couple of years, assuming European central banks go through with anticipated rate hikes.

US treasuries have begun to offer attractive returns, giving insurers with US liabilities a useful investment buffer with which to offset insurance losses and maintain competitive insurance pricing. As a result, a flight to quality is underway, while insurers are also favoring shorter duration fixed-income positions to allow leeway for further rate hikes.

“While the median duration of European life insurers’ technical provisions dropped in 2017, durations continued to extend overall. These insurers have been trying to add duration to their portfolios to close the duration gap between their assets and liabilities, but with gilt yields still at dismal levels they will be wary of locking themselves into longer duration assets too early,” says Deveikyte.

She notes that, while property and casualty (P&C) insurers are looking to position themselves defensively against rising interest rates, life insurers are tending to stick closer to the path determined by their asset-liability-matching frameworks. However, proposed changes to Solvency II that would penalize interest rate matching gaps at the shorter end of the yield curve could force European P&C insurers to close their duration gaps with long-dated products, limiting their ability to tactically defend against future rate hikes.

Cerulli believes most European insurers will continue to employ a strategy of seeking out diversified risk-adjusted returns beyond local government bonds and highly rated corporates until meaningful rate rises significantly improve the appeal of high-grade bonds. Hard currency emerging market debt, private credit, mortgages, and other specialist asset classes all remain attractive on a risk-adjusted basis—particularly for P&C insurers seeking to offset hits to their balance sheets from last year’s catastrophe losses.

“Liquidity in the face of major losses is, of course, essential, but Cerulli believes most insurers will absorb the catastrophe losses into their capital buffers and continue to increase their investments in sophisticated private-credit strategies and illiquid classes such as real estate and infrastructure using their surplus assets,” Deveikyte adds.

“Managers should adhere to their primary goals of helping insurance clients match assets to their liabilities while optimizing income in a low-yield environment. However, the onset of rising rates makes prudent timing and duration management vital when adding new investments.”

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