Insurers, due to their large reserves of cash, are some of the largest investment players around. However, the investment environment is becoming increasingly challenging, making it necessary for insurers to look at their strategic asset allocations to gain better returns and capture the opportunities provided by the market.
According to Tim Antonelli, multi-asset strategist at Wellington Management, insurers face several investment hurdles, such as greater regulatory scrutiny, changes in accounting standards, historically low interest rates, and an increasingly complex invested-asset universe.
“In addition, we believe the credit cycle is entering its later stages, economic growth is beginning to slow and risk from geopolitical events is high,” he told Insurance Business. “All told, there’s no shortage of externalities to consider.”
Antonelli also observed that while yield remains important, some insurers seem to be letting up in chasing better yield, and are more cautious in their investments. There’s a renewed focus on quantifying liquidity, given the significant push into illiquid assets (e.g. private debt, private equity, direct loans, hedge funds) over the past five to 10 years.
“We’re also seeing some of the most sophisticated investors embed risk mitigating techniques into their investment strategies, such as downside hedging, risk factor oversight, and volatility-based rebalancing,” he said.”
At this mature stage of the credit and business cycles, Antonelli believes that robust strategic asset allocation studies are important for insurers. To start, a study should consider the appropriate size of exposures to various asset classes, but it should also examine whether each asset class is conforming to its expected risk and return profile, and whether all the asset types are performing holistically as intended in terms of their cross-correlations with each other. Fine-tuning allocations within the insurer’s existing risk-asset budget will become increasingly important as market volatility intensifies.
“Strategic asset allocation should address the potential for fluctuations in capital markets, as well as the prospect of significant climate change in coming decades — an issue where insurance companies are on the front lines, given the long-term and often physical nature of their risk exposures,” Antonelli said. “Alternative investments can offer investors potential return streams with little or no correlation to traditional public market assets, a characteristic that may be especially useful in the later stages of a cycle. In addition, alternatives can be a gateway to investing with a focus on climate change.”
‘Sustainable investing’ and climate change
Having mentioned climate change, Antonelli explained how insurers can navigate ‘sustainable investing’, which is emerging as a new avenue for investments globally.
“An important first step in considering sustainability is to assess how your business is currently positioned, not only on the asset side of your balance sheet, but also within underwriting,” he said. “While firm financial commitments from global insurers are a positive for the sustainability movement, real change will only occur after current risks are quantified. At Wellington Management, we partner with our clients in calculating their risk exposures across numerous ESG factors (including climate change) both within the sectors in which they invest, and also across the business lines they underwrite.”
Increased climate awareness among insurers is mostly caused by regulatory pressure. Antonelli mentioned the Monetary Authority of Singapore (MAS) as one of the more proactive ones when it comes to sustainable investing.
“The MAS, for example, has been outspoken on getting insurers on board with climate awareness, noting that insurers are at the forefront of environmental issues given that they wear three hats: that of ‘environmental’ risk carrier, risk manager, and investor, and the development of sustainable insurance is strongly encouraged,” he said.
He added that with regard to integrating climate awareness into investment decision making, many insurers assume that a move towards sustainability and climate-aware investing must begin with exclusionary investing practices only.
“I would disagree,” he said. “In fact, you might find areas that have the potential to be more problematic over the longer term due to climate change, to be attractively priced in the current market at certain valuations. Effective risk management doesn’t always mean you should exclude, instead it means you are making sure returns compensate for the risks.”
Wellington Management, he added, is working with the Woods Hole Research Centre, a leading climate research institute. The two parties are working together to create quantitative models to help analyse and better understand how and where climate change may impact global capital markets.
Antonelli advised that new opportunities within the climate-aware space allow insurers to be creative with where they are investing.
“This doesn’t mean blindly investing in green bonds,” he said. “Instead, look for ‘gems’ in the traditional public sectors, such as air-conditioning-focused industrials and pool manufacturers where demand could increase as humans adapt to a warming world. Another possibility would be assets that stand to benefit from the increased need for pest control, because extended summers are stimulating an increase in pest populations.”
