January 4, 2018

United States, New York

Insurers encouraged to adjust investment approaches in anticipation of emerging risks

Mercer, a global consulting leader in advancing health, wealth and career, and a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), today detailed key investment ideas for insurers to consider as they manage their assets through 2018 and beyond. 

“With global equity markets at all-time highs, interest rates expected to rise, and continued geo-political risks, insurers need to adjust their investment approaches accordingly,” said Ravi Rastogi, Partner, Mercer Insurance Investment Team. “Insurers will also need to ensure that their internal governance and investment risk frameworks can handle any shocks that may arise.”  

The key themes outlined in the white paper, Can Insurers Relax While Central Banks Unwind? Top 10 Investment Ideas for Insurers in 2018, include: 

1. Plan for central bank actions

The US Federal Reserve raised interest rates during 2017 and 2018 is expected to see further rate increases. The European Central Bank (ECB) announced plans in late October 2017 to scale back its quantitative easing (QE) programme. These central bank actions are expected to increase yields and, eventually, steepen yield curves. As such, insurers should consider their investment positions – by reviewing any material Asset-Liability mismatches and, potentially, shortening fixed income duration in surplus assets. These actions may bring advantages if rates rise faster than expected. Further, caution is advised around exposure to credit, due to the potential for spread widening. 

2. Crystalize investment beliefs

It is generally rare for an insurer to review “first principles” when evaluating its investment strategy. Typically, current strategies are developed over a number of iterative stages, with each one targeting a single objective or new asset class. While this addresses an insurer’s stated key metrics, it may not fully reflect the underlying investment beliefs of the asset owners. Insurers would benefit from developing a robust statement of their investment beliefs which could help facilitate more nimble investment decision-making and ensure the asset owners are informed and on board.

3. Ensure the investment operating model is “fit for purpose”

Insurers should not lose sight of their underlying investment operating model, even if it is tempting to react to market events as they occur. A “health check” review of the investment operating model can be a simple, yet valuable tool in highlighting potential gaps, by benchmarking current approaches against industry best-practice.

4. Integrate ESG

Insurers continue to increase their focus on Environmental, Social and Governance (ESG) factors when considering their approach to investments. There are now almost 60 insurance signatories of the UN Principles for Sustainable Insurance, some of whom have even linked executive pay to ESG outcomes. Insurers should consider their approach to ESG and their investment decision-making across 6 main themes: ESG benchmarks and screening; stewardship and impact investing, internal ESG resource; ESG initiative signatory status; engagement with asset manager; and public disclosure, to ensure reporting meets the rapidly developing best-practice.

5. React to regulatory changes

Insurers need to ensure that their business models and internal processes have the robustness and agility to enable them to fully understand the consequences of new and changing regulations, and to take action if required. Specific regulatory developments that may impact an insurer’s investment approach include IFRS 9 and IFRS 17 and Solvency II-like capital adequacy regimes (e.g. SAM in South Africa and C-ROSS in China). In Europe, although Solvency II has now been embedded, many of the parameters of Solvency II are being reviewed, including capital charges for market risk and look-through requirements for assets.

6. Ensure fee efficiency to maximise net return

Insurers should be doubly focused on maximising the fee efficiency of their investments when yield is more difficult to obtain. Regular review of all costs (internal and external) against market norms and peers is a key step. Insurers looking to minimise asset manager costs through the use of internal resource should ensure that the true costs they face are regularly benchmarked against the best outsourced alternatives. Whilst insurers looking to invest in potentially better rewarded, but higher cost assets, should appropriately balance the expected higher return against the increased fees.

7. Investigate asset class risk premia developments

Insurers have continued to investigate different sources of return in non-traditional asset classes (e.g. private debt). That said, there may be further benefit from alternative risk premia within more traditional asset classes. However, while many of the more esoteric risk premia strategies may offer attractive financial benefits, there also needs to be consideration of the transparency offered, as well as the reporting and capital requirements.

8. Prepare for the late credit cycle and associated shocks

Expectations are that developed economies, and the US in particular, are approaching the later stage of the credit cycle. In the late cycle, risk premia typically compress, and there is a danger that aggregate risk appetite becomes excessive. Associated economic pressures cause central banks to tighten monetary policy, causing risk premia to expand and risk appetite to fall. Given the extremely accommodative monetary policy that has been prevalent in recent years, there is a chance that the late cycle this time around will be more dramatic than usual. Insurers should, therefore, ensure that their portfolios are prepared for the potential widening in credit spreads and an increase from the low current level of defaults.

9. Move from public to private markets

Many insurers have moved to higher risk strategies due to a need for sustained investment returns in a low yield environment. Though these strategies may have met investment goals, they will also have led to increased mark-to-market volatility and capital requirements. An alternative approach for insurers who want to keep the overall level of market risk the same, is to move from listed markets to private markets within an asset class (e.g. to move from listed debt to private debt of equivalent credit quality). This action offers a material illiquidity premium to insurers, to increase returns without necessarily increasing market risk. Though insurers do need to be comfortable supporting the lower level of liquidity in such investments, these kinds of strategies can provide a very real boost to return expectations, without the increase in market risk that might be required from public markets.

10. Active decisions enhance returns

Though the investment environment over the past decade has generally been supportive for asset returns, shifting monetary policy and the potential for a more challenging environment facilitate the need for a more dynamic approach to asset allocation. A more active approach could be delegated to an outsourced manager or managed internally through an insurer deciding on whether to underweight and/or overweight different asset classes and exposures in its portfolio. Insurers considering delegation should first create a strong risk, governance and operational framework. This kind of framework may mitigate slow implementation and measuring the wrong metrics, which typically lead to missed opportunities.

The Top 10 investment Ideas for Insurers in 2018 white paper can be found here

About Mercer
Mercer delivers advice and technology-driven solutions that help organizations meet the health, wealth and career needs of a changing workforce. Mercer’s more than 22,000 employees are based in 43 countries and the firm operates in over 130 countries. Mercer is a wholly owned subsidiary of Marsh & McLennan Companies (NYSE: MMC), the leading global professional services firm in the areas of risk, strategy and people. With more than 60,000 colleagues and annual revenue over $13 billion, through its market-leading companies including Marsh, Guy Carpenter and Oliver Wyman, Marsh & McLennan helps clients navigate an increasingly dynamic and complex environment. For more information, visit Follow Mercer on Twitter @Mercer.
This does not constitute an offer to purchase or sell any securities nor does it contain investment advice relating to your particular circumstances. No investment decision should be made based on this information without first obtaining appropriate professional advice and considering your circumstances.