Insurers looking to investment portfolios to improve profitability

Insurers are facing a profitability squeeze and are increasingly looking to their investment portfolios as a larger component of profitability, according to a study commissioned by BlackRock.

BlackRock’s sixth annual global survey of 300 senior insurance executives found that two-thirds of insurers agree that re-thinking the investment portfolio will be vital to maintaining or improving the future profitability of their business. Over two-fifths (41%) said they were under growing pressure to generate a greater contribution from investments to their overall profitability.

Against a backdrop of ultralow interest rates and challenging underwriting margins, insurers have taken numerous measures to grow revenues and cut costs in years past, and their efforts have helped somewhat: almost half of survey respondents (44%) reported no change to their profitability over the past five years, despite the headwinds facing the industry. To achieve these results, most insurers have primarily focused their efforts on underwriting and operational changes.

Now, however, two-thirds (66%) believe rethinking their investment portfolio will be key to improving future profitability. This is a major shift: only 28% of respondents have made generating higher investment returns their top priority historically.

An overwhelming majority of respondents (84%) state that embracing private market or alternative assets will be a key component in improving the returns of investment portfolios, while almost 70% see “significant room” to improve their management of portfolio risk and capital efficiency.

Patrick M. Liedtke, head of BlackRock’s insurance asset management business in Europe, commented: “Insurers are under increasing pressure to improve their profit margins against a backdrop of continued geopolitical uncertainty, the low yield environment, regulatory constraints and intense underwriting competition. We’re seeing attention turn to investment portfolios and performance as a greater source of total profitability. As appetite for increased investment risk exposure has ebbed over the last year, insurers are looking instead to optimize for risk and are turning away from traditional asset classes in order to generate returns.”

Risks rising up the agenda

As insurers look to improve returns from investment opportunities, an array of macro and regulatory obstacles remain. Geopolitical risk, encompassing worries over populism, protectionism and regional tensions, is now seen as one of the most serious macro risks the industry faces, selected by 71% of respondents, up from 51% in 2016 [1].

Concern around regulatory risk has also increased markedly. Almost two-thirds (64%) of insurers surveyed cited regulatory risk as one of the biggest challenges facing the industry, up 18% from 2016 (46%) and compared to just 40% in 2014. Over two-fifths (42%) of respondents highlighted the current regulatory environment as limiting the investment options available to their organization that would improve returns and drive total profitability.

Market risks have become increasingly pronounced, and for the first time in the survey’s history the three most cited market risks all scored above 70%. Liquidity risk and asset price volatility were both cited by 74% of respondents as one of the top three market risks posed to their firm’s investment strategy over the next 12-24 months, while a sharp rise in interest rates was cited by 72% of respondents.

Against this backdrop of perceived macro and market risk, 79% of insurers indicated that they feel comfortable with their current risk profile, up from 46% in 2016. The proportion of insurers looking to increase risk has dropped significantly, down to just 9%, compared to 47% in 2016.

The liquidity dilemma

Despite the appetite to leave overall risk profiles unchanged, insurers have signaled a move towards private market assets including illiquid assets. About two-fifths (39%) of those surveyed are looking to increase their allocation to private market assets, up from just 16% in 2016. Changes to asset allocation have already played an important role. According to respondents, the most effective investment action taken to increase profitability was an increase in exposure to private or alternative assets, with well over half (57%) stating this. Other contributors included increasing exposure to equities (35%) and extending the duration of fixed income portfolios (26%).

Insurers recognise that private markets will be critical to improving the profitability of investment portfolios and intend to increase allocations across the full spectrum of assets in the next 12-24 months. Just over a third of respondents (34%) intend to increase allocations to commercial real estate equity, which scores the highest of all private market asset classes, followed by infrastructure equity (33%) and private equity (33%).

Patrick M. Liedtke commented: “One of the key themes that has come to the fore in this year’s survey is how insurers are approaching their overall risk profile and levels of liquidity. While it is clear that insurers don’t want to increase their risk exposure, there is an increasing recognition that private market assets have the potential to provide greater returns than those available from more traditional asset classes. Sourcing the right assets will be one of the keys to unlocking that potential.”

Asset allocation trends also signal a move away from fixed income. Just 9% of respondents intend to increase allocations to government bonds, compared to 47% in 2016, while the proportion intending to reduce exposure has jumped to 31% from 3% last year.

Appetite for municipal bonds is also much weaker, with just 9% planning to increase allocations, compared to 42% last year. 16% of respondents plan to increase their weighting of high yield corporate bonds, down from 29% last year, with 33% opting to cut their exposure.

Capital management

Nearly three-quarters (70%) of respondents believe there is significant room to improve portfolio risk and capital efficiency management. Almost a third (30%) of participants say they are carrying more capital, relative to the amount required by their regulators, than they were five years ago, with 61% saying the level remains unchanged over the past five years. Respondents cited the needs to manage asset volatility (55%) and underwriting volatility (54%) as the main reasons for increasing or maintaining capital levels.

The need to manage asset volatility was also cited as one of the main justifications for carrying excess liquidity (51%). Insurers cited a desire to hold excess liquidity to be able to respond to rising rates (40%), volatility on the underwriting side of their business (40%) and regulatory requirements (36%). Overall however, three quarters of respondents believe their liquidity level is appropriate for their current and projected liabilities.