Europe Union (EU) insurance companies are adapting their investment approach via diversification and hedging techniques, yet much of the industry has a long way to go in responding to the challenges of the present low interest rate environment, and the prevalence of regulation and risk management. These were the key finding from a joint study by The Boston Consulting Group (BCG) and AXA Investment Managers (AXA IM).
The joint BCG and AXA IM report entitled ‘Adapting asset management strategies to the current market environment’ highlights the key challenges facing European insurers and how they are adjusting their investment approaches in response. The research interviewed chief investment officers (CIOs) from nearly 30 insurance companies across Europe, representing over €3 trillion in assets under management to obtain its findings. The concerns about the prevalence of regulation and extra risk reporting obligations will have key technology consequences with more integration and use of real-time data crucial responses to the changing, stricter asset management environment.
Over two thirds (68%) identified low interest rates as a key market challenge too, followed by new regulations (58%) and risk management complexity (47%), which both have technology implications. Macroeconomic uncertainty and related financial market volatility were lesser concerns at 26% and 16% respectively, suggesting that insurers may be growing accustomed to operating in the so-called ‘new normal’ low interest rate and highly regulated environment. What does concern insurers, however, is the prospect of continued political intervention in economics, with 30% of insurers citing political intervention as a major challenge, adding that it hinders their ability to make predictions and good investment decisions.
The BCG/AXA IM study found that while there is increasing appetite amongst CIOs to counter the impact of the low yield environment by allocating to alternative sources of return, there has been very limited actual movement towards real diversification of investment portfolios. While the majority of insurers pledge to allocate up to 10% of their portfolios to alternative asset classes, most currently sit at only 2% to 3%.
The study also shows that while most European insurers recognise the need to better manage the volatility of their balance sheets by using hedging strategies, 45% of them still do not currently employ hedging mechanisms, citing the lack of internal know-how, resources and technology infrastructure as the main obstacles. This raises questions around how EU insurers will manage volatility on their balance sheets with the onset of accounting standard IFRS 4 and the Solvency II capital adequacy regime in the coming years.
Outsourcing Not Universally Accepted
Deciding the optimal balance between managing assets in-house and outsourcing remains a live issue for insurers too. At present, fewer than 5% of European insurance assets are outsourced to non-affiliated third-party asset managers, compared with 20% of American insurance assets. Critically, during the interview process, no European CIO mentioned a structural reason for this failure to embrace outsourcing. Interviewees did cite “losing control of investment portfolios” and “less transparency and risk control” as barriers. On the flip side, having access to a partner with the required expertise, whom they can exchange ideas on a variety of topics, was seen as a benefit.
BGC and AXA IM comment that the asset and liability management (ALM) function and associated technology reporting tools continue to play an increasingly important role in insurance companies’ corporate governance structure, given the pressure to deliver on client’s investment objectives and update them and regulators more thorough about portfolios. Seventy-five per cent of large insurers surveyed have been, or are currently in the process of, moving their ALM functions from a business level to a group level. The move is in order to create strong central units that can manage all asset and liability positions across all of their businesses.