Risks are not off the table at European insurers

BY JORGE GROEN

COVID-19 has been a serious stress test for financial markets, but also for insurers’ balance sheets and capital ratios. The risks are not yet off the table, warns Alexander Duckwitz, Insurance Advisory EMEA and ‘risklab’ at Allianz Global Investors.

The year 2019 turned out better than expected for insurers’ investment portfolios. Although interest rates fell, other segments of financial markets did well. But in March 2020, with the Covid19 crisis, a perfect storm occurred for insurers’ investments. Between late 2018 and the first quarter of 2020, Allianz Global Investors considered the model portfolios of nonlife and life insurers, which largely consist of sovereign debt and credits. Due to the strong volatility in financial markets in March, they showed a significant decline in value in the first quarter of 2020. This also ended the positive value development that had started in late 2018.

‘Due to the flattening of the yield curve, the value of future obligations increased by 15% to 20% on average compared to late 2018 – especially in life insurers’ investment portfolios,’ says Alexander Duckwitz, who is responsible for Insurance Advisory EMEA and ‘risklab’, the department for ALM1 studies and portfolio studies at Allianz Global Investors.

According to Solvency II rules, a lot of capital should be held for life insurances with longterm guarantees. Combined with the sharp downturn in financial markets, this has significantly impacted Own Fund levels. Duckwitz expects that life insurers with a significant duration gap between assets and liabilities will be hit hardest.

Absorbing short-term market stress

Duckwitz points to the robustness of the Solvency II rules, which have led many European insurers to be rather resilient. ‘A positive side effect of Solvency II was that shortterm market stress could be absorbed, enabling insurers to keep focusing on the long term. The framework prevented them from having to reduce risks all at once and make unwise decisions at a fairly inconvenient time. The European umbrella organization of pension fund and insurer supervisors, EIOPA, has also taken measures to mitigate the effects of the crisis. For example, the timetable for the revision of Solvency II 2020 has been rescheduled, probably aiming for the end of this year. IFRS17 has been postponed, too.’

Amidst a falling interest rate late last year and the strong volatility in March due to the coronavirus outbreak, Allianz Global Investors’ optimized portfolios for nonlife and life insurers maintained a much steadier pace than the market. Sound risk management and dynamic realtime matching of obligations weakened extreme market movements.

Risks are not off the table

For insurers, the landscape looks substantially different than late last year due to Covid19. Budget deficits and central bank balance sheets will rise, which means that limiting the interest rate risk seems to be the

A positive side effect of Solvency II was that short-term market stress could be absorbed, enabling insurers to keep focusing on the long term.

Most major insurers have passed the corona stress test, but the risks are still high, and they are not off the table.

wisest decision. For the time being, there is no prospect of a higher interest rate, and whether there will be deflation or inflation strongly depends on the actions central banks will take.

The question is how fragile the recovery of the financial markets will be. Most major insurers have passed the corona stress test, but the risks are still high, and they are not off the table, warns Duckwitz.

’The health threat is clear and seems to be under control, especially in Western countries. But the same doesn’t apply to the effects of social distancing and the time it takes for the economy to recover.’

He highlights four risks for financial markets for the coming period. A flattening of the yield curve due to aggressive monetary stimulus. The fact that the interest rate will stay low for the time being puts further pressure on insurers’ balance sheets. Then there’s the risk of writedowns and bankruptcies, whose first effects, he believes, will be seen in the second half of the year.

There is an opportunity in every crisis

There is an opportunity in every crisis, says Duckwitz. The same goes for investing in the new reality. Infrastructure debt, subsovereign debt and mortgages have a positive impact on the ALM position, provide additional returns, and decrease interest rate sensitivity. ‘This is also a good time for bank loans. When

Figure 1: Evolution of insurance assets valuation since 2018

Source: AllianzGI Insurance allocation monitor as of end of April 2020, EIOPA RFR curves, simplified methodology for illustrative purpose only

seeking a solution to the crisis, governments consider banks as a critical infrastructure. Nobody wants to deal with a financial crisis on top of the current crisis. In stock markets, there is a lot of disparity, and dividends are under pressure. That is the ‘ideal’ environment for active management.’

Lastly, Duckwitz is quite taken with alternative investments – especially in private markets – to decrease the interest rate sensitivity of investment portfolios and better align cash flows, among other things.

When governments start up their economies after the pandemic, many projects and transactions will likely become available to longterm

Our outlook for alternatives is positive. Insurers can benefit from potentially higher returns and lower volatility.

investors. ’Our outlook for alternatives is positive. Insurers can benefit from potentially higher returns and lower volatility. But selectivity is the key.’ «

1 ALM: Asset liability management.

Contact

For further information contact Tim.soetens@allianzgi.com or Sjoerd.Angenent@allianzgi.com

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