Falling Investment Yields and Quest for Alternative Investments August, 2013 BLOG POST
The quest for alternative asset class is different for Life and General Insurers Insurance industry has long been traditionally investing in fixed income products like sovereign and corporate bonds as they offered dependable cash flows over long time frames. But as yields on these products has been going down and have dropped to nothing in current scenario, the insurance industry has been forced to look for alternative forms of assets class and better return on investment (ROI). The quest for alternative asset class is different for Life and General Insurers as the industry is not homogenous. A general insurance company which provides home or car cover is totally different to a life insurer. Both have different limitations and objectives to look for alternative investments. For a life insurer investing in a fixed income products with a long duration is relevant as they can match their long term cash flow by investing in such assets, they know beforehand what it will have to pay out in the long term. On the other hand is a General insurer which must keep a large proportion of its funds in cash so that it can pay out on claims. The investments that it can make must have short-term goals. Need for alternatives in terms of investments is equally important for Life and General insurer, however it seems more challenging for general insurers because they have to have a high degree of liquidity and their investment horizon is so short term.
Yield and Composition of Investments – North America Pre-Tax Yield - Life North America
Pre-Tax Yield - P&C North America
Investment yield for North American Life insurers has come down to 5.1% in 2012 as compare to 5.72% in 2007 after peaking to 6.3% in 2009. P&C insurers witnessed a sharper decline in their investment yield, which plunged to 3.5% in 2012 as compare to 4.8% in 2007.
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Portfolio by Investment Type – Life
Portfolio by Investment Type – P&C
The major proportion of insurance investments by Life as well as P&C insurers in North America is allocated to fixed income securities both available for sale (AFS) and held to maturity (HTM). Between the years 2007 and 2012, insurers have maintained the average share of fixed income assets in the range of 63% to 65%. With over 65% of all investments by insurance companies being in fixed income, the strategy for fixed income is the key driver of capital compliance. Corporate bonds have the largest share of insurance portfolios, making the insurance industry significant to the bond market. Insurers, and specifically life insurers, are the largest single group of bond investors, far ahead of mutual funds, pension funds, hedge funds, banks and retail investors. Paradigm shift by US insurer Insurers in the United States have started moving its portfolio into alternative investments in an effort to improve returns and diversify out of assets that have high correlation to financial markets. Allstate Insurance Group, the large US insurer is investing in real-asset alternatives such as natural resources, infrastructure, property and hedge funds & private equity vehicles, whilst simultaneously reducing exposure to its fixed income investments. The change is strategy is designed to generate superior return on investment and fulfill the company’s long-term targets. This paradigm shift by the insurer mirrors a broad shift by US insurers out of income bearing annuitytype products and into longer term life insurance products. The largest US insurer – MetLife Inc. has recently reduced their sales of variable annuities and other equity-linked retirement products, whilst Sunlife in Canada is halting sales of these types of products in the US altogether. Quest for alternative investment Insurers are forced to look for other asset class and better returns to meet their liabilities as yields on traditional assets such as government bonds near historic lows. Assets such as infrastructure, commercial real estate loans and farmland in particular have been gaining in popularity among US insurers. Exposure to ‘real assets’ is showing popularity with insurers as they offer uncorrelated investment which is less volatile than equities and often does not have the interest rate risk like with fixed income exposure. Falling investment yields and quest for alternative investments
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This is particularly the case with availability-based infrastructure (which offers returns on the basis that the infrastructure is kept available for use) and where the underlying exposure and associated revenues are partly insulated from potential future economic downturns. Farmland has delivered resilient investment returns across economic cycle, is a natural inflation hedge and has delivered consistent returns through all manner of economic cycles, as the charts to the right demonstrate. Commercial real estate loans trade at attractive spreads over cash, are asset-backed and offer investors a more liquid route to gaining property-like exposure than direct commercial property. In the current scenario Banks’ loss seems to be the Insurers’ gain .There are number of assets which not only provide the essential investment characteristics for insurers but are now also more available because banks are less willing to lend. These include property-backed lending, sale and leaseback, ground rents, equity release as well as infrastructure lending. All these assets have similar profile as they are directly lent to corporate or individuals but with a high certainty regarding the cash flow. Commercial mortgage loans have also become particularly popular among insurance companies. US commercial mortgages are particularly attractive for insurance companies because they include a prepayment penalty which gives a guarantee and predictability to cash flows.
“US property/casualty (P/C) insurers invest in alternative and other less traditional asset classes, including hedge funds and private equity investments, in an effort to gain portfolio diversification and enhance investment returns” Fitch Ratings
Source: Federal Insurance Office (FIO), Bloomberg, OECD Journal: Financial Market Trends
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