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QE conundrum fuels dramatic rise in insurers’ risk appetite, says BlackRock study

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Accommodative central bank policy is causing global insurance firms to take on more investment risk to protect profit margins, a new BlackRock-commissioned study of insurers representing over USD6.5 trillion of assets has found.

Against a backdrop of loose central bank policy, depressed bond yields, and stuttering economic growth, BlackRock’s research, conducted by the Economist Intelligence Unit, found that quantitative easing’s (QE) impact on asset prices has caused insurers’ risk appetite to nearly double, with 57 per cent planning to increase risk exposure over the next 12-24 months, compared to 33 per cent a year ago.
 
Patrick M Liedtke (pictured) head of BlackRock’s insurance asset management business in Europe, says, “Insurance companies operate in an extremely challenging investment environment. QE has driven insurers to take on significantly more risk than in previous years, and central bank policy divergence is a looming challenge to their businesses.”
 
Insurers are weighing the short-term benefits QE and monetary policy have had on asset prices and economic growth, with the long-term market imbalances these policies could potentially create. 49 per cent have made significant changes to their investment strategy in response to QE and monetary policy, while a further 43 per cent intend to make changes over the next 12-24 months. 83 per cent of global insurers expect QE and ongoing monetary policy to support price levels in the next two years.
 
However, many also worry that QE and monetary policy have the potential to create imbalances in markets that negatively impact the economy, as well as create an unsustainable environment for the insurance industry. The persistently low interest rate environment is viewed as the main market risk (44 per cent), followed by a sharp rise in interest rates (36 per cent) and asset price correction (33 per cent).
 
As a result, and in order to create more room for tactical manoeuvres in the future, nearly half (47 per cent) of respondents expect to increase cash holdings over the next 12-24 months. More than one-third (36 per cent) plan to increase cash holdings more generally. Importantly, this includes nearly half (45 per cent) of those looking to increase their risk exposure.
 
Liedtke adds: “The macroprudential picture is causing a lot of people to have one foot on the says and one foot on the brakes at the same time, which unsurprisingly makes driving the balance sheet difficult.”
 
Some 82 per cent plan to increase holdings in one or more income-generating alternative credit asset classes like commercial real estate debt, direct lending to SMEs, and direct commercial mortgage lending – domains traditionally dominated by banks.
 
This is significant as insurers have traditionally been heavily invested in investment grade government and corporate debt securities. As traditional bank lenders have pulled back from the lending market in recent years, BlackRock’s survey suggests insurers have – at least partly – picked up this slack, lending to commercial real estate development and to small and medium enterprises (SMEs).
 
“Insurers are turning to a broader range of assets, particularly income-generating alternative credit investments such as direct lending, in order to diversify returns and boost income. But it isn’t easy as these markets often aren’t their natural habitat, and there are barriers to being successful here,” adds Liedtke.
 
Regulatory change is highlighted as the most critical driver of industry change in the insurance industry in the next 12-24 months, with 49 per cent citing this.
 
Stricter capital requirements under Solvency II which take effect on January 1st 2016 are pushing European and global insurers – particularly those with lower solvency ratios – to increase holdings of investment grade fixed income and diversify under tighter risk budgets. Surprisingly, and contrasting with the trend towards alternatives, the number of respondents looking to increase their holdings of investment grade fixed income assets has nearly doubled to 45 per cent, from 24 per cent a year ago.
 
Liedtke stated, “If you don’t get Solvency II right, you won’t attract capital to your business. Those with higher solvency ratios can branch out further and invest in higher returning strategies which carry higher capital charges with them. But for those with lower solvency ratios, this is becoming more difficult as monetary policy, strong demand for quality paper, and financial regulatory reform have contributed to reduced dealer inventories and lower bond turnover, pressuring fixed income liquidity.”
 
More than two-thirds (68 per cent) of insurers say a lack of liquidity is making it difficult to access fixed income investments and roughly three quarters (73 per cent) believe that liquidity is lower than pre-financial crisis levels. As a result, the majority of insurers are planning to increase use of derivatives (69 per cent) and exchange-traded funds (67 per cent), citing a lack of liquidity in investment grade fixed income as a key driver of this.
 
Liedtke says: “The mix of divergent central bank policy, bond market liquidity risk, and a heightened regulatory regime, presents the industry with a dilemma. Opportunities exist to protect balance sheet health and maintain challenged business lines, but investors need to quickly get familiar with diversifying portfolios into higher-risk, higher-yield assets, and also closely manage the risks inherent in these new areas.”

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