Standard Life Investments

Inside Global Insurance Investment

Latest trends in insurer asset allocation

The current environment of low/negative bond yields is forcing insurers to revisit their asset allocation strategies.

August 2017

In Europe, many insurers have been so busy implementing Solvency II that they have been unable to prioritise the key strategic asset allocation work needed to optimise the asset side of their balance sheets to generate returns in a risk-efficient manner.

Before they can consider more sophisticated asset allocation strategies, one area where we believe insurer boards and senior management have been seeking improvements is with their internal governance structures. These are vital to help control and manage risk. For example, an effective risk and investment committee structure can ensure appropriate oversight and management of investment risks.

Our recent interactions and discussions with insurers reveal that even the smallest insurers are now moving forward at pace with these improvements. As a consequence, they are now at the stage of designing and implementing greatly improved asset allocation strategies.

Negative government and corporate bond yields in many markets are acting as a catalyst for change. Insurers realise that they will have to move away from traditional insurer asset classes towards solutions-driven classes if they are to generate attractive returns in a risk-managed way.

Optimal investing for insurers

Most insurers have their own internal asset allocation risk-return performance metrics that they will attempt to optimise, with most of these metrics being bespoke and specific to each insurer. At the more sophisticated end of the scale, for example, some insurers will try and maximise the expected yield on the asset, minus the cost of the associated risk capital.

We have found that, in practice, charts like the following fixed-income schematic can be very useful when discussing with insurers their asset allocation objectives (see Chart 1).

Chart 1: Expected portfolio yield per unit of risk

Managing credit in the context of Solvency II

The vertical axis in Chart 1 shows the expected yield on the portfolio, net of the expected cost of defaults, per unit of risk, as measured by Solvency II’s standard Solvency Capital Requirement (SCR). The other two axes show how this expected yield moves with asset duration and credit rating.

Inspection of the surface then allows insurers to identify where they are likely to get most return, per unit of risk and according to their own liability-duration matching and credit-risk appetite objectives.

While relatively simple, we find that tools like this schematic are extremely effective in helping insurers and asset managers discuss, agree and formalise investment goals.  

Recent specific insurer asset allocation examples

Some areas of particular interest at present include:

  • designing Solvency II-optimised investment grade corporate bond portfolios to replace sovereign bond portfolios, to enhance yields in a Solvency II capital-efficient manner
  • using derivative overlay strategies to reduce the capital requirements of equity portfolios, thereby allowing insurers to de-risk without divesting from the equity portfolio.

In recent months, we have seen an upsurge of interest in insurer asset allocation projects and optimisation work. It seems likely this interest will only keep growing.

Dr Bruce T. Porteous
FFA, FIAI
Investment Director
Insurance Solutions