Insurers Turn to Swaps, Futures, and Options in Risk Management Push

(September 25, 2013) — Managing investment risk has risen up the agenda for insurance CIOs, with 90% of them saying they have increased their investment in risk management.

Research from BlackRock found around 66% of the 200 insurers quizzed planned to use interest rate options for risk management purposes over the next three years, and 42% planned to use equity options.

Another 35% planned to use swaps and equity futures, while 20% were also looking at foreign exchange futures.

David Lomas, global head of BlackRock’s insurance business, said: “Risk management is clearly an area where insurers are strengthening to handle market volatility and a more diverse set of products.

“This increased focus on risk is giving them the confidence to grow their businesses organically and innovate with new products.”

There was also a significant number of insurers interested in doing more tactical asset allocation and increasing their exposure to beta.

As part of that decision, 83% of insurers said they wanted to increase their ETF use over the next three years, but 70% admitted they needed to know more about how to use them as part of an investment strategy.

“Most insurers have used ETFs before, but the ways they are using ETFS are changing, and adoption is accelerating,” said Raman Suri, head of iShares insurance.

“Constructing diversified bond portfolios is time-consuming and costly, given low inventory and liquidity levels. This is prompting insurers to seek new solutions.”

Recent regulatory changes—such as allowing designated ETFs which receive favourable financial statement and risk-based capital treatment in the US and product innovation—are also driving the change.

Asset allocation strategies are also going through a period of significant change, due to the low-yield environment—insurers are being encouraged to increase investment in alternative asset classes.

Around half of the insurers questioned said they were likely to ramp up their allocations to real estate equity and debt, infrastructure equity and debt, hedge funds, and private equity in response to fixed income supply constraints and the hunt for yield.

In addition, 75% of EMEA insurers, 60% of North American insurers, and 82% of Asia Pacific insurers agreed that they were likely or very likely to make higher allocations to investments in the emerging markets.

The research, compiled in partnership with the Economist Intelligence Unit, also found insurers are planning to shorten durations and move away from benchmarks in preparation of quantitative easing (QE) ending.

Around 70% of Asia Pacific based insurers, and just over half of US and EMEA based insurers, were planning to shorten duration.

The decision has been driven by the future unwinding of QE and the fact that shorter duration bonds tend to become more popular during periods of market volatility.

The full report can be read here.